The Purpose and Transparency of the Repurchase Agreement in the South African Financial System
THE PURPOSE AND TRANSPARENCY OF THE REPURCHASE AGREEMENT IN THE SOUTH AFRICAN FINANCIAL SYSTEM
by
JUANITA STEENKAMP
DISSERTATION
submitted as partial fulfillment of the requirements for the degree
MAGISTER COMMERCII
in
BUSINESS MANAGEMENT
in the
FACULTY OF ECONOMIC AND MANAGEMENT SCIENCE
at the
RAND AFRIKAANS UNIVERSITY
STUDY LEADER:MR. C.H. VAN SCHALKWYK
2001 ACKNOWLEDGEMENT
I wish to express my sincere gratitude and appreciation to:
The Almighty Lord without whom I would never have had the ability to continue my study.
My husband Jaco, for his support with my research and studies.
The late Mr. Callie Engelbrecht, head of Money Market Funding at Absa, for his encouragement and inspiration.
My mother, Walda, and father, Johan Steenkamp for their love and upbringing.
My sister, Elaine, and brother, Dirkie, for their moral and physical support.
Absa Corporate Bank for providing the support systems in my research.
My friend and colleague, Correy Jansen van Vuuren. We have made it!
My supervisor, Henco van Schalkwyk for his expert and professional guidance.
—000--- OPSOMMING
DIE DOEL EN DEURSIGTIGHEID VAN DIE TERUGKOOPOOREENKOMS IN DIE SUID-AFRIKAANSE FINANSIELE STELSEL
deur
JUANITA STEENKAMP
STUDIELEIER: Mnr C.H. van Schalkwyk
FAKULTEIT: Fakulteit Ekonomiese en Bestuurswetenskappe
GRAAD: MAGISTER COMMERCII
Die vorige akkommodasiestelsel het nie, volgens die monetere beleidsmaatreels van die Suid-Afrikaanse Reserwebank, daarin geslaag om effektief deur middel van opemark- transaksies te funksioneer nie. In hierdie navorsing word daar gepoog om deursigtigheid van die terugkooptransaksie-ooreenkoms en inflasie-mikpuntstelling te ondersoek. Rentekoersbewegings was die alleen-diskresie van die Reserwebank en was beheer deur die tradisionele bankkoers. Die behoefte aan 'n meer deursigtige en effektiewe akkommodasiestelsel het ontstaan. Dit moes gebaseer word op 'n opemark- transsaksie en bepaal word deur die vraag en aanbod van likiditeit in die mark. Vandaar die implimentering van die stelsel van terugkooptransaksie-ooreenkoms as vervanging van die ou bankkoers. Die primere doelwit van monetere beleid is om prysstabiliteit te verkry, met ander woorde, dat die interne en eksterne waarde van die rand so stabiel as moontlik bly. Die Reserwebank het hiervolgens 'n inflasie-mikpunt gestel wat goed vergelyk met die gemiddelde inflasiekoers van Suid Afrika se belangrikste handelsvennote en internasionale mededingers. Daarom is dit belangrik dat die Reserwebank 'n deursigtige beleidsraamwerk nastreef om sodoende sy inflasie- mikpunte suksesvol te kan bereik. Deursigtigheid lei tot voorspelbaarheid en verseker dus dat markverwagtinge in lyn is met doelwitte van algehele prysstabiliteit. Die vlak van rentekoerse in 'n land kan prysstabiliteit direk beinvloed. 'n Deursigtige monetere beleid sal weereens verseker dat die markte nie onkant betrap word nie. Finansiele markte moet besluite van die Reserwebank te wagte wees en hiervolgens sal deursigtige monetere beleid ook voorspelbare montere beleid kan word. Sedert die implementering van die "repo-stelsel" in 1998 het daar 'n aantal beperkings aangaande die deursigtigheid van die stelsel die lig begin sien. Deursigtigheid van die regering se inflasie-mikpunte het ook vrae laat ontstaan of die regering by magte gaan wees om hierdie mikpunte te bereik. Rentekoerse beinvloed inflasie, en indien beide nie deursigtig bestuur word nie, kan dit 'n wesenlike invloed op effektiewe monetere beleid in Suid-Afrika tot gevolg he.
---oOo--- SUMMARY
THE PURPOSE AND TRANSPARENCY OF THE REPURCHASE AGREEMENT IN THE SOUTH AFRICAN FINANCIAL SYSTEM
by
JUANITA STEENKAMP
SUPERVISOR: Mr C.H. van Schalkwyk
FACULTY: Faculty of Economic and Management Sciences
DEGREE: MAGISTER COMMERCII
Under the previous accommodation system the monetary policy of the South African Reserve Bank failed to operate by means of open market transactions, and interest rate movements was solely the discretion of the South African Reserve Bank and was driven by means of the traditional Bank rate. The need for a more efficient and transparent accommodation system that is based on open market transactions and determined by demand and supply of liquidity was evident, and therefore the introduction of the repurchase agreement system in March 1998 was unavoidable. The ultimate objective of monetary policy is to achieve price stability, i.e. to ensure that the Reserve Bank has a goal of maintaining inflation at a level that would be more or less in line with the average rate of inflation in the economies of South Africa's major trading partners and international competitors. It is important that the Reserve Bank enhances transparency for the effective operation of an inflation-targeting framework. Transparency introduces predictability and helps to ensure that market expectations are consistent with the objective of price stability. The level of interest rates in a country can influence price stability directly. A transparent monetary policy will mean that changes in short-term interest rates should not surprise the market. Markets should anticipate decisions taken by the Reserve Bank and therefore transparency should promote the predictability of monetary policy. Since its implementation, the current accommodation system (repurchase agreement) has raised some concerns regarding transparency. The government's new monetary policy framework of inflation targeting also has some limitations that can influence the achieving of such targets.
