BSP shifts to variable rate repo auction

THE BANGKO Sentral ng Pilipinas (BSP) will shift to a variable rate format in the auction for the overnight reverse repurchase (RRP) facility starting Friday (Sept. 8), as well as introduce a formal operational target called the “Overnight (ON) RRP Rate.”

Similar to the existing BSP securities facility or the BSP bill auction, the variable rate format for the RRP will have a pre-determined offer volume.

BSP Governor Eli M. Remolona, Jr. in a statement on Monday said  an operational target is a market-determined, short-term interest rate that a central bank can “guide” on a daily basis to reflect the current monetary policy stance.

“For the BSP, the shift to variable rate RRP auction format will yield a market-determined rate for overnight funds, the ON RRP Rate, that conveys the results of the daily RRP auctions,” he said.

The BSP chief noted that the ON RRP Rate is an appropriate operational target due to the regularity of RRP auctions and market players’ familiarity with the instrument.   

Earlier in June, the BSP created the overnight rate as the benchmark for determining short-term interest rates amid the phaseout of the London Interbank Offered Rate (LIBOR).

Meanwhile, Mr. Remolona said that in the shift to a variable rate auction format, the BSP’s monetary policy rate would now be called the “Target RRP Rate.”

He said the BSP would signal its monetary policy stance through the Target RRP Rate. The rate will also be set after each policy review of the Monetary Board, similar to the central bank’s prevailing practices.

The RRP facility will also remain as the BSP’s primary monetary policy instrument, Mr. Remolona said.

“The ON RRP Rate is expected to move closely around the Target RRP Rate. Deviations of the ON RRP Rate from the Target RRP Rate will reflect changes in liquidity conditions from time to time, or when deviations from the liquidity forecasts occur,” he said.

Still, the ON RRP Rate should revert and move in accordance with the policy rate over time, as the RRP auction size is adjusted based on observed demand, he said.

“As the market familiarizes itself with the operational target, the ON RRP Rate will carry useful information on liquidity conditions and how they relate to the prevailing stance of monetary policy,” Mr. Remolona said.

“Thus, the introduction of an explicit operational target will provide monetary authorities an important market-based indicator that can help in assessing the effective stance of monetary policy,” he said.

ING Bank N.V. Manila Senior Economist Nicholas Antonio T. Mapa said the BSP would now set the Target RRP Rate based on their preferred stance. It will then report a prevailing daily rate that reflects liquidity conditions and demand.

“If the ON RRP Rate is lower than the Target RRP Rate, the BSP may look to increase auction volumes to drain more liquidity that leads to tighter financial market conditions, which would cause rates to rise,” he said. 

“But if the ON RRP Rate is higher than the Target RRP Rate, the BSP may look to downsize auction volumes to allow liquidity buildup, which in turn will push rates closer to the Target RRP.”

The BSP also noted that the changes in the RRP facility are part of the central bank’s set of planned reforms during the adoption of the interest rate corridor (IRC) framework in 2016. 

These changes are largely operational and do not constitute any shift in the BSP’s monetary policy stance, Mr. Remolona said. It will also enhance the transmission of monetary policy.

“The shift to the variable rate auction format will also help strengthen the price discovery process by providing market participants and monetary authorities alike a market-determined interest rate that conveys the prevailing cost of and demand for overnight funds in the financial system,” he said.

Rizal Commercial Banking Corp. Chief Economist Michael L. Ricafort said the changes are part of the development of a credible, market-determined funding rate that will be determined by market forces daily.

“The yield curve (should be) more realistic and credible for market players, instead of being distorted and artificially priced, thereby making the IRC system implemented since 2016 more dynamic and effective,” he said. 

This may also lead to a more effective and transparent transmission of monetary policy rates coursed through banks and financial markets. — Keisha B. Ta-asan