A number of economies in transition have instituted central bank credit auctions as part of a package of reforms seeking to improve monetary control and foster money market development. This paper examines the use of those auctions and features of their design, including collateralization and access rules intended to minimize adverse selection and moral hazard. The implementation of credit auctions in Eastern Europe and the countries of the former Soviet Union is surveyed. The experiences of countries in Eastern Europe suggest that credit auctions can be a useful tool in the transition toward indirect monetary control and the development of interbank markets.

Abstract

A number of economies in transition have instituted central bank credit auctions as part of a package of reforms seeking to improve monetary control and foster money market development. This paper examines the use of those auctions and features of their design, including collateralization and access rules intended to minimize adverse selection and moral hazard. The implementation of credit auctions in Eastern Europe and the countries of the former Soviet Union is surveyed. The experiences of countries in Eastern Europe suggest that credit auctions can be a useful tool in the transition toward indirect monetary control and the development of interbank markets.

Auctions or tenders are used as means of allocating portions of central bank credit in many industrial and developing countries.1 In these countries, credit auctions are used in combination with other monetary policy instruments, including other central bank credit facilities, to manage bank liquidity or short-term interest rates. In a number of economies in transition from centrally planned to market-based systems, the central banks have begun to use credit auctions as part of broader packages of reforms to foster market-based monetary operations, promote money markets, and improve monetary control. However, while the monetary operations of central banks in market economies are supported by well-functioning interbank markets, adequate risk management, including the use of collateral, and effective banking supervision, these factors may be insufficiently developed in economies in transition.

This paper discusses ways in which credit auctions can be designed to reduce the negative impact of these deficiencies, and presents the experiences of some countries in transition that have implemented credit auctions as one of their monetary policy instruments. It takes as its starting point the present-day realities of many economies in transition: economic and financial activity cannot be put on hold until enterprise restructuring is completed, commercial banks form the core of the financial system, and these banks are heavily dependent on central bank credit.2 This dependence stems from the concentration of household deposits in the savings banks and of credits with the specialized commercial banks inherited from the monobank era; low rates of deposit mobilization; and underdevelopment of interbank markets. These structural factors resulted in a need for central bank intermediation between banks and for extensive central bank financing of bank lending during the initial stages of transition (Sundararajan (1991)). In many economies in transition, the authorities have reduced the structural dependence on central bank credit over time.3 Nevertheless, policymakers are still faced with the challenge of designing central bank credit facilities that can ensure monetary control and at the same time foster a smooth transition toward market-based indirect instruments.

I. Credit Auctions as an Alternative to Administrative Allocation

In most planned economies, credit was allocated administratively to specific sectors or borrowers at preannounced interest rates. The main disadvantages of this approach are that the use of directed credit is prone to misuse and abuse, the pricing of credit may be inefficient, and administrative allocation procedures tend to favor the state-owned sector and do not lay a foundation for more market-oriented financial systems. An auction-based allocation system can allocate credit transparently, based on objective criteria. In the absence of distortions, auction-based allocation mechanisms function efficiently: that is, they assure that resources accrue to those that value them most highly and where they will be most productive (Feldman and Mehra (1993)). Furthermore, an auction-based system introduces market interactions and price flexibility, which can form a basis for further financial sector development.

When no restrictions are placed on the use of auctioned credit and on the interest rate in the auction, and banks act rationally to maximize profits, it would be expected that central bank credit will flow to banks that can make the best use of the available resources. Since the end use of funds will be determined by the commercial banks, the government will no longer be presumed to guarantee banks’ loans, and banks will be forced to develop their credit analysis capabilities. State-owned enterprises will be forced to compete with other bank customers in terms of both price (loan interest and expected project rate of return) and quality (reliability of returns).4

Furthermore, credit auctions can be an important component of the package of measures needed to liberalize and manage interest rates and improve monetary control in economies in transition.5 Regularly scheduled auctions introduce a market-based reference lending rate that can influence and guide the market as well as other central bank operations. Moreover, the central bank can control the volume of credit auctioned, taking into account other factors affecting bank reserves, and thereby influence either the level of bank reserves or the interest rate in the auction and in the interbank market.6