The one influences the other, and if interest rates and inflation is not managed transparently, it will have a severe impact on the overall efficiency of monetary policy in South Africa.
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TABLE OF CONTENTS
Page CHAPTER 1 Introduction and Orientation
1.1 INTRODUCTION 1
1.2 RESEARCH PROBLEM 2
1.3 CONCEPTUALISATION 2 1.3.1 PURPOSE 3. 1.3.2 TRANSPARENCY 3 1.3.3 MONETARY POLICY 3 1.3.2.1 Repurchase agreement 3 1.3.2.2 Inflation 5 1.3.4 FINANCIAL SYSTEM 6
1.4 DEMARCATION OF THE FIELD OF STUDY 7
1.4.1 MANAGEMENT 7 1.4.2 ECONOMICS AND FINANCES 8
1.5 OBJECTIVES AND AIMS OF THE RESEARCH 9
1.5.1 OBJECTIVE OF THIS RESEARCH 9 1.5.2 AIMS OF THIS RESEARCH 9
1.6 RESEARCH METHODOLOGY 10
1.7 RESEARCH DESIGN (PROGRAMME) 13
1.8 CONCLUSION 14 — ii —
Page CHAPTER 2 An overview of Monetary Policy and Inflation Targeting in South Africa
2.1 INTRODUCTION 15
2.2 MONETARY POLICY 18
2.3 OBJECTIVES OF MONETARY POLICY 18 2.3.1 FIRST-ORDER OBJECTIVES 18 2.3.2 SECOND-ORDER OBJECTIVES 19
2.4 MONETARY POLICY DECISION-MAKING 20
2.5 MONETARY POLICY IN SOUTH AFRICA 22 2.5.1 MONETARY POLICY OPERATIONAL PROCEDURES 23
2.6 INFLATION TARGETING MONETARY POLICY 24 2.6.1 DEFINITION OF INFLATION 24 2.6.2 DISADVANTAGES OF INFLATION 25 2.6.3 DEFINING THE ANNUAL INFLATION RATE, CPIX, CORE AND HEADLINE INFLATION 26 2.6.4 INFLATION TARGETING MONETARY POLICY 27 2.6.4.1 Specification of inflation targeting 28 2.6.4.2 Advantages of inflation targeting 29 2.6.4.3 Disadvantages of inflation targeting 29
2.7 MONETARY POLICY INSTRUMENTS 30
2.8 SUMMARY 31 — III —
Page CHAPTER 3 The South African Reserve Bank's Monetary Policy Instruments
3.1 INTRODUCTION 32
3.2 INSTRUMENTS OF MONETARY POLICY IN SOUTH AFRICA 33 3.2.1 OPEN MARKETS OPERATIONS 33 3.2.1.1 Types of open market transactions 33 3.2.2 CASH RESERVES AS MONETARY POLICY 34 3.2.3 TAX AND LOAN AS MONETARY POLICY INSTRUMENT 36 3.2.4 RESERVE BANK ACCOMMODATION AS MONETARY POLICY INSTRUMENT 37 3.2.4.1 The previous system: The bank rate 38 3.2.4.2 Reserve Bank as lender of last resort 39 3.2.4.3 Advantages of the bank rate accommodation system 40 3.2.4.4 Disadvantages of the bank rate accommodation system 40
3.3 THE REPURCHASE AGREEMENT 41 3.3.1 DESCRIPTION AND USES 41 3.3.2 ADVANTAGES OF THE REPURCHASE AGREEMENT SYSTEM 43 3.3.3 THE MECHANICS OF THE REPURCHASE AGREEMENT SYSTEM 43 3.3.3.1 Background of repurchase agreements 43 3.3.3.2 Collateral and eligible securities 44 3.3.3.3 Procedures of daily transactions 45 3.3.3.4 The marginal lending facility (MLF) 47 3.3.4 PROPOSED REFORMS TO THE REFINANCING SYSTEM OF THE RESERVE BANK 47 3.3.4.1 Proposed adjustments to the current accommodation system 48 — iv —
Page CHAPTER 4 The Transparency of the Repurchase Agreement and Monetary Policy Framework
4.1 INTRODUCTION 51
4.2 THE TRANSPARENCY OF THE REPURCHASE AGREEMENT 52
4.3 TRANSPARENCY OF INFLATION TARGETING 54 4.3.1 DEFINING ADMINISTRATIVE PRICES 55 4.3.2 DESCRIPTION OF CATEGORIES 56 4.3.3 THE EFFECT OF ADMINISTRATIVE PRICES ON CORE INFLATION 59
4.4 A PROPOSED TRANSPARENCY MANAGEMENT PLAN 62 4.4.1 The Bank Supervision (management) department 62 4.4.1.1 The South African Reserve Bank 64 4.4.1.2 The South African banks 64 4.4.1.3 The private sector 65 4.4.1.4 The corporate sector 65 4.4.1.5 The government sector 65 4.4.1.6 The consumer 65
4.5 A PROPOSED APPLICATION OF THE MANAGEMENT PLAN 66 FOR TRANSPARENCY 4.5.1 SUPERVISION 66 4.5.2 MONITORING 66 4.5.3 CO-OPERATION 67 4.5.4 CO-ORDINATING 67 4.5.5 CONTROL 67
4.6 SUMMARY 68 - v -
Page CHAPTER 5 Summary, Findings and Recommendations
5.1 INTRODUCTION 69
5.2 SUMMARY 70
5.3 FINDINGS 71 5.3.1 To ENSURE THAT TRANSPARENCY THROUGH EFFECTIVE MANAGEMENT OF 71 THE SOUTH AFRICAN FINANCIAL SYSTEM WILL BE POSSIBLE 5.3.2 To DEFINE THE PURPOSE OF THE REPURCHASE AGREEMENT IN THE SOUTH 72 AFRICAN FINANCIAL SYSTEM 5.3.3 To OBTAIN A BETTER UNDERSTANDING OF MONETARY POLICY WITHIN THE 73 MONETARY POLICY FRAMEWORK 5.3.4 To ELEVATE THE SOUTH AFRICAN FINANCIAL SYSTEM THROUGH TRANSPARENCY 74 5.3.4.1 Supervision as application 74 5.3.4.2 Monitoring as application 74 5.3.4.3 Co-operation as application 75 5.3.4.4 Co-ordinating as application 75 5.3.4.5 Control 75
5.4 RECOMMENDATIONS 76
5.5 CONCLUSION 76
BIBLIOGRAPHY 78
APPENDIXES — vi —
LIST OF FIGURES
Page Figure 1.1 An illustration of the financial system 7
Figure 4.1 Weights in the different inflation indices 56 Figure 4.2 Changes in prices indices 59 Figure 4.3 Comparison between CPIX and administrative prices 61 Figure 4.4 The implication of high administrative prices 62 Figure 4.5 Proposed transparency management plan 63
