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Inflation Targeting: The BSP's Approach to Monetary Policy
 


The Inflation Target

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Inflation Targeting: The BSP's Approach to Monetary Policy

Download Primer on Inflation Targeting

  • The primary objective of the BSP's monetary policy is “to promote price stability conducive to a balanced and sustainable growth of the economy” (Republic Act 7653). The adoption of inflation targeting framework of monetary policy in January 2002 is aimed at achieving this objective.

Other monetary policy instruments include:

  • encouraging/discouraging deposits under the term deposit auction facility (TDF);
  • standing liquidity facilities, namely, the overnight lending facility (OLF) and the overnight deposit facility (ODF);
  • increasing/decreasing the reserve requirement;
  • adjusting the rediscount rate on loans extended to banking institutions on a short-term basis against eligible collateral of banks' borrowers;
  • outright sales/purchases of the BSP's holding of government securities

1. Reverse repurchase facility

With the implementation of the IRC system, the RRP facility was transformed into an overnight facility and offered using a fixed-rate and full-allotment method, where individual bidders are awarded a portion of the total offer depending on their bid size. Fixed-rate, full allotment method will help ensure that the overnight rate sits close to the BSP policy rate. The features of the O/N RRP facility can be accessed on the monetary operations page.

2. Acceptance of term deposits

The BSP, like other central banks, offers term deposits as one of the monetary tools to absorb liquidity. In November 1998, the BSP offered the Special Deposit Accounts (SDA) to banks and trust entities of banks and non-bank financial institutions. With the adoption of the IRC system in 2016, the SDA facility was replaced by the term deposit auction facility (TDF).

The TDF is a key liquidity absorption facility used by the BSP for liquidity management and used to withdraw a large part of the structural liquidity from the financial system to bring market rates closer to the BSP policy rate. A more detailed discussion on the features of the TDF can be accessed on the monetary operations page.

3. Standing liquidity facilities

The BSP offers standing liquidity (lending and deposit) windows that help counterparties adjust their liquidity positions at the end of the day. These standing overnight facilities are available on demand to qualified counterparties during BSP business hours. The two standing facilities that form the upper and lower bound of the corridor are set at ± 50 basis points (bps) around the target policy rate (the overnight RRP rate under the new IRC structure).

4. Rediscounting

The BSP extends discounts, loans and advances to banking institutions in order to influence the volume of credit in the financial system. The rediscounting facility allows a financial institution to borrow money from the BSP using promissory notes and other loan papers of its borrowers as collateral. In August 2013, the BSP restructured the rediscounting window to align it further with the BSP's market-based monetary operations framework and with the international central banking practice of scaling down directed credit operations. 3

Under Circular No. 806 series of 2013, two separate rediscounting windows were established, namely: (1) the Rediscounting Window I (RW I) for universal and commercial banks (U/KBs); and (2) the Rediscounting Window (II) for thrift banks (TBs), cooperative banks (coop banks), and rural banks (RBs). Banks will be able to access RWs I and II on an open-volume basis consistent with the objective of reorienting the BSP rediscounting window as a regular liquidity standing facility. In the RW I, the rediscount rate was aligned with the lending rate under the BSP RP facility plus the appropriate term premium to encourage banks to exhaust other possible sources of funding before trying to access the central bak rediscounting window. Meanwhile the interesrtrate in the RW II is pegged to the overnight RRP rate plus a term premium. TBs will have access to the RW II until November 2018, while coop banks and RBs will have access to the RW II until November 2023. By November 2023, the RW II will no longer be operational and all banks shall have access only to RW I.

5. Reserve requirements

Reserve requirements refer to the percentage of bank deposits and deposit substitute liabilities that banks must set aside in deposits with the BSP which they cannot lend out, or where available through reserve-eligible government securities. Changes in reserve requirements have a significant effect on money supply in the banking system, making them a powerful means of liquidity management by the BSP.

Reserve requirements are imposed on the peso liabilities of universal/commercial banks (UBs/KBs), thrift banks (TBs), rural banks (RBs) and cooperative banks (Coop Banks), and non-bank financial institutions with quasi-banking functions (NBQBs). Reservable liabilities include demand, savings, time deposit and deposit substitutes (including long-term non-negotiable tax-exempt certificates of time deposit or LTNCTDs)

The existing reserve requirement ratios vary across bank types and liabilities. The current headline reserve requirement ratio of 20 percent is imposed on certain liabilities of UBs/KBs and NBQBs. Previously, the eligible forms of compliance to the reserve requirements included banks' deposits in their demand deposit account (DDA) with the BSP, reserve-eligible government securities, and vault cash. Effective on the reserve week beginning on 6 April 2012, the BSP excluded vault cash (for banks) and demand deposits (NBQBs) as eligible forms of reserve requirement compliance. 4 At the same time, the BSP unified the existing statutory reserve requirement and liquidity reserve requirement into a single set of reserve requirement as well as discontinued the renumeration of the unified reserve requirements.

 

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