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Monetary Policy and Financial Stability Turalay Kenç Deputy Governor July 7, 2011 Beijing, China Monetary Policy is a Science Sound monetary frameworks lowered sharply the level and volatility of inflation Price stability is the main policy objective Independent central banks Formal inflation targets But financial stability was neglected Reliance on market discipline and microprudential policies Interactions between Monetary Policy and the Financial System (I) Price stability is a necessary condition for FS But it is not a sufficient condition MP affects FS by influencing the leverage maturity mismatch risk-taking behaviour of the financial sector. Interactions between Monetary Policy and the Financial System (II) FS is a necessary precondition for MP The original motivation for creating CBs Orderly functioning of the transmission of MP New monetary economics: Short-term policy rates are important per se The bulk of finance for financial institutions is very much short-term. Interactions between Monetary Policy and the Financial System (III) How should MP incorporate FS? Asset prices Financial and monetary imbalances Monetary and financial quantities Microprudential Regulation vs Macroprudential Regulation To repair their ratio of in crisis, banks can: Raise new capital; or Shrink their balance sheet 𝑐𝑎𝑝𝑖𝑡𝑎𝑙 𝑎𝑠𝑠𝑒𝑡𝑠 This could lead to fire sales! Negative externality: cost of excessive borrowing is not fully internalized Macroprudential approach: Incentives to raise capital rather than balance sheet restructing (Hanson, Kashyap and Stein, 2010) Macroprudential Policies The objective of macroprudential policy is to reduce systemic risk by 1. (Time dimension) reducing the pro-cyclicality of the financial sector 2. (Cross-sectional dimension) improving its resilience to adverse shocks by explicitly incorporating the inter-linkages between, and common exposures of, all institutions Incorporating Financial Stability How can price stability and financial stability be aligned 1. Adding financial stability as a separate objective for monetary policy 2. Macroprudential policy: Linking prudential tools to macrofinancial developments Central banks are less effective on long-term rates Foreign-financed consumptions generate less inflationary pressure but current account deficits It is global liquidity that builds financial imbalances Macroprudential Tools 1. Policies to reduce pro-cyclicality in the financial system i. ii. Instruments (e.g. counter-cyclical capital buffers) to limit supply-driven credit expansions Instruments (e.g. loan-to-value ratio) to limit demand driven credit booms 2. Calibrate prudential tools to individual institutions’ contribution to systemic risk i. ii. Tools to strengthen institutions Tools to change the structure of the industry Asian Experience with Macroprudential Tools Objective Tools Examples Manage aggregate risk over time (ie procyclicality) • Countercyclical capital buffers linked to credit growth Countercyclical provisioning Loan-to-value (LTV) ratios • China • China, India • Debt-to-income (DTI) ratios Direct controls on lending to specific sectors • China, Hong Kong Korea, Singapore Korea • Korea, Malaysia, Philippines, Singapore Capital surcharges for systemically important banks Liquidity requirements / funding Limits on currency mismatches Loan-to-deposit requirements • China, India, Philippines, Singapore • India, Korea, Philippines, Singapore India, Malaysia, Philippines China, Korea • • • • Manage aggregate risk at every point in time (ie systemic oversight) • • • • Source: BIS • • Indicators to Assess Risks Related to Procyclicality 1. 2. 3. 4. 5. 6. 7. Domestic, external and sectoral balances Leverage ratios Credit-to-GDP gap measures Fundamental analysis (Noncore liabilities) Asset prices Various Value-at-Risk (VaR) models Macro stress tests Methodologies to Assess Risks Related to Interconnectedness 1. 2. 3. 4. Linkages through bilateral balance sheets exposures Contingent claims analyses Probabilities of distress Measures of financial institutions’ contributions to systemic risk 5. Other market-based indicators (detecting regime shifts) A Case for Macroprudential Policy: Turkey Central banks are less effective on long-term rates Foreign-financed consumptions generate less inflationary pressure but current account deficits It is global liquidity that builds financial imbalances The Policy Challenge Unbalanced composition of growth Strong domestic demand vs. sluggish external demand Strengthening but shortening capital inflows Rapid credit expansion and worsening current account deficit Raising noncore liabilities Indicators to Assess Risks Related to Pro-cyclicality 1. 