---o000000--- CHAPTER 1 INTRODUCTION AND ORIENTATION
1.1 INTRODUCTION
The new socio-political structure in South Africa led to a need to reintegrate the economy after a long period of severe isolation (Van der Merwe, 1999:228). South Africa therefore faced an unavoidable change, so that the available liquidity in the market could guide interest rate movements. Under the previous accommodation system the monetary policy of the South African Reserve Bank failed to operate by means of open market transactions, and interest rate movements were solely the discretion of the South African Reserve Bank and was driven by means of the traditional bank rate. The need for a more efficient accommodation system, that is based on open market transactions and determined by demand and supply of liquidity surfaced, and therefore the introduction of the repurchase system in March 1998 was unavoidable.
This research discusses the background of the South African Reserve Bank's repurchase agreement (as transparent financial system) and inflation targeting as monetary policy framework. It also includes a focus on the inflation rate and some aspects regarding the changing economic environment that led to this unavoidable change in the monetary policy by the South African Reserve Bank.
In practice, financial intermediaries started observing certain weaknesses in the efficiency of the repurchase system and inflation targeting in the South African financial market.
The limited number of role-players operating in the daily repurchase tender do not always reflect the direction of short term interest rates as clearly as the South African Reserve Bank would want it to be. Another concern is whether the repurchase system and inflation targeting is more effective and if it can be managed in a more transparent manner. The question can also be asked of how convincingly the South African Reserve
— 1 — Bank sends out its signals, implying its intentions to market players in an ever-changing financial environment. This can be done through using indirect monetary policy instruments, for example, the repurchase agreement.
The task of monetary policy is to maintain a stable financial environment that will be conducive for sustainable economic growth and development (Stals, 1998:1). There is a fairly general consensus in the world of central banking about the goals and objectives of monetary policy, but there will always be differences of opinion on various possible alternative combinations of monetary policy instruments that could be used to achieve the ultimate goal, or on priorities that could be given various intermediate targets within the overall objective.
1.2 RESEARCH PROBLEM
In this research the problem statement is focused on the South African financial system that should apply transparency and purpose of the repurchase agreement, which is not done at this moment. Therefore the problem statement is as follows: "Can the repurchase agreement bring purpose and transparency in the South African financial system?"
To discuss this problem statement the research will also focus on monetary policy and inflation targeting.
1.3 CONCEPTUALISATION
The concepts that form part of the research strategy are purpose, transparency, monetary policy, repurchase agreement, inflation targeting, and the financial system (South African) in which transparency should be managed.
—2— 1.3.1 PURPOSE
Kirkpatrick (2000:656) defined the concept "purpose" as the "reason, point, motivation or justification of a situation." In this research the purpose of the repurchase agreement lies in introducing and implementing a new system to replace the previous accommodation system.
1.3.2 TRANSPARENCY
The concept "transparency" is defined as "clearness, clarity or glassiness" (Kirkpatrick (2000:839). For the purpose of this research, the focus of transparency will imply the methods by which managerial structures can be improved to ensure transparency of the repurchase agreement in the South African financial system.
1.3.3 MONETARY POLICY
Truu and Contogiannis (1996:286) wrote about "monetary policy" as the agency officially in charge of a country and its (in South Africa the South African Reserve Bank) stated mission is to protect the internal and external value of the rand, the implications of monetary targeting means the income equation.
The focus of the monetary policy in this research is in determining the transparency within the South African financial system.