By introducing a flexible-price market in bank liquidity, auctions contribute to the development of the interbank money market, and thereby pave the way for strengthening indirect instruments and phasing out any direct controls on credit and interest rates. Early introduction of credit auctions allows the central bank to gain experience in market-based monetary control and, as money markets develop, sets the stage for more sophisticated open market operations. As banks learn to assess liquidity conditions and price credit through participation in the auction, they will become more active in managing their reserve positions, thereby stimulating money market dealing. Furthermore, imposing uniform and transparent access to credit will force banks that have historically been supplied by directed central bank credit to look at other sources, including the interbank market.

However, some of the assumptions underlying the expected efficiency of an auction-based system may not apply in economies in transition. Possible impediments to the use of uncollateralized credit auctions in these economies involve deficiencies in incentives and information, which can increase the credit risk to the central bank and compromise the allocational efficiency of the auction mechanism. Credit risk may result from adverse selection—the tendency to attract banks willing to offer the highest bids but bearing the highest risks; and from moral hazard—the inability of the central bank to influence or monitor how the borrowing bank uses the funds. Collusion among auction participants or market dominance by a few large banks might also affect the efficiency of credit allocation.7 These problems could be more significant in economies in transition, where some banks may be insolvent, the banking system as a whole may not be competitive, banks’ accounting and reporting are insufficiently developed, and banks’ weak portfolios induce an inelastic demand for central bank credit, than in countries that use collateralized credit auctions in the context of well-developed banking systems and financial markets.8

Thus there are potential advantages and disadvantages to using an auction mechanism for the allocation of credit in economies in transition. The next section will discuss how auctions can be designed to minimize the problems of adverse selection, moral hazard, and collusion.

II. Design of Auctions to Control Credit Risk

Adverse selection and moral hazard may be addressed by requiring adequate collateral, formulating appropriate access rules for the auction, and setting limits on the volume of central bank credit that each bank is allowed to borrow.9 Ideally, central bank lending should be collateralized by government securities or other high-quality paper, but in economics in transition, banks’ securities holdings are often negligible, particularly in the early stages of reform. In these circumstances, the collateral requirement can be introduced only gradually. Since a program to develop treasury bills and other securities is typically part of the transition strategy, some requirement of collateral is feasible and desirable even if it covers less than 100 percent of the loan. In addition, the range of admissible collateral can be broadened to include such assets as foreign exchange and bankers’ acceptances,10 As the volume of treasury bills and government securities in the market increases, the rate of collateralization can be increased, gradually transforming the uncollateralized credit auctions into a repurchase auction.11

Rules of access are particularly important in the absence of adequate collateral. They must be uniform and transparent, and should include compliance with all mandatory prudential ratios, including foreign exchange exposure limits; compliance with reserve requirements; satisfactory repayment record for previous credits; compliance with reporting requirements; and satisfactory performance in clearing and settling payments. Even under uniform and transparent access rules, present uncertainties underlying the computation of prudential ratios may temporarily limit the effectiveness of these ratios in screening banks. In addition to access rules, credit limits as a ratio (or multiple) of each bank’s deposits could be set. This would encourage banks to compete for deposit resources in the market. However, there is a trade-off between regulation and competition. The need to limit central bank credit risk must be balanced against the need to ensure fairly wide access by banks so as to permit adequate competition at the auction.

In many countries the auctioneer retains the right to screen bids and reject any that are deemed inappropriate. However, the option to reject a bid must be exercised judiciously so as not to diminish confidence in the fairness of the auction or interfere with the price discovery function of the auction. Frequently, central banks set a minimum auction rate to increase monetary control, discourage recourse to central bank lending, or coordinate the auction with other central bank facilities. Setting a floor interest rate could also prevent banks from colluding to bid a low interest rate. However, announcing the minimum rate in advance provides a focal point for collusive bidding. Even if the minimum rate is not announced, participants may guess the level and their bids may cluster around the assumed minimum rate. Although this outcome may appear to demonstrate collusive behavior, widespread bidding at the minimum rate may also indicate that there is excess liquidity at the floor price.

