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Selling securities on the open market. Open market operations are a quick and effective method of influencing the money supply

Selling securities on the open market. Open market operations are a quick and effective method of influencing the money supply

OPERATIONS OF CENTRAL BANKS ON THE OPEN SECURITIES MARKET

S. R. MOISEEV

Moscow State University of Economics,

statistics and computer science

Unlike reserve requirements, open market operations (OOPs) are a highly flexible monetary policy tool that are used on a voluntary rather than a coercive basis. OOPs can be carried out with any frequency and volume of assets, due to which they act as an effective means of managing money supply and liquidity in the banking sector. In addition, OOPs are a good way to encourage competition in the financial system.

INTRODUCTION TO OPEN MARKET OPERATIONS

Open securities market operations involve the purchase and sale of securities in order to increase or decrease the amount of funds available to financial institutions. First of all, OOP affects bank reserves, and also, through the multiplier effect, affects the supply of credit and economic activity in general. OOP can be carried out both in the primary market (through issues of securities) and in the secondary market. In the primary market, transactions are carried out when financial markets are not yet sufficiently developed. Gradually, with the establishment and liberalization of the financial system, the main focus of OOP has shifted to the secondary market, which provides greater operational flexibility for the central bank. The object of OOP are marketable securities, such as debt obligations of the state treasury (Ministry of Finance), state corporations, major national corporations and banks.

OOP uses various technical procedures, which allows them to be classified in a variety of ways:

According to the terms of the transactions (direct operation or purchase and sale for a period with an obligation to repurchase on pre-agreed conditions);

By objects of transactions (transactions with government or private securities);

By the urgency of transactions (short-, medium- and long-term);

By counterparties (banks, non-banking institutions, financial sector as a whole);

By fixing the interest rate (by monetary authorities or the market);

By fixing the volume of OOP (by monetary authorities or the market);

On the initiative of concluding a transaction (by monetary authorities or the market).

Open market operations are the main instrument of monetary policy in industrial countries and are now becoming increasingly important for developing countries and transition economies. OOPs allow central banks to enter into transactions on their own initiative, that is, to be more flexible in the timing and volume of monetary transactions. They also encourage impersonal business relationships with market participants and move away from ineffective direct control. The development of indirect instruments of monetary policy is one of the most important moments in the process of economic development, due to the fact that as the country's markets develop, direct instruments lose their effectiveness, because markets ultimately find ways to circumvent restrictions, especially when is about international operations.

Open market operations affect the supply of money and credit through their impact on the reserve base of the banking system. As a monetary policy tactic in managing bank reserves, OOP can be carried out in one of two ways: (1) active: fixing the volume of reserves and freely determining the price of resources (i.e. the interest rate); or (2) passive: fixing the interest rate while varying the volume of reserves. Industrial countries with well-developed money markets typically take a passive approach, although there have been exceptions in the past. A passive approach is now also becoming the norm for emerging markets that have reached some level of development. Nevertheless, in the author’s opinion, in developing countries there is every reason to use

using an active approach. In such countries, the lack of effective secondary or interbank money markets - designed to transmit the effects of monetary policy - may be one reason for using an active approach. Another reason is that a proactive approach allows the central bank to define its policies in a transparent and open manner. The active approach is implemented in many stabilization programs in developing countries supported by the IMF.

OBJECTS OF OPEN MARKET OPERATIONS

During OOP, the central bank prefers securities that have maximum liquidity and minimum credit risk. Liquidity of securities is an important aspect of intervention for several reasons. To effectively implement monetary policy, manage assets and liabilities, and fully perform the functions of lender of last resort, the central bank needs to ensure that during OOP, distortions in securities prices are as small as possible. As a rule, any securities actively traded on the secondary market have sufficient liquidity. Of these, the most suitable for monetary authorities are those for which the credit risk is insignificant, that is, the likelihood of the issuer failing to fulfill its obligations is extremely low. Considering both criteria for selecting securities, most central banks chose government securities. They perform several functions in the activities of the central bank. First, securities are used in managing the liquidity of the financial system. Secondly, they serve as collateral that supports the smooth operation of payment and clearing systems. Thirdly, foreign securities act as an asset of the monetary authorities, covering the issue of the national currency.

In addition to purely operational considerations, the selection of securities is also influenced by the degree of development of financial markets and the independence of the central bank. In many countries, the securities market has not yet developed sufficiently to allow OOP to be carried out effectively. In a number of industrialized countries, the implementation of a program to reduce public debt or a budget surplus makes it possible to do without borrowing on the debt market. According to OECD statistics, the volume of market securities

mag issued by industrialized countries (except Japan) fell over 1995-1999 from 45 to 40% of GDP. In order to solve the problem of shortage of OOP objects, central banks issue their own securities. The most common types of obligations issued by monetary authorities are:

> debt certificates (Bank of the Netherlands,

National Bank of Denmark, Bank of Spain,

European Central Bank);

> financial bills (Bank of England, Swedish

Riksbank, German Bundesbank, Bank of Japan);

> bonds (Bank of Korea, Central Bank

Chile, Bank of Russia).

However, most central banks refuse to issue their own securities for several reasons. They seek to avoid the emergence of market fragmentation and support government securities as a basic guide for financial market participants. By using not their own securities, but the obligations of the fiscal authorities, central banks thereby isolate themselves from unnecessary interference in the sphere of financial intermediation. In addition, monetary authorities minimize the risk that may be imposed on the private sector in the form of distorted prices of financial assets resulting from the selection of a particular asset as an object of public investment.

Another important aspect of the selection of OOP objects is the independence of the central bank. If non-government securities are chosen as targets for intervention, the central bank may be accused of disloyalty and protectionism towards certain issuers. To avoid such scandals, monetary authorities limit their choice to government securities.