1.3.2.1 Repurchase agreement
One of the South African Reserve Bank's monetary instruments, namely the repurchase agreement system that was introduced on 9 March 1998 (Government Gazette, no 17115) is intended to introduce greater flexibility into the financial market adjustment process, contributing to the main task of monetary policy of maintaining a stable financial environment with sustainable economic growth.
—3— This system used by the South African Reserve Bank to intervene in the money market will have an important influence on the level of interest rates in the South African economy, which itself is one of the key influences of economic growth. The level of interest rates in turn, directly influence the inflation targeting monetary policy framework.
The Reserve Bank changed the procedures of providing liquidity to the banking system, from a virtually automatic accommodation of banks' daily liquidity needs to a repurchase based auction system. A Repurchase agreement can loosely be described as a contract involving the simultaneous sale and future repurchase of an asset at the same price at which it was sold; also on buy-back date, the original seller pays the original buyer interest on the implicit loan created by the transaction. Interest due on a repurchase agreement at maturity is at the stated repurchase agreement rate for the stated maturity of the repurchase agreement.
Repurchase transactions are undertaken regularly in the form of a tender. Banks have to submit their tenders at 12:00 for central bank funds, to provide liquidity in the market. The Reserve Bank might, at 9:00 the next morning, offer a final clearance repurchase agreement if their forecast of the money market shortage was incorrect. It is important to bear in mind that banks tender for the liquidity provided by the central bank (Reserve Bank).
Only banks are allowed to tender and they have to provide collateral such as government bonds, against the money they want from the central bank. This system reduces the pressure from the central bank to take the lead in making political incorrect decisions of manipulating interest rates. The purpose of this provision of central bank funds to the banks via a tender system is to give the banks more scope to manage their liquidity positions efficiently. These operations have the further advantages that they can be implemented quickly, they do not have a significant effect on the price of the underlying asset and they can easily be adapted to changing conditions. Under the new repurchase agreement system, banks participate in a daily tendering procedure, based on repurchase agreements.
—4— The objective is to obtain funds or repay funds to the South African Reserve Bank (Du Plooy, 1998:56). It includes a marginal lending facility where banks can obtain overnight loans subject to certain collateral for funds, which these banks failed to obtain via the repurchase agreement transactions. The marginal lending rate, which is currently fixed at the repo rate plus 5%, is payable on marginal lending transactions. The repurchase agreement system also includes the cash balances with the South African Reserve Bank, which must be maintained on a daily basis, so that the average level of reserves during the maintenance month, also known as a certification month (running from the 15th business day of each month to the 14 th business day of the following month), equals or exceeds the minimum cash reserve requirement set by the South African Reserve Bank. The repurchase agreement system provides for more day-to-day discretion on the side of the South African Reserve Bank, with the objective of making domestic liquidity management the most important operational tool of monetary policy. The repurchase rate assumes a dominant role in the money market, and directly affects both the deposit and lending rates of banks (South African Reserve Bank, 1998).
The ability of the South African Reserve Bank to influence interest rates, depends more than ever on how convincingly it can signal its intention to market participants in today's integrated but volatile financial markets. The new monetary policy operational procedures allow for various forms of signalling which facilitates greater transparency in monetary policy implementation than previous procedures did (South African Reserve Bank, 1998).
This research will discuss the purpose and transparency of the repurchasing agreement of the South African Financial system with reference to monetary policy and inflation targeting.
1.3.2.2 Inflation
In order to understand the concept "inflation" as a phenomenon, the essential nature of inflation must be understood. It is necessary to examine the forces that initiate and sustain inflation (inflation targeting).
—5— Truu and Contogiannis (1996:205) defined inflation as follows: "Inflation is an integral part of the economic system. It is a process of continuously rising prices in a country." Inflation may at times reach proportions where it ultimately threatens to destroy the monetary system, therefore the urgency to have transparency through management in the South African financial system.
1.3.4 FINANCIAL SYSTEM
In South Africa the preferred financial system is the system managed by the South African Reserve Bank. The central bank of the Republic of South Africa is responsible for a number of authoritative functions and tasks which lie outside the domain of other banks and financial institutions. The bank functions in terms of the Reserve Bank Act of 1944, as amended. Kelly (1993:22) claimed the Reserve Bank:
• Issues the banknotes and coin of South Africa's monetary system.
• Is the government's banker. • Acts as bank to the private sector banks and provides the inter-bank clearing and settlement mechanism. • Provides facilities for the clearing and settlement of inter-bank claims. • Is the custodian of South Africa's gold and other foreign reserves, and the marketer of the country's gold production. • Originates and executes monetary and exchange-rate policies in conjunction with the Department of Finance.
• Maintains South Africa's relations with various international and private financial institutions, organisations, central banks and governments.
This institution is the basis from which the financial system is managed. Hence the hypothesis that the management of the financial system can bring transparency in the monetary policy framework.
The other players in the financial field are the commercial banks, monetary institutions such as the JSE Securities Exchange and international investors.
—6— Figure 1.1 The financial system (financial intermediation)
LENDERS • BORROWERS Money Money
FINANCIAL INTERMEDIARIES SECTORS Indirect Primary SECTORS r securities securities r Household Household Corporate Money Corporate Government Government Foreign Primary securities Foreign
(Fourie, Falkena & Kok, 1992:4)
1.4 DEMARCATION OF THE FIELD OF STUDY
The research discloses the field of study as the effective management of monetary policy in the South African financial system. Management of a financial system can be done in different ways. In this research the focus is on monetary policy that will enhance the transparency of the South African financial system. Therefore the first focus of this research is on the management tasks to be fulfilled in order to ensure effective management.
