This Technical Note has been prepared by Kelly Eckhold, IMF. The guidance of Carlos de Barros Serrao from the IMF is gratefully acknowledged although all errors are my own.
Historically, the interbank CDI market was an important component of bank funding costs and hence the CDI rate was a natural benchmark for the market to use.
Kang and Saborowski (2015) note that Brazilian law (Decree-Law No. 857) states that every contract, security, document or obligation, in order to be fulfilled in Brazil, cannot stipulate payment in gold or foreign currency, or, in any form, restrict or refuse fulfillment in the Brazilian currency. The exceptions to that law are: currency exchange operations, import/export contracts, export financing (when a Brazilian bank buys, paying in Reals, in advance, the amount of foreign currency to be received by an exporter in an export operation) or loans or any obligations in which the creditor or debtor is domiciled outside Brazil.
The literature well documents the importance of the futures market as the center of price discovery in Brazil—see for example Garcia, Madeiros and Santos (2015) “Price Discovery in Brazilian FX Markets” Brazilian Review of Econometrics, v. 35, no 1, pp. 65–94 May 2015.
The standing lending and deposit facilities have a two-day maturity so any transactions at these facilities do not enter into the overnight SELIC benchmark calculation. Intraday liquidity is available secured on government securities and is free intraday and rolled over at 100 basis points over SELIC if still outstanding at the end of the day. The BCB only accepts Brazilian government securities as collateral in its normal operations. The BCB determines its collateral haircuts considering the volatility of government securities prices and the maturity of collateral and transmits these haircuts daily to market participants.
Reserve requirements are partly remunerated depending on the nature of the liability. Required reserves on demand deposits are not remunerated whereas required reserves on time deposits and savings deposits are remunerated at the SELIC rate and savings deposits interest rates respectively.
Article 9 of draft Senate Law 314/2017 of Senator Ricardo Ferraco.
The proposed new 4 percent minimum threshold is an effective increase in the existing minimum threshold of 20 billion Reals.
See Kang and Saborowski (2015) “Assessment of Foreign Exchange Intervention”, Selected Issues in IMF Country Report 15/122, March 2015, for a thorough discussion of the BCB’s intervention approach up until 2015 https://www.imf.org/external/pubs/ft/scr/2015/cr15122.pdf
The list of entities eligible to participate in BCB spot FX intervention operations is available at http://www4.bcb.gov.br/pec/dealers/principal.asp
Repo lines of credit are often offered at the end of the calendar year when foreign firms operating in Brazil remit profits to their parents offshore resulting in increased demand for FX. Year-end US dollar funding pressures are generally high globally making it difficult for Brazilian banks to fund these FX needs cost effectively. The BCB’s lines of credit help meet these FX needs and are generally repaid a few months later when commodities revenues are received by the banking system.
See Figure 7 in Kang and Saborowski (2015) for a discussion of these data and related charts.
Traded volumes are available at www.bcb.gov.br/pec/Indeco/Ingl/indecoi.asp. FX Swap auction results are available at http://www.bcb.gov.br/htms/selic/selicedital.asp?idpai=SELICOFERTA. The BCB’s International Reserves and Foreign Currency Template is available at http://www.bcb.gov.br/ingles/economic/seriehistqsriliq-i.asp.
The BCB selects 13 banks to participate in spot FX auctions but a larger set of counterparts including banks, financial institutions and non-residents can participate in Brazilian FX Swap operations (financial institutions registered in the Oferta Publica system).
While this approach reduces refinancing risk through lengthening the average maturity of government bonds, the MOF remains exposed to interest rate risk given inflation linked and floating rate bonds are not issued at fixed rates.
The BCB is authorized to also operate in the government bond market but does not do so in practice.
The volume of securities lent is determined through the Central Bank Circular Letter 3,336, of 2008.
The BCB believes that some of the liquidity of banks might be potentially available for investment in deposits as opposed to repo operations but there is uncertainty regarding the amount. Discussions with banks confirmed that banks have some capacity to invest in very short-term deposits (for example overnight or less than one week) – although the total volume might relatively small. Reduced reserve requirements could increase banks’ capacity to invest in term deposits.
The BCB’s repo operations currently focus on the 45 day to 6 month maturities—hence BCB bills would substitute for repo operations already occurring in this area of the curve thus limiting any impact on the government bond market relative to the status quo.
The BCB’s 3 and 6-month repo operations work differently as in these cases the BCB determines the total volume offered and the maximum amount of each bond banks can bid for as collateral. Allocation occurs using Dutch (single price) auctions.
The authorities have some concern that, by moving to fixed volume, variable rate auctions that some downward pressure on, as well as volatility in, the SELIC rate may emerge. The mission did not share the same concern because the market is clearing at the current SELIC rate, indicating a balance of supply with demand for funds. A greater concern is that the existing allocation system may not be robust to changes in the structural liquidity situation as the price of liquidity is not directly tied to the quantity of liquidity sterilized. The result would be an inability of the market to clear and reduced relevance of the SELIC rate as an indicator of liquidity conditions. Fixed rate-full allotment operations would be another alternative for short-term repo auctions if unacceptable volatility in SELIC did arise.
The authorities note that the current approach is useful as it helps minimize income mismatches between income earned on its bond portfolio and interest paid on the TSA. The mission acknowledges that this approach has been useful but thinks that looking forward, given the changes in distribution arrangements and the potential use of term deposits for sterilization, the existing model may be less useful.
The BCB notes that spot markets are more important drivers of liquidity in derivative markets in countries where most FX trading occurs OTC – which is very common globally. The BCB notes that in Brazil, exchange trading is much more important – hence they see spot market activity as being less relevant in the Brazilian context.
On May 18, 2017, turnover in the spot market increased by around 30 percent as some activity moved from the unavailable derivatives market to the spot market.
13 banks are eligible to participate in the BCB’s FX spot market intervention auctions while a larger group of 189 financial institutions can trade in deliverable instruments such as spot FX including banks, brokers and money changers. The current list of financial institutions is available at http://www.bcb.gov.br/rex/IAMC/Port/Instituicoes/inst_autorizadas.asp
See BIS (2016) “Derivatives markets in Brazil” https://www.bis.org/publ/qtrpdf/r_qt1612x.htm, IMF (2015) https://www.imf.org/external/pubs/ft/scr/2015/cr15122.pdf and Garcia, Medieros and Santos (2015) http://www.economia.puc-rio.br/mgarcia/Pricediscovery.pdf for discussions on the relevance of regulatory constraints in shaping the FX markets in Brazil. Itau (2017) provides details on rules applying to the use of spot transactions in Brazil including that Mutual funds so not have authorization to trade spot FX – see https://www.itau.com.br/_arquivosestaticos/itauBBA/contents/common/docs/Handbook_FirstEdition_20170717_.pdf.
The BCB notes that, if spot FX turnover occurring within the country only is considered, then Brazil fares better in comparisons with Turkey and South Africa as relatively more activity occurs in Brazil.
See IMF (2012) http://www.imf.org/external/np/pp/eng/2012/111412.pdf for the Fund’s “Institutional View”.
The authorities approach to managing volatility in May 2017 is discussed in more detail in chapter 2 of the BCB October 2017 Financial Stability Report, http://www.bcb.gov.br/ingles/estabilidade/2017_10/fsrContents.pdf pages 38–43.
See King et al (2017) for a discussion on the conduct of Central Bank operations to support securities markets at https://www.imf.org/en/Publications/WP/Issues/2017/07/10/Central-Bank-Emergency-Support-to-Securities-Markets-45012.
The BCB believes the spot FX market is adequately developed at present.