While the best insurance against collusion and uncompetitive behavior is a dynamic and competitive banking sector, some auction procedures may reduce the likelihood that collusive arrangements can be sustained. These include using sealed bids rather than an open outcry mechanism; awarding credit at a uniform price; limiting the postauction sharing of information with bidders; and limiting the share of total volume offered for which any one bank may bid (see Feldman and Mehra (1993) and Guasch and Glaessner (1993)).

Ultimately, the design of an auction cannot ensure against all risks, from both the credit risk and monetary control perspectives. Credit auctions are typically initiated on a small scale, allowing central banks to gain experience in monitoring borrower behavior in conditions of limited total risk. In any event, the likely alternative, administratively allocated credit, cannot control for these risks either. Economies in transition have long records of nonrepayment of directed credit. Administered allocation of credit led to outstanding loans being serviced through additional directed credit, a form of adverse selection in that the borrowers were those who could not repay previous loans. In the early stages of transition, assets in the portfolios of the newly created commercial banks were largely loans carried over from the previous systems of administrative allocation; of these assets, nonperforming loans were estimated at 15–20 percent in Czechoslovakia and Hungary, 20–30 percent of assets in Poland, and 40 percent in Bulgaria (Calvo and Kumar (1993)). Clearly, credit risk is significant under administrative allocation. Furthermore, the potential for collusion between enterprises, banks, and officials may be worse under a system that explicitly allows discretionary allocation than under a rules-based auction.

III. Experience with Credit Auctions in Economies in Transition

Credit auctions have been used both in Eastern Europe and in the countries of the former Soviet Union. The following discussion surveys the use of this monetary instrument in these countries, highlighting its role in paving the way for the development of interbank markets and more refined open market operations.

Eastern Europe

The central banks of Bulgaria, the Czech and Slovak Republics. Hungary, Macedonia, Poland, and Romania have used credit auctions both as a means to extend structural credit and as an instrument of monetary control (see Table 1). For example, the Bulgarian National Bank (BNB) auctioned one-month interbank deposits to inject and redistribute liquidity in the system. The liquidity need arose in part because of a lack of collateral that could be used to borrow from the Lombard facility; the redistribution need stemmed from underdevelopment of the interbank market and the commercial banks’ lack of a deposit base (Mladenov (1992)). The auction allowed the BNB to replace some refinance credit with a competitive funding instrument, and enabled banks to become familiar with auction procedures and interbank trading of deposits (see Filipov (1992)). The National Bank of Macedonia (NBMa) also structured its refinancing auction to redistribute excess deposits among commercial banks.12

Table 1.

Credit Auctions in Selected Eastern European Countries

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Note: The information in this table was compiled in May/June, 1994.Sources: Central bank bulletins: and IMF staff.

Most Eastern European countries have continued to allocate credit according to objective or administrative planning criteria in parallel with their credit auctions, sometimes to the detriment of the auction. The National Bank of Hungary (NBH) began in 1991 to offer some refinancing loans at regularly held auctions. Over the next few years, an increased proportion of short-term refinancing loans was awarded through auctions, replacing allocation based on banks’ capital. However, long-term refinancing loans continued to be allocated for priority projects (Balassa (1992)). The National Bank of Romania (NBR) began to auction some of its credit to banks in January 1992. In the latter half of 1992, government directives resulted in a shift of NBR lending to direct allocation of subsidized credits (for on-lending to the agricultural sector) and the auction became inoperative. In July 1993, government deposits were shifted to the NBR to force banks to resort to the NBR for liquidity, and the auction of short-term NBR credit was reactivated in September 1993.