1.4.1 MANAGEMENT
A general definition of management is fixed on the managerial tasks of planning, organising, leading and controlling in a certain situation. In the financial world a manager has to perform above-mentioned managerial tasks to ensure effective outcomes of an organisation's mission statement.
—7— Different authors define and describe management in the field of finances as follows:
• Fourie, Falkena and Kok (1992:32) express the following about management, "Management is the single most important aspect and often the most difficult to assess by a manager."
• Kelly (1993:54) claimed "Financial management is an essential aspect of successful bank management at the highest level to make an optimal allocation of a bank's money, creating potential opportunities."
When banks require cash balances, which are not obtainable from any other source (inter-bank movements), they may obtain such cash balances through the use of credit channels made available to them by the Reserve Bank (Kelly, 1993:295). For this reason the South African Reserve Bank is known as "lender in the last resort." Management of these tasks require good planning, organising, leadership and control. The use of these credit facilities by the banks entails the rediscounting of Treasury Bills and Land Bank Bills at the Reserve Bank, or by obtaining overnight loans from the bank secured mostly by securities acceptable to the Bank for this purpose. To implement managerial tasks (mentioned above) they must ensure that other avenues of accommodation or refinancing is also available at the Bank, such as the purchasing by the Bank of eligible securities under the repurchase agreements.
The outright purchase of securities by the Bank, the placement of funds of the Corporation for Public Deposits with banks, sometimes by tender, and by varying the amount of Treasury Bills offered at the weekly Treasury Bill auctions are functions that have to be exercised in a transparent way by management.
1.4.2 ECONOMICS AND FINANCES
A financial system forms part of the economic system of a country. Economics has a double meaning. On the one hand it is a science, an academic discipline, on the other hand it is a practical side of everyday life. Economics has been associated with the measuring of money, the causes of material welfare, the system of exchange of goods
—8— and services. Finances are the "measuring of money" that enable people to exchange goods and services.
Kelly (1993:5) describes the financial system as "(The) financial securities (described below) are of extreme importance in the functioning of the banking system. Banks, including the Reserve Bank, and other financial institutions trade extensively and continuously in such securities on the money and capital markets."
1.5 OBJECTIVES AND AIMS OF THE RESEARCH
1.5.1 OBJECTIVE OF THIS RESEARCH
The objective in this research is "To ensure that the purpose and transparency through effective management of the South African financial system, the monetary policy framework will compliment monetary instruments e.g. repurchase agreement and inflation targeting." Thus, the aims of the research, discussed in the following paragraph, have to enlighten the practical implementation of such purpose and transparency.
1.5.2 AIMS OF THIS RESEARCH
The following research aims will define the research strategy. The aims of the research are:
To ensure that transparency through effective management of the financial system is possible. To define the purpose of the repurchase agreement in the South African financial system. To obtain a better understanding of the monetary policy within the monetary framework. To elevate the level of efficiency of the South African financial system through transparency.
—9— The aims mentioned above will enable the researcher to follow a research path concentrating on literature that will contribute to the research paradigm.
1.6 RESEARCH METHODOLOGY
The researcher chooses to exploit and search the existing literature to enhance the scientific fundamentals of this research and the trends arid facts of this research: "Monetary policy has to ensure transparency of the financial system in South Africa."
Research is a science where the researcher must focus and concentrate on ethical issues that influence the researcher's decisions and activities through the course of the research. Therefore concepts like "truth", "rationality" and "objectivity" has to lead the research path.
This formulation of the close relationship between truth, rationality and objectivity, emphasises the "social" dimension of science. The judgements according to which (problem) statements are accepted or rejected are the collective judgements of the scientific (research) community. Thus the scientific research comprises of:
• Truth: statements that establish stronger or weaker fits/approximations of the truth, that are • Rationality: accepted by the scientific community — on the basis of rational evaluation and scrutiny. • Objectivity: based on objective evidence derived from the application of objective methods/techniques.
The researcher can use different methods to gather data for the research. In this research the research of literature was chosen. A literature study is focused on existing sources written by authorities on a particular field of study.
The sources must be studied and patterns or conquering behaviour must be looked at to find the links to enlighten the problem statement of the research. This will be an asset to existing research and prospects for future research.
— 10 — McMillan and Schumacher (1992:112) wrote the following about literature study as research methodology. "An interpretative review of the literature is exactly that — a summary and synthesis of relevant literature on a research problem." A literature study is a critical review of the status of knowledge on a carefully defined topic. Literature review enables a reader to gain further insights from the purpose and the results of a study. Literature study includes many types of sources:
Professional journals Reports Scholarly books Monographs Government documents and Dissertations
A review of the literature serves several purposes in research. Knowledge from the literature is used in stating the significance of the problem, developing the research design, relating the results of the study to previous knowledge, and suggesting further research. A literature study enables a researcher to:
Define and limit the problem Place the study in a historical and associational perspective Avoid unintentional and unnecessary replication Select promising methods and measures Relate the findings to previous knowledge and suggest further research (McMillan & Schumacher, 1992:113).
In a literature study, the researcher has primary and secondary sources to use for the theoretical foundation of the research. Primary sources are the original research studies or writings by a theorist or researcher. Primary literature contains the full text of a research report or a theory and thus is more detailed and technical. Examples of primary literature sources are:
Empirical studies published in journals/books
— 11 — Scholarly monographs Research reports Dissertations
Secondary literature provides different information. A secondary source gives an overview of the field, a general knowledge of what has been done on the topic of research and a context for placing current primary sources into a framework.
