Summary: Lately the Central Bank has been putting a greater emphasis on financial stability. In order to fulfill this goal, they have started using the alternative monetary policy tools other than interest rate more effectively. Having already made some revisions about the RR, the Bank signals that the RR may also be employed as a tool to extend the maturities of deposits. The Central Bank also underlines that the cost associated with the accumulation of financial risks would be higher level of interest rates and therefore a more limited interest rate hike than normally expected may suffice provided that the macroprudential tools are put into force.
The repercussions of the alternative monetary policy tools started to be used by the Central Bank continue to be felt in the markets. Among last week’s decisions launched by the Central Bank, the removal of the interest paid on required reserves (RR) was the major shock to the markets, rather than the increase in the RR ratios. The Central Bank’s exit strategy had not mentioned such a change in regulation and therefore the decision should be considered as a surprise. The Central Bank said their aim is to use RR ratios more actively as a policy tool to mitigate the macroeconomic and financial risks. After all, it was obvious that the increase in the RR by itself would not be enough to limit the credit expansion, given the interest paid on TRY RR which is 80% of the Central Bank’s O/N borrowing rate. Moreover, the news that in order to extend the maturities of deposits the Central Bank may apply varying RR ratios depending on their maturities is a sign that the Central Bank would continue using this alternative policy tool more actively. In the meantime, the Central Bank’s emphasis on further possible reduction in the O/N borrowing rates hints that the Bank would keep utilizing liquidity management facilities more effectively. Having summarized the fresh developments regarding the monetary policy framework, we will now have a closer look into the “financial stability” concept that appears to be the reason behind the regeneration of alternative monetary policy tools, as well as the implications of this concept for the Central Bank’s monetary policy. The financial stability can be defined as avoiding or dispelling the financial system inadequacies and disruptions that could potentially have major distortions on the real economy. Recently, the Central Bank has been putting a special emphasis on this concept, as should be understood from the latest MPC meeting summary where the Bank said that “….global crisis has demonstrated the importance of central banks having an auxiliary financial stability mandate as well as the objective of price stability.” Accordingly, this adds another objective to the Bank’s current obligations of fighting inflation, as well as supporting growth and employment. It at the same time hints that the Central Bank anticipates this objective to become more widespread going forward. The CBRT Law says: “The primary objective of the Bank shall be to achieve and maintain price stability. The Bank shall determine on its own discretion the monetary policy that it shall implement and the monetary policy instruments that it is going to use in order to achieve and maintain price stability.“ Whereas, via the presentations recently made by Central Bank Governor, another mandate has been added and the Bank’s primary roles have been defined as follows: 1. To achieve price stability; 2. To take measures to enhance stability in the financial system; 3. To support the growth and employment policies of the government provided that it shall not be in confliction with the objective of price stability.
This new mandate would likely be included in the Central Bank Law as soon as there is a chance for such an amendment. On the other hand, there is another independent entity in Turkey, namely BRSA that has the responsibility of supervision of the financial system. Therefore, it seems that there may be problems associated with enlarging the authorization of the Central Bank, as was understood from BRSA Governor’s comments that came after the Central Bank’s decision to raise the RR.
Returning to the Central Bank’s financial stability mandate, the Bank defines primary objectives as given in the following lines. Therefore, following the Bank’s plans about applying varying RR ratios for deposits depending on their maturities, other steps associated with either of these items may also be expected going forward.
1. Debt Ratios: Use of more equity, less debt
2. Debt Maturities: Extending maturities of external borrowing and domestic deposits
3. FX Positions: Strengthening FX position of the public and the private sectors
4. Risk management practices: More effective management of financial risks by all agents in the economy
In another presentation, the Bank lists the macroprudential tools that can be used to achieve these objectives as follows: Reserve Requirements, Central Bank’s Liquidity Provision, Bank’s Capital Requirements, Banks’ Liquidity Requirements and Taxes.
The first two of these are the Central Bank’s responsibility, while the BRSA is authorized for the following two and the Finance Ministry has the control over the last tool. Therefore, institutions must cooperate in order to use these tools efficiently.
The graphs in the Central Bank’s mentioned presentation suggest that, financial stability curve would urge for a higher interest rate if there is positive output gap, while a lower interest rate would be implied by the curve when output gap turns negative. On the other hand, if macroprudential tools are employed to meet the financial stability objective, then the Taylor rule, which is the most common approach to determine the policy rate, would suggest lower interest rate when output gap is positive and higher interest rate when output gap is negative. A straightforward interpretation of this might be that in the period ahead when the output gap would be closed and eventually turn positive, the Central Bank is likely to keep the interest rate at a lower level than would be suggested by Taylor rule under normal circumstances, thanks to the macroprudential tools.
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