Auctioned credit has been used as a monetary control instrument both through direct liquidity effects and through interest rate transmission mechanisms. For example, the use of auction credit allows the NBR to retain short-term control over a significant portion of bank liquidity, and to effect a tightening or loosening of its policy stance on a week-by-week basis. In a number of countries, Lombard and other central bank rates have been pegged to the refinance auction rate. The State Bank of Czechoslovakia (SBCS) linked the rate on its daily refinance facility (1-to 7-day maturity, allocated on the basis of bank capital) to the auction rate in 1992. By the end of that year, the SBCS had phased out refinancing credit offered at the discount rate and made auctions of refinancing credit the primary indirect instrument of monetary control. The National Bank of Slovakia (NBS) reintroduced lending at the discount rate: credit auctions were dormant for a period, but by mid-1994 auctioned credit accounted for about 40 percent of NBS refinance. Since late 1993, the NBS has linked the discount and Lombard rates to the refinance auction rate. Interest rates on NBS auction credit have generally been below the Lombard rate and above the treasury bill rate, while interbank rates have hovered around the auction rate. The NBH used to set its minimum rate for the uncollateralized auction above the interbank rate to encourage banks to participate in the interbank market; from 1993 the repurchase rate has been a key determinant of interbank rates (National Bank of Hungary, 11–12/1993).

Interest rates on loans and deposits have tended to track the auction rate in most countries. The behavior of interest rates has not suggested that the auctions have attracted banks willing to pay any price with the expectation (or intent) of defaulting. Interest rates in the credit auctions have been responsive to changes in volumes auctioned and general liquidity conditions. For example, Romanian commercial banks have responded in the expected direction to central bank signals conveyed via the minimum acceptable bid rate (set by the NBR) or the auction volume. In December 1993 the volume was cut for one week, resulting in a jump in the average interest rate. The NBR raised its floor rate prior to the next auction, and banks raised their lending and deposit rates.13

In general, banks are required to be in compliance with prudential and reserve regulations (to the extent that the central bank is capable of monitoring) to participate in auctions.14 In addition, some countries have introduced restrictions to widen participation and encourage competition in the auction or to prevent excessive credit risk exposure to particular banks (Macedonia, Romania, and Slovak Republic).

There has been a trend toward increasing collateralization of bank borrowing from the central banks. The CNB has raised the level of collateral required for auctioned credit to 40 percent; at the same time, banks holding bills of exchange have access to a rediscount facility at a rate generally below the rate of auctioned credit. As collateralization of credit auctions moves toward 100 percent, the auction will become a repurchase facility. The BNB has not required collateral for the credit auction, but the increased availability of suitable collateral has reduced the need for credit auctions and increased usage of Lombard and discount operations at the BNB. Moreover, the BNB began using repurchase agreements in 1993, and during 1994 relied increasingly on this instrument, winding down the uncollateralized credit auction. Poland is an unusual case in that the National Bank of Poland moved directly to repurchase agreements soon after the introduction of treasury bills; thus the auction facility was fully collateralized from the start.

Uncollateralized credit auctions have diminished in importance as interbank markets have developed and commercial bank dependence on central bank credit declined. The Bulgarian auction’s initial structural importance in intermediating between the State Savings Bank and other banks with less developed deposit-taking networks diminished as the interbank market developed. This, together with the introduction of treasury-bill-based open market operations for monetary control, allowed the outstanding volume of auctioned credit to be reduced from the equivalent of 17 percent of broad money at end-1991 to 1 percent at end-1993. At the same time, outstanding central bank credit to banks relative to domestic credit to the private sector declined from 21 percent to 9 percent. As the interbank market and other monetary operations developed in Hungary, commercial bank dependence on NBH credit declined from over 40 percent at end-1991 to 30 percent in 1992, and the auction became unattractive, in part due to the high minimum bid rate. The Czech refinance auction now mainly serves smaller banks that lack sufficient rediscountable collateral and that do not have access to the interbank market. Czech interbank rates have at times been well below the auction rate, possibly indicating adverse selection in the auction.

The developments in the countries surveyed suggest that as the financial sector develops, in the absence of adjustments in auction design the riskiness of the credit auction may increase, since the worthiest counterparties will seek financing in the interbank market. The central bank may in fact be assuming the intermediation credit risk that the market refuses to bear; while this may be justified in the early stages of market development, it is not a sustainable position. A decline in participation in the auction coupled with significantly higher interest rates in the auction than in the interbank market may signal a need to review the purpose and structure of the auction.15

The trends in Eastern Europe also suggest that certain aspects of credit auctions can diminish in importance as the banking system develops. While in some countries the auction may continue to fulfill a structural function in that it redirects some amount of credit toward banks that do not have the collateral necessary to participate in the other facilities and are not considered appropriate counterparties for interbank lending, in countries where conditions have improved the focus of the auction has moved to short-term monetary control. The trend toward increased collateralization of borrowing from the central bank and increased recourse to interbank markets indicates that the use of an auction allocation mechanism is indeed in conformance with, and probably has helped foster, the development of these features of market-based financial systems.