2. 3. 4. Domestic, external and sectoral balances Leverage ratios Credit-to-GDP gap measures Fundamental analysis (Noncore liabilities) Current Account, Credit Growth and External Finance Main Sources of Current Account Deficit Finance Credit Use and Current Account Deficit 9 (12-months cumulative, billion USD) 14 Portfolio and Short-Term 8 Current Account Deficit/ GDP* 12 7 70 FDI and Long Term Current Account Deficit 60 10 50 6 8 5 40 30 4 6 20 3 4 2 ∆ in Credit Stock/GDP (right axis)** 1 0 2 -20 2006:12 2007:02 2007:04 2007:06 2007:08 2007:10 2007:12 2008:02 2008:04 2008:06 2008:08 2008:10 2008:12 2009:02 2009:04 2009:06 2009:08 2009:10 2009:12 2010:02 2010:04 2010:06 2010:08 2010:10 2010:12 2011:02 2011:04 0 -10 0104 0404 0704 1004 0105 0405 0705 1005 0106 0406 0706 1006 0107 0407 0707 1007 0108 0408 0708 1008 0109 0409 0709 1009 0110 0410 0710 1010 0111 0411 0 10 *12-months cumulative current account deficit / GDP ** Rate of annual change in credit stock / GDP Source: BRSA, CBRT. *Short-term capital movements are sum of banking and real sectors' short term net credits and deposits in banks. Source: CBRT. Excessive Credit Growth Total Credits Extended to Private Sector/GDP (2008Q3=100) Source: IMF, CBRT Trade Balance Monthly Imports and Exports (Seasonally Adjusted) 22000 20000 18000 imports 16000 imports (excluding energy) 14000 12000 10000 exports (excluding gold) 8000 Source: CBRT. 05-11 03-11 01-11 11-10 09-10 07-10 05-10 03-10 01-10 11-09 09-09 07-09 05-09 03-09 01-09 11-08 09-08 07-08 05-08 03-08 01-08 6000 Non-Core Liabilities: A source of funding for excessive credit? Non-Core Liabilities/M2 (%) Source: CBRT Last observations: March, 2011 Non-Core Liabilities: Procyclicality During booms: credit growth > deposit growth Need for alternative sources of funding! Excess liquidity: both before and after crises! Shin (2010) Capital flows to emerging markets. U.S. is a net creditor in the banking sector even though it is a very large debtor overall. In effect, the U.S. borrows long and lends short through the banking sector. Non-core liabilities: an indicator for financial stability? Non-core liabilities: Turkish Case Non-Core Liabilities (thousand TL) 250,000,000 CENTRAL BANK MONEY MARKETS PAYABLES TO BANKS FUNDS FROM REPO FUNDS SECURITIES ISSUED SUBORDINATED DEBT 200,000,000 150,000,000 100,000,000 50,000,000 Source: CBRT Last observations: March, 2011 03-11 12-10 09-10 06-10 03-10 12-09 09-09 06-09 03-09 12-08 09-08 06-08 03-08 12-07 09-07 06-07 03-07 12-06 09-06 06-06 03-06 12-05 09-05 06-05 03-05 12-04 09-04 06-04 03-04 12-03 09-03 06-03 03-03 12-02 0 Non-core liabilities: Turkish Case Payables to Foreign Banks (TL billion) • Source: CBRT Last observations: March, 2011 Strong recovery after the crisis. Non-core liabilities: Turkish Case Leverage Growth and Asset Growth of Turkish Banks (14 banks listed in ISE) 0.20 Total Assets (log change) 0.15 0.10 0.05 0.00 -0.05 -0.10 -0.15 -0.06 -0.04 -0.02 0.00 0.02 Leverage (log change) Source: CBRT Last observations: May, 2011 0.04 0.06 0.08 0.10 3 0 -2 -5 Source: IMF Latest Data Available varies btw 2009-2010 Portugal Greece Australia 1 Lithuania Slovenia Spain Italy Poland France Norway Slovak Republic Sweden Latvia Ireland Netherlands Hungary Romania Czech Republic Bulgaria Switzerland Turkey (Feb'11) Russian Turkey ('10) Estonia Latvia Romania Greece Hungary Netherlands Slovenia France Italy Estonia Sweden Switzerland Portugal Slovak Republic Spain Russia Poland Norway Bulgaria Lithuania Czech Turkey (Feb'11) Turkey (2010) Outstanding outlook in the banking sector… Return on Assets (%) Capital Adequacy Ratio (%) 25 2 1 20 15 -1 10 -3 -4 5 0 Source: IMF Latest Data Available varies btw 2009-2010 16 14 8 6 0 Source: IMF, BRSA Latest Data Available varies btw 2009-2010 02.08 04.08 06.08 08.08 10.08 12.08 02.09 04.09 06.09 08.09 10.09 12.09 02.10 04.10 06.10 08.10 10.10 12.10 02.11 Switzerland Norway Australia 1 Netherlands Turkey (Feb'11) Portugal Turkey (10) Poland France Spain Slovak Republic Estonia Czech Republic Slovenia Lithuania Bulgaria Greece Hungary Russian Federation2 Italy Romania Ireland Latvia …with comparatively very low NPL ratios, NPL Ratios of Selected Countries (%) NPL Ratios in Turkey (%) 8 7 12 10 SME Corporate 6 Total Individual 5 4 4 2 3 2 Source: IMF, BRSA Latest Data Available varies btw 2009-2010 Healthy household’s