Table 1 provides a comprehensive overview of central banks' OOP targets. Government securities used in interventions are included in the assets of central banks, and their own securities are included in liabilities. The stock portfolio of most central banks consists of debt obligations of foreign governments and domestic fiscal authorities, supranational agencies and financial institutions. All of them are actively traded on the market and have a high credit rating. From an OOP perspective, two factors influence the balance sheet structure of central banks. First, the openness of the economy and its dependence on the dynamics of the exchange rate of the national currency lead to a larger share of foreign reserves in

Table I

Balance sheet structure of central banks of the world's leading countries, %

Source: Zelmer M. Monetary Operations and Central Bank Balance Sheets in a World of Limited Government Securities. IMF Policy Discussion Paper No. 7, 2001. - P. 6.

Central Bank Net Debt securities issued Credit financial Other

loans to foreign institutions

assets government financial institutions other institutions Repo Lombard loans

Reserve Bank 65 9 0 0 26 1 0

Australia

Bank of Canada 4 85 4 0 4 2 0

National Bank 52 7 11 0 0 29 1

European 39 10 1 1 47 0 2

central bank

Central Bank of Iceland 23 5 4 0 64 3 1

Bank of Japan 4 60 0 12 19 1 4

Reserve Bank 3 50 0 0 47 0 0

New Zealand

Central Bank 94 2 0 0 0 4 0

Norway

Swedish Riksbank 66 13 0 0 21 0 0

Swiss 75 1 1 2 21 0 0

National Bank

Bank of England 0 5 0 2 53 2 39

US Federal Reserve 5 88 0 0 7 0 0

Central Bank Cash Deposits Own Others

in circulation of financial governments of other valuable net items

institutions paper institutions

Reserve Bank 47 1 27 1 0 24

Australia

Bank of Canada 96 5 0 1 0 -1

National Bank 20 20 17 3 23 16

European 43 30 6 0 0 21

central bank

Central Bank 12 34 15 6 0 32

Iceland

Bank of Japan 60 6 23 0 5 6

Reserve Bank 46 1 42 1 0 9

New Zealand

Central Bank 8 4 80 0 0 9

Norway

Swedish Riksbank 45 2 0 0 0 53

Swiss 30 5 9 0 0 56

National Bank

Bank of England 78 6 1 13 0 2

US Federal Reserve 95 3 1 0 0 1

assets and, as a consequence, to a significant share of foreign debt in the portfolio of central banks. The most striking examples are demonstrated by the monetary authorities of Norway, Australia and Denmark. Secondly, depending on the specifics of short-term refinancing of the financial system, the assets of the monetary authorities contain more loans or securities. Especially-

The performance of payment systems, the efficiency of the money market and the tradition of refinancing determine whether the financial sector is regulated through the securities market or the discount window. In Denmark, the eurozone and Iceland, refinancing is carried out through a discount window, and in Japan, Canada, and the USA - through the stock market.

table 2

Open market operations of central banks of the world's leading countries

Source: Zelmer M. Monetary Operations and Central Bank Balance Sheets in a World of Limited Government Securities. IMF Policy Discussion Paper No. 7, 2001. - P. 7.

Central Bank Peno Direct transaction Bill discounting Currency swap Lombard loan Issue of own securities

Reserve Bank of Australia Yes No No Yes Yes No

Bank of Canada Yes Yes No No Yes No

National Bank of Denmark No No No No Yes Yes

European Central Bank Yes No No No Yes No

Central Bank of Iceland Yes No No No Yes No

Bank of Japan Yes Yes Yes No Yes Yes

Reserve Bank of New Zealand Yes No No Yes Yes No

Central Bank of Norway Yes No No No Yes No

Swedish Riksbank Yes No No No Yes No

Swiss National Bank Yes No No Yes Yes No

Bank of England Yes Yes No No No No

US Federal Reserve Yes Yes Yes No No No

In table Table 2 shows the main OOPs carried out by central banks of developed countries. As it follows, most central banks prefer to use peno and pawn loans instead of direct transactions (outright operations). In both cases, financial institutions pledge financial assets to the monetary authorities or temporarily transfer ownership of them. The differences between peno transactions and pawn loans are primarily legal rather than economic. For example, in the European System of Central Banks, an OOP may be defined as a peno or pawn loan depending on the legal status of the financial institution. For example, in Germany all OOPs take the form of a security pledge, while in France the same transactions are identified as peno transactions.

Most central banks prefer to use government securities or government-guaranteed obligations in peno operations (Table 3). As a rule, monetary authorities prefer not to create a peno market “from scratch”, but resort to the private peno market, where transactions with government securities are already being actively concluded. In addition to government obligations, central banks use private securities in pawnshop and rediscount operations. This partly reflects the fact that most deals are concluded in one

day. With the help of ultra-short-term loans, banks smooth out the deficit or excess of funds when completing settlements of payment systems at the end of each working day. For overnight transactions, where financial risks are minimal, private rather than government securities are quite suitable.

In all transactions where banks pledge securities to the monetary authorities, the amount of collateral must be greater than the amount of the loan. The initial margin protects the central bank from unwanted changes in the value of the pledged financial asset. To ensure that possible adverse consequences for the monetary authorities are as minimal as possible, additional requirements have been established for private securities. These may be a minimum external credit rating (Canada and Japan) or a minimum reliability threshold established within the central bank's internal credit review system (the European System of Central Banks). In some cases, monetary authorities pre-determine the list of securities suitable as collateral (Sweden, Great Britain).