At the same time, it should be noted that credit auctions have often been used side by side with direct instruments of monetary control; for example, even though Poland instituted a repurchase facility in 1991, bank-specific credit ceilings were only removed in 1993.16 A credit auction should be implemented as part of a carefully designed financial program. The case of Romania, where government-dictated credit allocations superseded auctions and led to monetary control problems, highlights the fact that commitment to the overall financial program matters more than the design of any one instrument. The early implementation of market-based institutions can support, but is not a substitute for, consistent and well-formulated macroeconomic policies; even well-designed monetary instruments will not prevent the loss of monetary control if political commitment to appropriate policies is absent.17

Countries of the Former Soviet Union and Baltic Countries

Countries of the former Soviet Union have, in general, more fragile banking systems than those in Eastern Europe. Thus, the ex ante concern for moral hazard and loss of monetary control is greater. Nevertheless, in recent years, many countries of the former Soviet Union, including Kazakhstan, the Kyrgyz Republic, Moldova, and Russia, have relied partially on central bank credit auctions to allocate credit and to determine interest rates (see Table 2). Particular attention has been paid to elements of auction design, including collateralization, limits on participation, and the use of sealed bids.

Table 2.

Credit Auctions in Selected Baltic Countries and Countries of the Former Soviet Union

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Note: The information in this table was compiled in May/June 1994.Source: IMF staff.

The introduction of credit auctions for monetary management is intended to be associated with a phased reduction in directed credits and in the structural dependence on central bank credit. Although the amounts auctioned have been relatively small (generally below 20 percent of the flow of credits), there has been a gradual increase in the use of the auction mechanism in some countries. For example, in Kazakhstan, about 39 percent of the flow of credits in March 1994 was auctioned; in Moldova, this ratio reached over 80 percent in May 1994.

The auction mechanism has provided some flexibility in the implementation of monetary policy in the Baltic countries and the countries of the former Soviet Union. In Lithuania, the auction facility was activated at a critical time to provide liquidity at a penalty rate to banks with reserve deficiencies.18 Given the volume of directed credit dictated by the Government in the Kyrgyz Republic, the net domestic assets target of the central bank was achieved by reducing the amount of auctioned credit. However, in some countries, such as Armenia, there has been limited room to implement an auction facility owing to the excess liquidity in the banking system. Maturities of auctioned credits in the countries of the former Soviet Union tend to be about three months, which is relatively long for monetary control purposes but is shorter than directed credit had been. This reduction in maturity of central bank credit should increase monetary control and interest rate flexibility.

In a few cases, auction rules have been circumvented to provide additional auctioned central bank credit to a specific sector or bank. For instance, the National Bank of Georgia has often waived its own access rules with regard to large state-owned banks. The Bank of Lithuania has deviated at times from its own limits on access in order to provide additional credit to the agricultural sector. These procedures reduce transparency at the auction by mixing monetary and directed credit objectives; it would be preferable to use an administered window to provide such specific credits.

In some countries, such as Russia, Lithuania, and the Kyrgyz Republic, a minimum interest rate is established for the auction. For instance, the Bank of Lithuania rejected all bids at its first auction, indicating that the interest rates offered were too low. Bids at higher rates were offered and accepted at subsequent auctions. While in principle this may prevent low interest rates because of collusion, it may also reduce interest rate flexibility.

As noted earlier, collateralized lending and carefully defined access criteria reduce the potential for adverse selection in the auction process. In the absence of sufficient stocks of acceptable collateral in economies in transition, central banks in a number of countries have introduced partial collateralization to reduce the credit risk they face. For example, in the Kyrgyz Republic, the authorities require collateral equivalent to 10 percent of the loan.19 In addition, in most countries the range of admissible collateral has been broadened beyond treasury biils to include foreign exchange holdings, promissory notes, and some less liquid assets.

