Improving efficiency and limiting risks in interbank markets

Improving efficiency and limiting risks in interbank markets: the role of central banks Franco Passacantando World Bank Global Payment Systems Conference 2009 Cape Town, April 8 2009

Titelmasterformat durch NEW TRENDS IN LIQUIDITY CREATION AND CIRCULATION Klicken bearbeiten LIQUIDITY CREATION Globalization and financial crisis effects on central banks: § enhanced international cooperation ( foreign currency operations and swap operations) § extended scope of existing operations ( massive liquidity injections; new instruments adopted; wider collateral) § unconventional operations ( engagement in the set-up of new market; widening of counterparts) LIQUIDITY CIRCULATION - from unsecured to ‘secure’ market venues from multilateral to bilateral trading 2

Titelmasterformat durch MONEY MARKET TRADING MODELS Klicken bearbeiten uncollateralized: -bilateral (OTC) -multilateral (electronic platform e-MID) collateralized: -bilateral (repo) -multilateral (3 main platforms in Europe: Eurex Euro GC Pooling, MTS repo, ICAP Broker. Tec) Collateral management services Custody Triparty repo (third agents btw trading parties) 3

Titelmasterformat durch INTERBANK MARKET STRUCTURES: e-Mid Klicken bearbeiten § Created in 1990 on impulse of Banca d’Italia. It is the only screen-based unsecured money market platform in the world § More currencies gradually introduced. Now deposits in 4 currencies (€, $ USA, GBP and PLN zloty) are traded § Managed by a private company (e-MID SIM S. p. A) owned by 29 banks and by the Italian Banking Association (ABI) § 224 participants from 26 countries, including 28 central banks and 2 Ministries of Economy and Finance as observers § Supervised by Banca d’Italia 4

Titelmasterformat durch INTERBANK MARKET STRUCTURES: collateralized trading Klicken bearbeiten venues EUREX – Euro GC Pooling - Collateralized money market for ECB eligible securities trading. It offers CCP services (Eurex Clearing) and collateral management services (Clearsteam) CCP : anonymity, minimizing risk, netting Collateral Management: automated allocation and real-time substitution of securities (virtual collateral pool); re-use of collateral for other money market transactions and/or ECB operations via Clearstream Banking Trading data: on Feb 2009 Euro GC pooling outstanding volumes at 65 bln (nearly 40 bln in Feb 2008) MTS – Repo Trading Facility - General collateral trading of securities listed on the MTS markets in transparent and anonymous way via CCP (CCG Sp. A, LCH. Clearnet SA). Types of contract: Buy-Sell Back for Italian securities and Classic Repo for other countries instruments. CCP (not mandatory): anonymity, minimizing risk, netting Trading data: at Feb 2009 GC daily turnover at 40 bln (30 bln in Feb 2008) ICAP – Broker. Tec - Repo trading of a large pool of international securities both in bilateral (transparent) and multilateral (anonymous) CCP assisted segments CCP: anonymity, minimizing risk, netting Trading data: at Feb 2009 daily turnover of European repos at 150 bln (around 170 bln in Feb 2008) 5

Titelmasterformat durch CENTRAL BANKS’ INTERMEDIATION ROLE Klicken bearbeiten Daily outstanding balances – blns of euro) The Eurosystem case: banks recourse to the standing facilities greatly increased. A parallel significant increase of the deposit facility Lehman default Marginal lending facility Deposit facility 6

Titelmasterformat durch CENTRAL BANKS’ BALANCE SHEET Klicken bearbeiten As a result, the Eurosystem balance sheet has reached unprecedented levels Lehman default 7

UNSECURED MONEY MARKET Titelmasterformat durch ACTIVITY HAS SHIFTED Klicken bearbeiten … Klicken bearbeiten Activity in the e. MID platform sharply declined, but…. 8

Titelmasterformat durch … IN FAVOUR OF OTC TRADING. . . Klicken bearbeiten … Italian banks continued to exchange liquidity on an OTC basis (widely within the group circuits)… 9

Titelmasterformat durch … AND COLLATERALIZED SEGMENTS Klicken bearbeiten. . as well as in the repo segment 10