Not all central banks resort to classic OOP with securities. Monetary authorities in open economies are also forced to operate in the foreign exchange market. For example, the Reserve Banks of Australia and New Zealand use currency swaps in addition to traditional

Table 3

Objects of open market operations of central banks of the world's leading countries

Source: Zelmer M. Monetary Operations and Central Bank Balance Sheets in a World of Limited Government Securities. IMF Policy Discussion Paper No. 7, 2001. - p. 8.

Central Bank Government Securities Government Agency Securities Mortgage-Based Securities Financial Institution Securities Industrial Private Sector Securities Foreign I Securities

Reserve Bank of Australia Yes Yes

Bank of Canada Yes

European Central Bank Yes Yes Yes Yes Yes

Central Bank of Iceland Yes Yes

Bank of Japan Yes

Reserve Bank of New Zealand Yes

Swedish Riksbank Yes Yes Yes

Swiss National Bank Yes Yes Yes Yes

Bank of England Yes Yes Yes Yes

US Federal Reserve Yes Yes Yes

Pawn loan |

Central bank Government securities Government agency securities Mortgage-backed securities Financial institution securities Industrial private sector securities Foreign securities

Bank of Canada Yes Yes Yes Yes Yes No

National Bank of Denmark Yes Yes Yes No No No

European Central Bank Yes Yes Yes Yes Yes No

Central Bank of Iceland Yes Yes No No No No

Bank of Japan Yes Yes No No Yes Yes

Reserve Bank of New Zealand Yes Yes Yes Yes Yes Yes

Swedish Riksbank Yes Yes Yes Yes Yes Yes

Swiss National Bank Yes Yes Yes Yes Yes Yes

Direct deal

Central Bank Government securities. Government agency securities Mortgage-backed securities Financial institution securities Industrial private sector securities Foreign securities

Bank of Canada No No No Yes No No

Bank of Japan Yes No No No No No

Bank of England Yes Yes No Yes No No

US Federal Reserve Yes Yes No No Yes No

collateral instruments. In the past, when the national money markets operated with currency swaps were not yet sufficiently developed, and the supply of government securities was not yet sufficiently developed in Norway.

RELATIONSHIP OF OPEN MARKET OPERATIONS WITH OTHER MONETARY POLICY INSTRUMENTS

For OOPs to become an integral part of national monetary policy, other monetary instruments must be appropriately adapted and market infrastructure transformed. Let's look at how OOP relates to other monetary instruments. If OOP is to become the main policy instrument of the monetary authorities, other monetary instruments should be given less importance, especially the discount window through which the banking system obtains reserves by borrowing from the central bank. For OOPs to be effective, restrictions must be placed on banks' access to central bank credit. Without such restrictions, OOP cannot be used as the main instrument of monetary policy to manage liquidity in the financial sector of the economy. For this reason, the discount window must be configured in a special way to make market access to credit of last resort less attractive, for example through a high penalty rate or restrictive credit guidelines. Some countries, such as Germany, use a double rate mechanism consisting of a basic discount rate and a penalty pawn rate to discourage loan abuse.

At the same time, restrictions on the discount window should be used with caution. If the penalty rate is set much higher than current market conditions, the refinancing system will not be able to respond quickly enough to the sudden demand for liquidity. Short-term refinancing principles that take into account limited access to the window should allow for gradual, smooth adaptation to conditions of reserve shortages. For example, central bank loans can be divided into ultra-short-term loans, which eliminate liquidity shortages, and long-term structured loans through the discount window, which, among other things, allow banking institutions to obtain the necessary funds in a critical situation.

In addition to the discount window, central banks have traditionally used reserve requirements as a means of monetary regulation. Reserve requirements can be considered either as an alternative to OOP, or as a tool for increasing their effectiveness in terms of

meeting the goals of monetary regulation. Since the use of OOP has become widespread, central banks have resorted much less to changing the reserve ratio. In many countries they have been gradually reduced and in some cases eliminated entirely because reserve requirements make banks less competitive with other financial institutions.

A minimum, but not zero, level of reserve requirements may be necessary to assess the impact of OOP on interest rates and money supply. The experience of some countries, such as the UK, which have not resorted to reserve requirements, suggests that they are not absolutely necessary. On the other hand, financial crises such as the Mexican crisis in late 1994 have shown that reserve requirements are still useful in stabilizing market conditions. Even in the US, with its highly developed money market, reserve requirements remain mandatory for transaction deposits.

PUBLIC DEBT MANAGEMENT

It is clear that government decisions regarding debt management and deposit balance management affect OOP. Sometimes they can make operations easier, and in other cases they can make it more difficult. In all countries, the treasury and the central bank coordinate their actions, although with varying degrees of intensity and effort. In most cases, the final decision on debt management is made by the Treasury, with the central bank acting as its agent. In areas where government operations have a direct effect on bank reserves, the central bank has a strong say. Working relationships may differ depending on the traditions and financial history of the country.

In any case, OOP will be most effective where the central bank controls the factors affecting the reserve base of the banking system. In order to maintain a clear separation of monetary and fiscal policy operations, it is desirable that government debt issued for fiscal purposes be sold in the market by the Treasury, to avoid any conflict between government debt management and monetary policy needs. Such issuances should take the form of auctions, helping to develop a competitive, deregulated market system. This also avoids pressure

influence on the central bank in terms of supporting the placement of securities on the primary market at a predetermined rate. From an OOP perspective, it is particularly important for the central bank to influence—if not control—the Treasury operating balance, the fluctuation of which affects the supply of bank reserves.

It is highly unusual for a central bank to have the discretion to regulate government deposits, but there are a number of such examples around the world. The Bank of Canada, for example, has the power to transfer government deposits between its own balance sheet and the balance sheet of commercial banks. For the Malaysian Bank Negara, auctions of government deposits are a traditional tool of monetary policy. The German Bundesbank has veto power over government decisions to place deposits outside its balance sheet.