In the absence of adequate collateral, it has also been desirable to limit commercial banks’ access to the credit auction. Countries have restricted access by requiring banks to meet prudential norms. For instance, in Kazakhstan, of 200 banks only 50 meet prudential norms and thus are allowed to participate in the auction. However, appropriate access rules coupled with excess liquidity in the emerging interbank market may actually discourage participation in the auction; this has been observed in the Moscow region of the Russian Federation.

In addition, to manage the credit risk exposure of the central bank, some central banks have placed limits on individual banks’ access to central bank credit. For example, in the Kyrgyz Republic the total amount of credit granted to each bank may not exceed 20 times its capital. In Russia, commercial banks are subject to an overall borrowing limit equivalent to the lower of twice capital or 10 percent of assets.

Although the use of credit auctions in the countries of the former Soviet Union is relatively new, these safeguards appear to have achieved their purpose. For instance, low participation in the Moscow region of the Russian Federation suggests that the CBR auction did not attract high-risk borrowers that had been barred from accessing the local interbank market.

IV. Conclusions

This paper has examined the use of auctions as a means of allocating central bank credit. Central bank credit in economies in transition often serves both a structural and a monetary role, and is sizable in volume. The structural need for central bank credit can be reduced over time by commercial bank deposit mobilization, the development of interbank and money markets, and the development of securities markets to provide enterprise financing from outside the banking system, but it is unrealistic to expect a rapid reduction in the dependence on central bank credit. Both administered and market-based allocation coexist in most countries, even those that depend primarily on indirect instruments for monetary control. Thus, at least some portion of central bank credit in economies in transition can be extended using a market-based allocation mechanism that will facilitate the subsequent shift to market-oriented instruments of monetary control; this can usefully be done early in the transition process.

Credit auctions can be effective as a monetary instrument; central bank determination of volume and access procedures allows control of liquidity expansion and influence over interest rates. Operated flexibly, auctions have the potential to allocate credit in an economically efficient manner and provide the basis for further development of money markets and more refined indirect instruments such as repurchase facilities. The price discovery process inherent in an auction provides a market-based reference rate that can be used both inside and outside the central bank. Elements of auction design regarding access rules, collateralization, and auction procedures can ameliorate or prevent some of the problems associated with information and incentive deficiencies.

The evolution from uncollateralized credit to fully collateralized indirect instruments and from extensive dependence on central bank credit to greater use of interbank markets requires an appropriate transition strategy. The experiences of countries in Eastern Europe suggest that credit auctions can be part of such a strategy, providing a suitable instrument to effect monetary control and at the same time promote the use of market-based indirect instruments. However, while the auction can serve as a catalyst for further market development, it also has its limits. The central bank should not allow the auction to become a permanent substitute for an interbank market, or to become the refuge of uncredit-worthy banks after the other banks have moved on to interbank or deposit-based sources of funds.20 Use of a rule-based allocation procedure does not relieve the authorities of the need to implement consistent and well-formulated macroeconomic policies.

The early use of auctions should be associated with a phased reduction in directed credits and in structural dependence on central bank credit, and with further development in other areas of the central bank’s responsibilities, notably bank supervision and the payments system. As part of such packages of reforms, credit auctions in several Eastern European countries appear to have successfully paved the way for the development of interbank markets and more refined open market operations, and do not appear to have resulted in excessive credit risk or monetary expansion.21 Some countries of the former Soviet Union have also seen positive results from their early efforts to conduct monetary operations using credit auctions. It is hoped that in these countries too the auction will provide an institutional basis for further market-oriented development.

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*

The authors are Economists in the Monetary and Exchange Affairs Department. Matthew I. Saal holds degrees from Princeton and Oxford Universities. Lorena M. Zamalloa graduated from Universidad del Pacifico and received a Ph. D. from the University of Pittsburgh. This paper was originally issued as an IMF Paper on Policy Analysis and Assessment in June 1994. The authors would like to thank, without implication, members of the Monetary and Exchange Affairs, European I, and European II Departments who provided information on country experiences with credit auctions and comments on previous drafts, and Angeliki Kourelis, who provided able research assistance.