• Textbooks on the field of study • Articles in encyclopaedias and magazines that summarise above-mentioned sources.
The purpose of secondary sources is to get an overview of the field of study that the researcher is researching. Literature study is structured and organised to make sure all the relevant knowledge is found and use in the new research. Steps in reviewing the literature include the following:
Analyse the problem statement Search and read secondary literature Select the appropriate index for a reference service or database Transform the problem statement into search language Conduct a manual and/or computer search Read the pertinent primary literature Organise notes Write the review (McMillan & Schumacher, 1992:117).
Above-mentioned logical steps will ensure that the researcher write a logical review of literature researched. When research is undertaken on any topic, the three characteristics, validity, objectivity and accurateness must be taken into consideration to ensure the truthfulness of the research. The choice of research method must be motivated through the research objectives and aims.
The first aim is the universal validity that the researcher must search for.
— 12 — • The second aim of the researcher is to ground the research theoretically in a sound scientifically responsible way to ensure valid results for the research. • Thirdly the research must have a systematic organised framework that structures the research. • The fourth aim is to enhance research discipline with scientific language and knowledge (Mouton & Marais, 1992:198).
1.7 RESEARCH DESIGN (PROGRAMME)
In chapter one an introduction was given to which research path the researcher will follow. The focus of this research is to enlighten the following: "The purpose and transparency of the financial system in South African." The concepts of this research e.g. purpose, transparency, monetary policy and financial system were defined in order to determine the depth of the research focus.
Chapter two and three will cover the theoretical background of this research. In chapter two, monetary policy, management and inflation targeting in the financial system will be discussed while the purpose and transparency of the repurchase agreement will be researched in chapter three.
A possible transparency management style will be proposed in chapter four with suggestions of application in the workplace. In chapter five the findings of the trends and possible solutions in the literature with recommendations and summary will conclude the research. Chapter five will further summarise the results and findings obtained in the previous chapters. Some conclusions will be made, weaknesses will be pointed out, and recommendations will be suggested. South Africa, as a unique emerging market, might require some adjustments in order to make transparency more effective in an ever changing and extremely volatile market place.
— 13— 1.8 CONCLUSION
In this chapter the fundamental bases were established to underwrite the title of this research: "The purpose and transparency of the repurchase agreement in the South African financial system." Concepts that focus on the research path were defined.
These definitions declare the focus of the research to ensure the researcher follows a strategy of objectivity, truth and validity. The research discussed the method that the research will be conducted in. It also discussed the criteria that must be fulfilled to establish validity for the research. In the next chapter the researcher will give an overview of monetary policy and inflation targeting in South Africa.
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— 14 — CHAPTER 2 AN OVERVIEW OF MONETARY POLICY AND INFLATION TARGETING IN SOUTH AFRICA
2.1 INTRODUCTION
There is fairly general consensus in the world of central banking today that the task of macroeconomic policy is the promotion of economic growth and development, the employment of more people and the improvement of living conditions of all citizens in a country. Monetary policy, being part of macroeconomic policy, has an intermediate role to play in the implementation of overall macroeconomic policy and is conducted by the central bank of a country. Monetary policy is expected to create and maintain a stable financial environment within which overall economic activity can be expanded.
Like many other emerging countries, South Africa was severely affected by financial turbulence in international financial markets during the Asian crisis of 1998. The constitution of the Republic of South Africa and the South African Reserve Bank Act, therefore requires the Reserve Bank to maintain financial stability in the interest of sustained economic development, by practising monetary policy that appeals specifically to the South African financial system.
The current mission statement of the South African Reserve Bank adopted in August 1990 makes it clear that the ultimate objective of monetary policy is to achieve price stability, i.e. to ensure that the internal value (purchasing power, measured with the Consumer Price Index) and external values (Rand/Dollar exchange rate) of the rand are stabilised as far as possible.
This view of the Bank's prime responsibility was also emphasised in the Constitution of 1996, which orders the Central Bank to pursue price stability in the interest of economic growth and a sound economy. The suitability of this objective for a central bank has become widely accepted only in the past decade or so. During the 1960's and 1970's it
— 15 — was generally assumed that adopting stimulatory economic policies could increase employment, albeit at the cost of a somewhat higher inflation rate. Since the first oil crisis in 1973, which produced acceleration in inflation in most major economies, this relationship has largely broken down, and recent evidence suggests that employment and inflation are often positively correlated (Fourie, Falkena & Kok, 1999:310). It is now generally accepted that monetary policies, which promote higher inflation, may well lead to a weaker performance of the real economy. High rates of inflation discourage savings and investment, and thereby damage an economy's potential for economic growth.
Consequently, most monetary authorities around the world have come round to view that price stability should be the ultimate objective of monetary policy. In other words, price stability is perceived to be raising the growth rate of the economy. Many central banks in effect are now trying to maintain price stability to keep the growth in monetary demand more or less continuously and broadly in line with underlying growth capacity in the economy.