In general, OOPs will function effectively when the government adheres to, and the public believes in, a clear separation of debt management and monetary policy operations. In practice, this usually involves an agreement to neutralize the monetary effect of the treasury balance sheet or to delegate its management to the central bank. In virtually all countries, decisions regarding debt management are implemented through the central bank, both formally and informally.

IMPLEMENTING OPEN MARKET OPERATIONS IN DEVELOPING COUNTRIES

As national economies grow, financial markets expand and deepen. Their formation, as a rule, actively requires the guidance of the government and monetary authorities. Associated with the formation of the financial market, the development of monetary policy instruments on the open market usually occurs in two stages. First, through auctions of new issues of securities in the primary market, there is a shift from direct control to the use of OOP. At the second stage, with the development of secondary markets, there is a complete transition to flexible bilateral transactions with marketable securities in the secondary market.

Ideal conditions for effective implementation of OOP exist in only a few developing countries and transition economies. Nevertheless, OOP of one kind or another can and should be carried out in markets that are not yet fully ready and are at the stage of transformation. In such cases, OOP needs to be

limit in size or use on an off-period basis rather than on a regular basis. The participation of the central bank in the formation of the financial system, on the one hand, should accelerate the development of the market, and on the other hand, should not expose its balance sheet to risks, which could reduce confidence in the monetary authorities. A central bank will be able to intervene successfully if markets have confidence that its asset portfolio is highly liquid and risk-free.

The most suitable markets for OOP in developing countries are usually those in which short-term instruments are traded. Well-developed markets are characterized by large and sustained trading volumes involving a variety of players, including governments, financial institutions and other businesses. Three sectors present the best opportunities for effective OOP. These include government and central bank securities markets, the interbank debt market, and short-term instruments issued by financial institutions and other corporations, including commercial and financial bills and bank certificates of deposit. Given the government's ability to manipulate fiscal policy and quickly raise its revenues when necessary, the government securities market is generally seen as the most favorable environment for OOP in developing countries. Unstable political and economic conditions, however, may make it impossible for the government debt market to function properly. For the OOP to be carried out effectively, it is critical that the government strictly adheres to debt interest payments as well as debt repayments. The government securities market can be plunged into collapse not only due to refusal to fulfill contractual obligations, but also due to the pro-inflationary policies of the monetary authorities, which lead to investors fleeing the market.

Short-term private debt, including interbank liabilities, is less suitable for OOP. In developing countries it is characterized by specific credit risks. In addition, the use of private securities as a target for intervention forces the central bank to make difficult choices when conducting monetary policy. If the central bank buys private debt, businesses may be willing to issue riskier securities. And if the central bank suddenly refuses to buy them, players could

completely turn away from such securities, which will provoke a money market crisis. One of the options for solving this problem is for the monetary authorities to limit their operations to securities that have the maximum credit rating established by an independent rating agency. In an environment where government debt is low or rapidly declining, the central bank may find it has no choice but to switch to private money market instruments. When this occurs, transactions in commercial bank instruments or interbank obligations are much less problematic from a credit risk perspective than transactions in other private instruments. If the government debt market has not yet reached the required volume, the central bank can influence the banking system through specialized issues of government securities intended only for monetary policy purposes.

The central bank can also promote market development by introducing operating principles or codes for its counterparties. First of all, it is necessary to identify a circle of business partners. The criterion for a business relationship with the central bank may include membership in a dealer group. Many countries conduct OOP through primary dealers, who have an obligation to provide bid and offer quotes for securities when the central bank enters the market and during Treasury auctions. Brazil, the Czech Republic, India, Malaysia, the Philippines, Poland and Russia (until 1998), for example, introduced primary dealer systems. To perform their functions more effectively, dealers must seek retail customers, thereby helping to develop a wider and more liquid market.

In small countries, establishing a primary dealer system, where the number of participants may be insufficient, is problematic and often impractical. However, when the market becomes large enough, there are many incentives to limit the operations of a group of dealers, for example through minimum equity capital requirements. To avoid accusations of favoritism, the dealer group will likely have to be quite large. By establishing a dealer group, the central bank will benefit in terms of encouraging dealers to apply better market making standards, such as minimum transaction size for trades at quoted prices.

As already mentioned, to conduct effective OOP, both the central bank and the government need a developed government securities market infrastructure. It must have sufficient transparency for wide participation of various categories of players, as well as minimal counterparty risks. To achieve this quality of the market, the central bank needs to set standards for the performance of its participants. To do this, he will naturally need to observe the market by collecting statistics and publishing market summaries. Of course, the central bank can do without additional functions if it resorts to direct regulation and mandatory market supervision. However, such steps will force him to increase his staff, follow the path of red tape and, ultimately, loss of efficiency and trust. The solution to the problem lies in a clear separation of powers and responsibilities relating to monetary policy operations (the responsibility of the monetary authorities) and regulatory operations (the responsibility of some other agency or, if within the central bank, a department separate from the OOP).

STIMULATING THE DEVELOPMENT OF MARKET ARCHITECTURE

Any central bank prefers to operate in an efficient market, in which trading occurs continuously and where the speed of market response is high. Monetary authorities can take certain steps to develop the interbank market, engineer market instruments and trading infrastructure, provide financing facilities, set dealing criteria, collect and disseminate statistics, and promote a secure payment and clearing mechanism.

The Central Bank is the center for the collection and dissemination of market statistics. The process of collecting data, including daily information on positions, volume of transactions and financing by type of issue, should begin in the early stages of market development. Statistics provide the basis for observation. Later, when the number of participants is so large that data on an individual company or bank cannot be published, the central bank must release aggregate data on market activity. Publication must be delayed with a sufficient lag, for example for a week or

month, depending on the instrument, to avoid market overreaction.