1

Money market operations in Germany, France, and Belgium can be described as credit auctions (Laurens (1994)). The central banks of Israel and Indonesia conduct daily auctions of reserves, while the central bank of Malaysia auctions government deposits and the Bank of Norway auctions central bank deposits and short-term deposits at the central bank (Klein (1994), Carling (1994), Norges Bank (1993)). Credit auctions have also been used to on-lend multilateral development funds in countries such as Chile and Bolivia (Guasch and Glaessner (1992)).

2

At the end of 1993, central bank credit to commercial banks was equivalent to 30–65 percent of the volume of commercial bank credit to the economy in some countries of the former Soviet Union.

3

This was done in some countries by converting part of the outstanding central bank credit to long-term loans to be repaid in installments (e.g., Czechoslovakia, Macedonia, Poland), with the remainder used as short-term loans (including credit auctions) for monetary control purposes. In other countries, credit was gradually phased out as outstanding credits were repaid.

4

The increased responsibility of banks will also put them in a position that will both require and permit an increased level of monitoring, which could be expected to result in improved corporate governance.

5

Bredenkamp (1993) presents arguments in favor of the liberalization of interest rates in countries of the former Soviet Union early in the transition.

6

At the same time, however, auctions must be viewed as part of a broader package of monetary control instruments. Although variations in the volume of credit auctioned can be used to withdraw liquidity from the system, effective monetary management may require other instruments to reduce excess liquidity when necessary.

7

Although this by itself would not be expected to increase the credit risk to the central bank, the efficiency of resource use and the value of the auction rate as a reference rate would be diminished.

8

For further discussion of these issues, see Mathieson and Haas (1995).

9

While adverse selection in the auction can be addressed directly, the fungibility of money implies that the risk of moral hazard must also be addressed through improved bank supervision.

10

However, the use of foreign exchange as collateral could encourage banks and enterprises to hold liquidity in foreign exchange and may provide further incentive for dollarization.

11

This process will also create demand for collaterizable assets, reinforcing reforms in government finance such as the introduction of treasury bills and other government paper.

12

Through mid-1994, commercial banks had not offered funds through the NBMa. It is not clear whether banks perceive the NBMa as providing any implicit guarantee for interbank lending.

13

However, the minimum bid rate set by the NBR has provided a focal point for bidding, and possibly for collusion. In the first quarter of 1994. all bids tended to be at the minimum rate. As explained above, this may also indicate excess liquidity at the floor price.

14

The process of putting in place a supervisory regime need not be extremely lengthy, and has in some cases been accomplished within the first few years of transition. Fully ensuring compliance may require further development of supervisory skills as well as restructuring of some banks.

15

It may also indicate that the auction is functioning as a lender-of-last-resort facility, suggesting the need to evaluate the condition of the banks still participating in the auction.

16

For a discussion on the joint use of both direct and indirect instruments in transition economies, see Hilbers (1993).

17

The establishment of an auction can provide a benchmark for comparison of actual behavior (e.g., use of the auction relative to use of directed credit) with professed commitment to market mechanisms. Even if the auction is not operated ideally, it can give reformist groups (as well as bilateral and multilateral donors) an opportunity to point out backsliding.

18

While interbank rates ranged from 7–9 percent a month, the rate at the auction was about 13 percent.

19

Although credit auctions are fully collateralized in Russia, the effective rate of collateralization may be lower. Legal constraints limit the effectiveness of collateralization, since in principle Russia’s current legislation on collateral permits the pledger to retain control (and possibly dispose) of the assets until the loan is actually in default.

20

One way to avoid this is to increase the rate of collateralization.

21

This must, of course, be viewed as a preliminary conclusion. While it is difficult to demonstrate the absence of an event (and virtually impossible to prove that it will never occur), the restrictions on participation seem to have been reasonably effective in averting defaults. Furthermore, monetary control lapses have not been attributed to the credit auctions.