balance sheets… Household Liabilities to GDP Ratios (%) Turkey Romania Slovakia Slovenia Czech Rep Bulgaria Belgium Hungary Litvania Italy Poland Greece Latvia Austria France Estonia Finland EU27 Germany The Netherlands UK Sweden Luxembourg Portugal Spain Ireland Denmark Household FX Positions 15.4 0 Source: Eurostat, CBRT Last observations:Sep. 2010 20 40 60 80 100 120 140 160 2009 Sep. 2010 Households FX Assets* 67,597 69,338 Households FX Liabilities* 2,172 1,572 FX Position* 65,425 67,766 GDP* 616,753 734,723 FX Position/GDP (%) +10.6 +9.2 Source: Eurostat, CBRT Last observations:Sep. 2010 … with very low short-term FX positions of non-financial sector Bank Loans to Non Financial Companies (% of GDP) Poland Romania Czech Republic Slovakia Turkey Hungary Finland Belgium Lithuania Germany United Kingdom Greece France Bulgaria EU27 Estonia Latvia Italy Austria Sweden Netherlands Slovenia Denmark Portugal Spain Malta Ireland Cyprus Luxembourg FX Positions of Non Financial Companies (NFC) December 2010 28 0 20 40 60 80 100 120 140 160 NFC FX Assets* 86.7 NFC FX Liabilities* 181 FX Position* -94.3 FX Position/GDP (%)** -12.8 180 Source: Eurostat, CBRT * Million USD. Last observations: December, 2010 ** Note that the short FX position for short term liabilities are less than 1% of GDP (USD 313 mio). Non-Banking Sector FX position is balanced. 27 …and sound public balances all support financial stability. Public Debt Forecast for 2011 (% of GDP) Budget Deficit Forecast for 2011 (% of GDP) Hungary Sweden Estonia Luxembourg Finland Germany Bulgaria Turkey* Malta Austria Denmark Czech Rep. Netherlands Belgium Italy Romania Cyprus Slovenia Slovak Rep. Latvia Portugal Poland France Lithuania Spain Greece UK Ireland -11 Estonia Luxembourg Bulgaria Maastricht Criterion Maastricht Criterion Austria Sweden Romania Turkey* -2.8 40.6 Czech Republic Slovenia Latvia Lithuania Slovak Republic Denmark Finland Poland Cyprus Spain Netherlands Malta Hungary Germany UK France Portugal Belgium Ireland Italy Greece -9 -7 -5 -3 -1 1 3 *: Turkey’s budget deficit figure is MTP (2011-2013 projection) for central govenment. IMF WEO April 2011 budget deficit forecast for Turkey is 1.7% and better than what was envisaged in Turkey’s MTP as 2.1% for general government. Source: MoF, Treasury, MTP (2011-2013) Targets, IMF WEO April 2011 0 20 40 60 80 100 120 140 160 *: Turkey’s debt figure is MTP (2011-2013) projection. IMF WEO April 2011 public debt forecast for Turkey is 39.4%. 28 The New Policy Mix 1.A lower policy rate 2.Wider interest rate corridor 3.Reserve requirement policy i.Higher ratios on both TL and FX deposits ii.Unremunerated iii.Differentiated rates across maturities 4.Tighter liquidity management 29 Policy Mix TL Reserve Requirement Ratios (Percent) CBRT Policy Rates (Percent) 25 18 Overnight Lending - Borrowing Interest Rate Spread 1 Week Repo Rate The Maximum and Minimum Reserve Requirement Ratios Weighted Average Reserve Requirement Ratio 16 20 14 Introduction of 1 week repo rate as policy rate 15 12 10 8 10 6 4 5 2 Source: CBRT 0511 0211 1110 0810 0510 0210 1109 0809 0 0509 0511 0211 1110 0810 0510 0210 1109 0809 0509 0209 1108 0808 0508 0208 0 Source: CBRT 30 Liquidity Management - 1 The liquidity shortage of the banking system realized as 56.3 billion TL on average in June. Liquidity Level Source: CBRT 31 Liquidity Management - 2 Volatility in O/N interest rates, which has increased after widening of the corridor, continued in June. O/N Interest Rates Source: CBRT 32 Exchange Rates TRY and Other EM Currencies Against USD* (4 Jan. 2010=1) 1.15 Announcement of QE2 by the FED Depreciation TRY 1.1 1.05 1 Appreciation 0.95 EM Average 06.11 05.11 04.11 03.11 02.11 01.11 12.10 11.10 10.10 09.10 08.10 07.10 06.10 05.10 04.10 03.10 02.10 01.10 0.9 *Average of EM countries: Brazil, Chile, Czech Rep. Hungary, Mexico, Poland, S.Africa, Indonesia, South Korea and Colombia. Source: CBRT and Bloomberg 33 Credit Growth Total Credits (Annualized, 20 days moving averages) 80 80 70 70 60 60 50 50 40 40 30 30 20 20 10 10 2011 2006-2010 Ave. 2010 Dec Nov Oct Sep Agu Jul Jun May Apr Feb Mar 0 Jan 0 Consumer Credits (Annualized, 4 weeks moving averages) 70 BRSA Measures 60 50 40 30 20 10 2010 Source: CBRT 2011 Dec Nov Oct Sep Agu Jul Jun May Apr Mar Feb Jan 0 2006-2010 Ave. 34 Credit Volume Monthly Change of Total Credit Volume (Adjusted for FX) 5,0 Average of Previous Five Years Last Period Difference 4,0 RR Hikes QE2 3,0 2,0 1,0 0,0 -1,0 July Aug Sept Oct Nov Dec Jan Feb Mar Apr May June Source: BRSA, CBRT 35