The central bank should also take the initiative early in market development to introduce payment and delivery standards. No market operates without a guarantee that securities will be delivered on time and paid for as agreed. While the speed and reliability of clearing and payment systems obviously depends on the technological capabilities of the market and institutional arrangements, the central bank can play a large role in galvanizing such effects through lender of last resort leverage. It could also work with the Treasury to introduce modern technology into the government securities market, such as a ledger system that makes property account records secure and allows for simultaneous delivery versus payment through central bank deposit accounts. Monetary authorities must ensure that clearing institutions obtain the necessary credit lines from banks at the time of delivery and payment failures.

The interbank market is particularly important for monetary policy because it helps determine the appropriate timing and size of OOP. Many countries specifically tailor monetary policy instruments to the interbank market. The central bank, together with the treasury, should take the initiative to encourage market-based practices in the interbank market that promote competitive trading. This could be, for example, the introduction of computer systems for anonymous trading of securities. To promote market transparency, authorities should also discourage trading outside organized markets. The Treasury needs to take a special interest in competitive trading, given that the national debt burden is expected to decline over time as government securities become increasingly liquid.

FINAL OBSERVATIONS

Deregulation of financial markets makes administrative control over the banking system ineffective. International experience in this area shows that in the context of globalization, countries have no choice but to begin the transition to indirect regulation. Countries where the central bank delays the market transition subsequently face failure.

lamy in achieving monetary policy goals. On the other hand, as the crisis experience of Southeast Asia in the late 1990s shows, the use of market instruments does not at all guarantee the success of monetary policy. The presence of an arsenal of indirect instruments is a necessary, but not sufficient condition for the high efficiency of the actions of monetary authorities.

Most developing countries and countries with economies in transition have begun to use reserve requirements in conjunction with OOP. They also limited access to the discount window, which nevertheless remained open as a "safety valve" for the banking sector. At the same time, for most emerging markets and transition economies prone to liquidity crises and sudden capital outflows, combining all monetary policy instruments without relying on any one of them may be the optimal choice in terms of efficiency. Market transformation during the formation of OOP usually occurs in two stages: the organization of the primary market, and then the development of the secondary market.

It is difficult for the central bank to accelerate the development of the financial market through OOP alone, since it risks dominating the market and crowding out private borrowing with public borrowing. Peno and reverse peno trades are the most effective tools for encouraging early market development. At the same time, the central bank should actively promote the creation of a full-fledged interbank market, which will subsequently perform a signaling function for monetary policy. However, if a central bank relies excessively on private paper transactions, it is exposed to credit and liquidity risk. In the absence of a normal market for government securities, the use by the central bank of its own issues or special issues of the Treasury, strictly intended for monetary policy purposes, can be considered as an alternative option for intervention targets.

(Publication prepared based on materials from the International Monetary Fund)

The stock market is not only a means of earning money for investors and a place for issuers to place their own shares, but also serves as an important state economic regulator.

With the help of , the processes of investing investment funds in certain structures, if not absolutely uniform, then at least feed some industries. The sale of securities also allows the state to replenish its budget. This happens through the placement of bonds - securities representing a certain debt obligation.

The obligation is determined by the amount and timing. The amount is characterized by a specific investment for one unit of bonds, and the terms are specified by the contract, most often from several months to several years. There is a permanent option.

The investor receives his income both by reselling the bond on a secondary trading platform and by closing the debt obligation by the issuer and paying the assigned interest that was agreed upon during the debt process.

National mediator

The placement of state-owned products on the market is carried out with the help of the relevant authority. In Russia, these functions are assumed by the Bank of Russia, the country’s central financial institution.

It is worth noting that in addition to the representative office, a kind of national broker, the BR also takes upon itself control and monitoring of the implementation of the legislative framework by trading participants. It also conducts certification and registration of all persons who want to participate in the auction as professionals. This includes brokers, registrars, depositories and others.

Of course, the list of tasks does not end there. The Bank of Russia is the responsible person for issuing banknotes. Including its control, normalization of inflation and other functionality of economic importance.

By selling government securities, the Bank of Russia replenishes the country's budget. In addition to all of the above, the activity of the Bank of Russia as a regulator of economic relations does not end.

Banking regulator

The parameter of banking activity remains extremely important for the economic health of the state. Financial institutions at different periods may find themselves managing too large financial masses. Or they may experience an acute lack of financial support.

The central bank can solve both problems. His actions can often resemble bailouts of certain banks. In such a situation, the Central Bank buys a certain amount of the bank's bonds that it placed on the stock exchange.

Thus, a distressed financial institution receives a new portion of working capital, which it can implement through its own investments, or by issuing loans and debts from the depository accumulation of its clients.

The opposite situation is possible through the purchase by a rich bank of a fairly large amount of certain government bonds. On this scale, the bank transfers the money supply for the use of the state budget. Debt obligations are being purchased. Such activities are called banking operations on the open securities market.

Open market

In a broad theoretical interpretation, an open market is a trading space free from most restrictions. Any transactions can be carried out here. With regards to stock exchange business - buying and selling securities.

Open market theorists say that the absence of restrictions will allow the market to be capitalized to its maximum and become decisive in the economy. This concept involves the removal of all restrictions on taxes, registrations, exchange margins and tariffs. Exceptions based on restrictions are organized only in situations that contradict moral and legislative values.

This idea was introduced as a basis into some modern economic theories, which claim that self-government of market issues is quite possible to solve with one’s own hands through the actions of the market itself.

Such a theory opens the way to a new round of capitalist structure, in which everything and everyone can be bought. Parallels are often drawn with popular idealistic concepts in which all citizens have access to unrestricted trading on a financial exchange. Thus, generating passive income for yourself without working.