Barro (1995:166-175) carried out a statistical analysis of the effects of inflation on economic growth drawn from experience of more than one hundred countries over thirty years. His main finding was that an increase in the inflation rate of 10% tends to reduce national growth rates by 0,2 to 0,3 percentage points per annum. Taking this result and using compounded interest, it can be shown that a 10% increase in the inflation rate lowers the level of real gross domestic product after thirty years between 4% and 7% percent. The gross domestic product can be defined as the total value of all final goods and services produced within the geographic boundaries of a country in a particular period (Mohr, 1998:19).
In most industrialised countries price stability is considered to prevail if the rate of increase in consumer prices is in the range of 0% to 2% percent. In other countries, which suffer from higher rates of inflation, such as South Africa who's inflation rate during the period from 1994-1997 averaged above 10%, monetary policy must first aim at bringing down the inflation rate before attempting to stabilise prices in absolute terms. A low inflation rate is a key factor in attracting foreign capital, which in turn affects the growth potential of the economy.
— 16 — Financial stability is regarded as a prerequisite for the promotion and support of economic development. This could be achieved when there is a high degree of confidence that the financial infrastructure of the economy is able to meet the requirements of market participants. The two elements of financial stability, i.e. price stability and stability of the financial sector, are closely related. Failure to maintain one of these elements provides a very uncertain operating environment for the other, with causality running in both directions. For example, high inflation can lead to tighter monetary policy, higher interest rates, an increase in the non-performing loans of the banks and a fall in asset and collateral values, which can cause bank and other failure in the financial sector.
Conversely, disruptions in the financial system will make the transmission mechanism of monetary policy less effective and can materially affect changes in the general price level (Mboweni, 2000:2).
Since the late 1970's, the South African monetary policy has been brought progressively in line with, "accepted international practice." This occurred under two Governors of the Reserve Bank. Under Governor De Kock (1981-1989), most of the direct control instruments were replaced by market-orientated policy instruments. Interest rates also became the operational variable of monetary policy during this period. Governor Stals (1989 - 1999), adopted monetary stability as the primary monetary objective and initialised the harmonisation of banking business with other financial services within a consistent regulatory framework, recognising the increased freedom of movement of capital, not only locally, but also throughout the world (Absa Bank, 2000:2).
According to the Keynesian demand management approach, monetary policy was seen as a useful instrument to be used by authorities to depress demand in times of an excessive rise in total real expenditure on goods and services, or to stimulate real demand in times of recessionary conditions (Kaufman, 1977:304). Thus, the central bank will drive interest rates higher when it wants to reduce lending and borrowing in the economy, and slow down the pace of economic activity. On the other hand, it can lower interest rates when it wishes to stimulate business and consumer borrowing, as well as
— 17 — overall economic activity. In other words, financial stability should therefore be maintained throughout the business cycle in both the expansion and contraction phases of the economy (Stals, 1997:3).
2.2 MONETARY POLICY
According to Meijer, Falkena and Van der Merwe, (1991:107) monetary policy consists of decisions (excluding decisions involving the taxing and spending powers, but possibly including decisions involving the borrowing powers of the central government) that are formulated and implemented by the monetary authorities (i.e. by the central bank, or by the Treasury and the central bank) in their various fields of operations which are aimed at achieving certain ultimate objections with regard to the country's economy. These ultimate objections in turn are striven for by influencing primarily the volume or composition of domestic expenditure and output in an economy mainly through appropriate use of interest rates.
Monetary policy can also be defined as the total complex of measures applied by the monetary authorities, aimed at influencing the money stock and its rate of growth and/or the cost and availability of credit in the economy (Jones, 1988:114).
Moreover, in the contemporary world, and more particularly in the developed economies in the world, it is now widely accepted that these ultimate objectives crystallise around the aim of achieving broad monetary stability in an economy.
2.3 OBJECTIVES OF MONETARY POLICY
The following objectives will intend the focus on monetary policy as discussed previously.
2.3.1 FIRST-ORDER OBJECTIVES
Relative stability of the general price level; A high and stable level of employment of the labour force;
— 18 — A satisfactorily high rate of expansion of output (i.e. satisfactory real economic growth), provided this rate of growth is not inconsistent with optimisation of the country's rate of real economic growth and development in the long run; A satisfactory balance of payments, foreign reserves, and exchange rate position. Improvements in the distribution of income and wealth; The protection of, or promotion of the development of, specific industries or geographical regions; Improvements in the pattern of private consumption; Ensuring the security of supply (Fourie et al., 1992:294).
2.3.2 SECOND-ORDER OBJECTIVES
The following further objectives can be referred to as objectives served by governmental "instruments of money and credit":
• Improvements in the distribution of income and wealth; • The protection of, or promotion of development of, specific industries or regions; • Improvements in the pattern of private consumption • Ensuring the security of supply (Meijer, Falkena & Van der Merwe, 1991:361).
As listed above the primary objective (first and second order objectives) of monetary policy is to protect the value of the currency in order to obtain balanced and sustainable economic growth in the country. This objective is articulated in both the Constitution of the Republic of South Africa and in the South African Reserve Bank Act, No 90 of 1989. It requires the achievement of financial stability, i.e. price stability as well as stable conditions in the financial sector as a whole.
Price stability is achieved when changes in the general price level do not materially affect the economic decision-making processes. Although relative price movements will still have an impact on production, consumption, saving and investment, the rate of inflation or deflation would be so low that it would no longer be an important factor in economic decision making.
— 19 — Stable conditions in the financial sector are achieved when there is a high degree of confidence that the financial institutions and financial markets are able to meet contractual obligations without interruption or recourse to outside assistance.