Titelmasterformat durch THE INTERBANK COLLATERALIZED MARKET (MIC) Klicken bearbeiten § Temporary market segment (operational since 2 February up to 31. 12. 2009) aimed at overcoming: § higher credit and liquidity risk perception through collateralization § ‘stigma effect’ associated with funding on the interbank market through anonymity § In the first two months, 47 banks posted collateral to trade in the MIC; they account for more than 80% of banks’ consolidated assets § The scheme makes use of the current screen-based trading infrastructures (e. MID) and cash settlement infrastructures (TARGET 2) 11

Titelmasterformat durch FEATURES OF THE MIC Klicken bearbeiten § Traded deposits - 1 W, 2 W, 3 W, 1 M, 2 M, 3 M, 4 M, 5 M, 6 M (possible to insert broken dates in the future) § Participants Italian and EU banks (understanding with Banca d’Italia is requested) § Anonymity Participants’ names disclosed neither on trading pages nor on settlement instructions § Guarantee: each participant posts its collateral with the Bank of Italy to cover its own debt position § Mutual loss sharing: for each participant, up to 10% of posted collateral (in case collateral of defaulting bank is not sufficient) § Eligible collateral: assets eligible for the Eurosystem + assets/liabilities guaranteed by Italian & other EU Governments + eligible securities for securities lending at the Banca d’Italia + other financial instruments & credits accepted by Banca d’Italia on a discretionary basis 12

Titelmasterformat durch FEATURES OF THE MIC Klicken bearbeiten A single real time e-MID and MIC screen for the trader 13

Titelmasterformat durch THE ROLE OF BANCA D’ITALIA Klicken bearbeiten - “Facilitator” of trading (ensuring anonymity): § Opening of accounts for participants § Communication of the amount of the guarantee § Possibility to refuse/ask for the substitution of all or part of the collateral § Custody and administration of financial instruments deposited as collateral § Evaluation of collateral § reference to market prices (if existent) with a haircut for each § § category of instrument/asset Management of defaults - Supervision Authority 14

Titelmasterformat durch MIC GROWTH SINCE THE START UP Klicken bearbeiten Activity is largely concentrated (3/4 of the market) on three maturites: 1 week, 2 weeks, 1 month. But all maturities are quoted during the day 15

Titelmasterformat durch MIC ACTIVITY IS VARIABLE BUT OVERALL GROWING. . . Klicken bearbeiten Activity in MIC is approximately equivalent to that on the e. MID on the same maturities effective demand of collateralized trades 16

Titelmasterformat ISSUES durch FOR DISCUSSION: what is the proper role for a central bank? Klicken bearbeiten • Dual responsibility of liquidity creation and market development • MIC is designed to limit risks for central bank and preserve market incentives • Partial mutual sharing of losses • Losses are very unlikely and would be limited (several events should simultaneously occurr: default of both the trader and the collateral issuer; insufficient haircuts; insufficient mutual sharing) • No market maker role for Banca d’Italia. No public subsidy HENCE: in emergency situations, risks for central banks may be lower than those of open market operations 17

Titelmasterformat ISSUES durch FOR DISCUSSION: who bearbeiten should play the role of market catalyst? Klicken Central banks have often played the role of market catalyst. BI has been involved in developing: -the custodian and SSS operator (Monte Titoli) -the CCP (Cassa di Compensazione e Garanzia) -the Interbank electronic market (e-MID) -the wholesale Government Securities electronic market (MTS) -the cash clearing and settlement systems (at both national and euro-area level) some of which were later passed on to the market Alternative approaches: Private market infrastructures, Banking Associations • there is no optimal approach (local and historical conditions matter) • depends on the structure of a system (whether few big players dominate the market, or a fragmented system prevails) • central banks initiatives open to wider access (also greater flexibility in collateral management policy) 18

Titelmasterformat durch ISSUES FOR DISCUSSION: what model of risk management? Klicken bearbeiten Is there a risk of excessively limiting propensity to take risks? (collateralized vs uncollateralized; bilateral vs multilateral) • Bilateral monitoring important for market discipline • Uncollateralized contracts are “cheaper” in normal circumstances should a move to the generalized adoption of the central counterparty model be encouraged? • CCPs enhance transparency and standardization • Centralized risk assessment imply economies of scale in risk management • Most beneficial when operations can be netted what should be the role of central banks with respect to CCPS • Need of suspervisory powers • Access to lending of last resort facilities? 19