In a more material, narrow sense, an open market is a description of trading activities between the Central Bank and other financial institutions represented on the same trading platform with it.

Banks on the open market

A BR, entering the trading floor, most often has one of the following motivations:

Open market operations are conducted to regulate all banking activities. This happens by purchasing from other banking institutions and filling their reserve accounts. In such a situation, the Central Bank reduces the volume of its own reserves and gets a chance to expand the volume of active transactions of banks with theirs.
The BR can increase the quantitative amount of funds in its own fund. This happens by selling government securities on the stock exchange. The result is a fall in the volume of funds in the banking system. But this method increases the state budget, which is used to fulfill obligations to the population. By adjusting the supply and demand for assets, the Central Bank can influence not only the volume of reserves of other banks and their ability to provide loans, but also the total amount of money in circulation (for a particular region).

Types of operations

Operations on the open market, depending on the terms of the transactions, are divided into direct transactions (purchase and sale for cash) and forward transactions (purchase and sale for a period with mandatory re-sale - REPO transactions). Objects of transactions - transactions with government or private securities. In direct transactions, the purchase and sale of securities is carried out with immediate delivery, and interest rates are set at auction.

Repo transactions are carried out under the terms of a repurchase agreement. A distinction is made between direct REPO transactions and reverse (or paired) ones. In this situation, direct means the purchase of assets by the central bank with the obligation of the dealer or commercial bank to buy them back after a certain period. When concluding reverse repo transactions, the central bank sells securities and assumes an obligation to buy them back from a dealer or commercial bank after a certain period.

According to another parameter, according to the purposes of conducting open market operations, they are divided into protective and dynamic. Dynamic operations use direct transactions and are aimed at changing the level of bank reserves and the monetary base. Protective ones use repo transactions and are carried out to adjust reserves in case of unexpected deviations from a given level.

The purchase and sale of securities allows you not only to control the amount of money in circulation, but also to change it within the necessary parameters.

Interest regulation

One of these parameters is the regulation of interest rates. They are also reflected among citizens, in consumer loans and deposits. This instrument is called the refinancing rate, or, as they also say, the discount rate.

Formally, this rate is considered to be the one at which the Central Bank itself issues loans to commercial financial institutions. They, in turn, transfer it to their consumer goods - issuing loans and deposits. At the same time, commercial banks slightly (within the limits permitted by the Bank of Russia) increase interest rates on loans and reduce interest rates on deposits, thereby generating their own profits.

The uses of this tool are varied:

Serves as a benchmark for market interest rates on deposits and loans. This is a kind of indicator of the intentions of the Central Bank.
It is an indicator in the income taxation of citizens, in the processes of calculating income tax on material benefits generated under loan agreements, when paying insurance compensation, when calculating interest income on a deposit; also used for taxation of specific profits.
It is one of the factors in national currency quotes.
Becomes a tool for regulating the floating exchange rate.
Can be used as a central bank forecast for inflation.

In general, with the help of this rate the government can flexibly regulate the volume of money supply in circulation. However, changing the refinancing rate may have ambiguous economic consequences.

For example, a significant increase in the refinancing rate is often used as an anti-inflationary measure. At the same time, an increase in the refinancing rate during a budget deficit increases public debt due to growing interest payments on government securities, which can ultimately fuel the inflationary process (especially if the budget deficit is significant).

To use this instrument, the country must have a developed securities market. By buying and selling securities, the Central Bank influences bank reserves, interest rates, and therefore the money supply.

To increase the money supply, he begins to buy securities from commercial banks and the public, which allows commercial banks to increase reserves, as well as issue loans and increase the supply of money (the “cheap money” policy).

If the amount of money in a country needs to be reduced, the Central Bank sells government securities, which leads to a reduction in lending operations and the money supply ("cheap money" policy).

Open market operations are the most important, operational means of influence of the Central Bank on the monetary sphere.

Depending on the state of the country’s economy, the Central Bank can choose the following types of monetary policy and certain goals. In conditions of inflation, a policy of “dear money” is being pursued, aimed at reducing the money supply: 1) increasing the discount rate, 2) increasing the required reserve ratio, 3) selling government securities on the open market. The “dear money” policy is the main method of anti-inflationary regulation.

During periods of production decline, a “cheap money” policy is pursued to stimulate business activity. It consists in expanding the scale of lending, weakening control over the growth of the money supply, and increasing the money supply. To do this, the central bank:
1) reduces the discount rate;
2) reduces the reserve ratio;
3) buys government securities.

Banks: their types and functions.

Banks are special economic institutions, their types being centers of credit relations. Their main function is to accumulate funds and lend them out. Banks also accumulate cash income and savings of the population, funds of state, public and other organizations. These amounts themselves are intended to be spent as a means of purchase or payment. Meanwhile, when they fall into the hands of businessmen, they are used to make a profit.

Banks also issue credit means of circulation - signs of value that serve as money in trade turnover and payments (cash, banknotes).

Banks perform their functions in two interrelated types of operations: passive - operations for the formation of banking resources and active - operations for their placement and use (Fig. 12.2.).

Banks' funds consist of their own capital (they form, as a rule, an insignificant part of all funds: in the USA, for example, 8%) and deposits - customer deposits. Deposits are divided into time deposits (investments for a predetermined period and not subject to withdrawal before its maturity) and demand deposits (deposits to current accounts that the bank is obliged to issue upon the depositor’s first request).

Fig. 12.2. Functions of banks

Active operations include a variety of loans: bill, stock, commodity, blank. The most common is bill accounting. The bank buys the bill from the entrepreneur if he seeks to turn it into money before the due date. When issuing cash, a discount percentage is withheld from the amount indicated on the bill of exchange - a fee for providing the amount of money. When the bill of exchange becomes due, the bank presents it for payment to the issuer of the debt obligation. The discount rate can vary greatly. Thus, the highest discount rate of an English bank from November 15, 1979 to July 3, 1980 was 17%. The lowest was 2% from October 26, 1939 to November 7, 1951.

Banks conduct stock transactions - they give loans secured by securities - shares, bonds, mortgages, etc., and also buy such securities. Commodity loans are provided against products that are in warehouses, in transit, or in trade. If the loans are not repaid on time, the pledged securities and inventories become the property of the banks. The largest entrepreneurs, whose solvency is beyond doubt, are provided with a blank loan: the loan is issued without any collateral.

In addition to passive-active operations and settlements, banks are engaged in trading and commission activities - buying and selling gold, exchanging national currency for foreign currency, placing loans, selling stocks and bonds, etc.

Depending on the nature of the functions and operations performed, banks are divided into three main types: central, commercial and specialized (Fig. 12.3.).

Fig. 12.3. Types of banks.

No credit institution is one hundred percent insured against unplanned financial losses, therefore, in the process of its functioning and regulation of banking risk, a financial institution must play an important role in the formation of bank reserves.

In order to ensure its financial reliability, the bank is obliged to create various types of reserves to cover possible losses, the procedure for the formation and use of which is established in most cases by the Bank of Russia and legislative acts. The minimum amount of bank reserves is determined Central Bank of the Russian Federation. The amount of contributions to bank reserves from pre-tax profits is established by federal tax laws.

The bank multiplier is the process of increasing (multiplying) money in the deposit accounts of commercial banks during the period of their movement from one commercial bank to another.

The bank multiplier characterizes the animation process from the perspective of the subjects of the animation. Here is the answer to the question: who multiplies money? This process is carried out by commercial banks. One commercial bank cannot multiply money; it is multiplied by a system of commercial banks.

The open market is the Central Bank's operations for the purchase and sale of government securities in the secondary market. Open market purchases are paid for by the Central Bank by increasing the seller's bank reserve account. The total monetary reserves of the banking system increase, which, in turn, leads to an increase in the money supply. Sales of open market securities by the Central Bank will lead to the opposite effect: the total reserves of banks decrease and, other things being equal, the money supply decreases. Since the Central Bank is the largest open market dealer, an increase in the volume of purchase and sale transactions will lead to changes in the price and yield of securities. Therefore, the Central Bank can influence interest rates in this way. This is the best tool, but its effectiveness is reduced by the fact that the expectations of market participants are not entirely predictable. Advantages of this method:
The central bank can control the volume of transactions;
operations are quite accurate, bank reserves can be changed to any given value;
transactions are reversible, since any error can be corrected by a reverse transaction;
the market is liquid and the speed of transactions is high and does not depend on administrative delays.
In the open market, central banks use two main types of operations:
direct transactions - purchase and sale of securities with immediate delivery. Interest rates are set at auction. The buyer becomes the owner of securities that do not have a maturity date;
repo transactions are carried out on the terms of a repurchase agreement. Such transactions are convenient because the repayment terms can vary.
The types of open market operations are divided into:
dynamic operations - aimed at changing the level of bank reserves and the monetary base. They are permanent and involve direct transactions;
protective operations - carried out to adjust reserves in the event of their unexpected deviations from a given level, i.e., aimed at maintaining the stability of the financial system and bank reserves. For this type of transaction, repo transactions are used.
The use of open market operations depends on the level of development, the institutional environment and the degree of liquidity of the government securities market. As an analogue of open market operations, the Bank of Russia also uses foreign exchange interventions.
Foreign exchange interventions are the purchase and sale of foreign currency on the domestic market to increase or sterilize the money supply. They affect the exchange rate of the ruble against the dollar. The sale of dollars by the Central Bank will lead to an increase in the ruble exchange rate, the purchase - to its decrease. If the Central Bank conducts foreign exchange interventions to correct short-term exchange rate fluctuations, then it loses control over bank reserves and, accordingly, over the money supply. In addition to currency interventions, the Bank of Russia plans to use a more flexible instrument - currency swaps.
Currency swaps are transactions of purchase and sale of currency on the terms of immediate delivery with a simultaneous reverse forward transaction. They allow you to adjust the level of liquidity of the foreign exchange market without creating additional pressure on the ruble exchange rate.
What is bank refinancing?
Bank refinancing is a monetary policy instrument whereby the Central Bank grants a loan to a bank, that bank's account with the Central Bank is credited. The passive part of the Central Bank's balance sheet increases, and total reserves in the banking system increase. The assets of the Central Bank increase by the amount of the loan. As a result, an increase in refinancing volumes increases the volume of borrowed reserves in the banking system, the monetary base and money supply, while a reduction decreases it.
The central bank can influence the volume of refinancing in two ways:
influencing the interest rate on loans;
influencing the amount of loans at a given interest rate using refinancing policies.
The refinancing policy affects the volume of bank lending through the mechanism for issuing loans and involves the Central Bank determining the goals, forms, conditions and terms of lending. Credit refinancing is also used as a stabilization tool
banking system. This is the most effective way to provide additional reserves and, accordingly, liquidity to banks during crisis periods.
The traditional form of refinancing is the recounting of bills by the Central Bank, the meaning of which is that the Central Bank buys bills that have already been discounted by banks.
The volume of refinancing depends on the level of the refinancing rate (the cost of loans from the Central Bank). But still, the refinancing rate is usually considered as an indicator of the intentions of the Central Bank. By changing the refinancing rate, the Central Bank announces its intentions regarding monetary policy.
Refinancing policy has less direct impact on the monetary system. It is possible to directly determine the required change in borrowing reserves, but it is not known how much the refinancing rate needs to be changed in order for banks to apply for loans from the Central Bank. The costs for banks to use the refinancing rate are high and changing the refinancing rate turns out to be an ineffective tool due to the ambiguity of the impact on financial markets.

State management of a market economy involves guaranteed support by the Central Bank of Russia for the activities of commercial banks. This is due to the fact that the latter are the working link of the monetary system, directly organizing credit relations in the national economy in the real sector of the economy.

Let's consider the main tools with which the Central Bank carries out its policy on the open market. These include, first of all, changes in the refinancing rate, changes in required reserve norms, open market transactions with securities and foreign currency, as well as some measures of a strict administrative nature.

If we talk about refinancing, then refinancing means lending by the Central Bank of Russia to banks and credit institutions to regulate the liquidity of the banking system.

The forms, procedure, terms, conditions and limits of refinancing are established by the Bank of Russia. Federal Law of the Russian Federation “On Banks and Banking Activities” dated 02/03/1996

The refinancing rate is a tool of monetary regulation, with the help of which the Central Bank influences the rates of the interbank market, as well as rates on deposits of legal entities and individuals and loans provided to them by credit institutions.

The limit on open market operations is approved by the Board of Directors.

Open market operations vary depending on:

- terms of the transaction: purchase and sale for cash or purchase for a period with mandatory re-sale - reverse transactions;
- objects of transactions: transactions with government or private securities;
- urgency of the transaction: short-term (up to 3 months), long-term (up to 1 year or more) transactions with securities;
- scope of operations: only in the banking sector of the securities market or in the non-banking sector of the market;
- method of setting rates: determined either by the Central Bank or the market.

Open market operations first began to be actively used in the USA, Canada and the UK due to the presence of a developed securities market in these countries. Later, this method of credit regulation was widely used in Western Europe.

According to the form of market transactions of the Central Bank with securities, they can be direct or reverse. A direct transaction is a regular purchase or sale. The reverse operation consists of the purchase and sale of securities with the obligatory completion of a reverse transaction at a predetermined rate. The flexibility of reverse operations and the softer effect of their impact make this regulatory instrument popular. Thus, the share of reverse operations of the Central banks of leading industrialized countries on the open market reaches from 82 to 99.6%. If you look at it, you can see that in essence these operations are similar to refinancing against securities. The Central Bank invites commercial banks to sell it securities on terms determined on the basis of auction (competitive) trading, with the obligation to sell them back in 4-8 weeks. Moreover, interest payments accruing on these securities while they are in the ownership of the Central Bank will belong to commercial banks.

Thus, open market operations are the use of more flexible regulation, since the volume of securities purchased, as well as the interest rate used, can change daily in accordance with the direction of the Central Bank's policy. Commercial banks, taking into account the specified feature of this method, must closely monitor their financial position, while avoiding a deterioration in liquidity.

In fact, the Central Bank of Russia performs the functions of an agent of the Ministry of Finance of the Russian Federation for servicing, as well as a regulatory and control body.

The Central Bank of Russia provides the “organizational” side of the functioning of the government short-term bonds (GKO) market: it conducts auctions, redemptions, prepares the necessary documents, and transfers the necessary funds to the account of the Ministry of Finance of the Russian Federation. In addition, he actively participates in the work of the GKO market as a dealer, which makes it possible to have a targeted economic impact on the market depending on the events that occur directly in and around him, and in accordance with the current policy of the Central Bank.

At the same time, the Bank of Russia does not set as its goal making a profit from operations on the market. The Central Bank is focused on maintaining a certain level of certain indicators of the GKO market, which determines the attractiveness of the GKO market for investors.

The fundamental purpose of the Central Bank's open market operations is to help the Russian economy achieve an overall level of output characterized by full employment and price stability.

The Central Bank, with the support of the state, has the opportunity to provide the payment system with powerful telecommunications tools necessary for settlements by market participants. The Central Bank is able to register all payment transactions occurring between banks and efficiently offset the mutual obligations of banks.

The Central Bank pursues a discount rate policy (sometimes called a discount policy), acting as a “lender of last resort.” It provides loans to the most financially stable banks experiencing temporary difficulties. The Federal Reserve System (Fed) sometimes makes long-term lending under special conditions. These could be loans to small banks to meet their seasonal cash flow needs. Sometimes loans are also provided to banks that find themselves in difficult financial situations and need help to get their balance sheets in order.

Interest rates of the Bank of Russia represent the minimum rates at which the Bank of Russia carries out its operations.

The Bank of Russia may set one or more interest rates for various types of transactions or pursue an interest rate policy without fixing the interest rate.

The Bank of Russia uses interest rate policy to influence market interest rates in order to strengthen the ruble (Article 37). Federal Law on the Central Bank of the Russian Federation (Bank of Russia) (as amended by Federal Laws dated April 26, 1995 No. 65-FZ, dated December 27, 1995 No. 210-FZ, dated December 27, 1995 No. 214-FZ, dated June 20, 1996 No. 80- Federal Law, dated February 27, 1997 No. 45-FZ).

Carrying out macroeconomic supervision over the functioning of the banking system as a whole, as well as supervision over the activities of each bank separately, the Central Bank can quickly take preventive measures to stabilize the financial situation of participants in the payment services market and carry out the rehabilitation of a particular problem bank in order to prevent a break in the links of the settlement chain due to bankruptcy or illiquidity of its participants.

The Central Bank of the Russian Federation considers the main task of monetary policy on the open market to be reducing inflation while maintaining and possibly accelerating GDP growth while simultaneously creating the prerequisites for reducing unemployment and increasing real incomes of the population.