Such stable conditions do not preclude the failure of individual financial institutions. A financial institution can fail and be allowed to fail even under stable financial conditions. It is only when the whole, or an important part, of the financial sector is at risk, that the situation can be described as financially unstable. For example, high performing loans of banks and a fall in asset and collateral values, which could precipitate bank and other failures in the financial sector. Conversely, disruptions in the financial system will make the transmission of monetary policy less effective and could materially affect changes in the general price level.
Financial stability is not an end in itself, but is regarded as an important precondition for sustainable high growth and employment creation. By establishing and maintaining financial stability the monetary authorities make their unique contribution to general economic development in South Africa. If financial institutions and markets are uncertain or unstable, it is difficult to produce, consume and invest, and therefore to increase employment. The recent emerging-market financial crisis in 1997 and 1998 has also clearly illustrated that foreign investment can be withdrawn easily and in large amounts when investors feel that uncertainty exists in a country and that a country have difficulty in maintaining inflation at satisfactory levels (Stals, 1998:4).
2.4 MONETARY POLICY DECISION-MAKING
Some important changes were introduced during the past year in the internal decision- making structure of the Reserve Bank, i.e. on management level.
The focus is on decision-making as one of managerial sub tasks to bring resolution and resolve certain issues (transparency) in the structure of the Reserve Bank. The functions of the Governors' Committee, a sub-committee of the Board of the Bank, have been redefined to distinguish clearly between its responsibilities with regard to monetary
— 20 — policy, and those pertaining to the administration of the bank. The former General Managers' Committee, consisting of the top administrative management of the Bank, has been replaced by three functional committees:
• The Monetary Policy Implementation Committee (MPIC), responsible for the development and implementation of monetary policy, mainly by co-ordinating the Bank's operations in the money and capital markets and in the market for foreign exchange; • The Currency, Payment and Financial Systems Committee, responsible for the monitoring and administration of the national payment system, the provision of banknotes and coins and other instruments of payment, and the supervision and regulation of banking institutions; and • The Management Committee, with the task of co-ordinating and monitoring the internal administration of the Bank (Stals, 1998:5).
All three committees advise and make inputs to the Governors' Committee on aspects of monetary policy in the broadest sense, directed towards the maintenance of overall sound and stable financial conditions. Each one of the committees is headed by a Deputy Governor to ensure that the work of the committees and the Governors' Committee will be fully integrated. The MPIC is headed by the Deputy Governor responsible for the Bank's domestic money and capital market and foreign exchange market operations and other members comprise the senior officials of the relevant departments.
The other Deputy Governors may also attend MPIC meetings. In addition, the Economics Adviser to the Governors serves as a link between the Governors' Committees and the MPIC. It remains the responsibility of the Governors' Committee to obtain final direction from the Board of Directors for all the activities of the Bank (Stals, 1998:2). The Integration of the South African Financial System in the Global Financial Markets was addressed by the Governor of the South African Reserve Bank, at the Financial Forum of the National Bank of Belgium on 13 May 1998, Brussels, Belgium.
—21 — 2.5 MONETARY POLICY IN SOUTH AFRICA
The Reserve Bank's monetary policy is aimed at creating an environment of financial stability, which is conducive to economic growth in the medium to long term. The monetary policy objective therefore is an intermediate objective and is deemed to be a necessary but not sufficient precondition for economic growth and employment creation. The growth and employment objectives fall within the ambit of the South African governments' macroeconomic strategy, .Growth, Employment and Redistribution (GEAR).
Significant success has been achieved with the monetary policy model of the South African Reserve Bank during the past decade. However, important structural changes in the South African financial system in recent years have altered the transmission mechanism and weakened the more stable relationships that previously existed. These changes consisted between the money supply and in bank credit extension, on the one hand, and nominal spending on goods and services and in prices on the other hand. Changes in the monetary aggregates have for the time being, lost some of their usefulness as the most important indicators of possible future trends in inflation, and therefore also as an anchor for monetary policy decisions.
The Reserve Bank has tentatively assumed a goal of maintaining inflation at a level that would be more or less in line with the average rate of inflation in the economies of South Africa's major trading partners and international competitors.
In the current international inflation environment this translates into an inflation rate of between 1% and 5% per cent per annum. In the current circumstances, South Africa must move gradually towards targeting inflation directly: "In the [altered] situation, South Africa has to consider more seriously the introduction of inflation targets as an anchor for monetary policy purposes" (Stals, 1998:3).
It is important that the Reserve Bank enhances transparency for the effective operation of an inflation-targeting framework. Transparency introduces predictability, and helps to ensure that expectations are consistent with the objective of price stability, thus lowering
— 22 — the cost of achieving the inflation target. As pointed out by prominent economists many years ago, monetary policy should avoid exacerbating fluctuations of output and employment by introducing unnecessary uncertainty.
A transparent monetary policy will mean that changes in short-term interest rates should not surprise the market. Markets should be able to anticipate decisions taken by the Reserve Bank. Transparency should promote the predictability of policy. In this regard Mervyn King, deputy governor of the Bank of England, has stated that a successful central bank should be boring, it is like a referee whose success is judged by how little his or her decisions intrude on the game.
2.5.1 MONETARY POLICY OPERATIONAL PROCEDURES
Kirkpatrick (2000:563) defined "operational procedures" as "workable processes", thus procedures that will enhance transparency.
The application of an inflation-targeting monetary policy framework in South Africa will not directly affect the monetary policy operational procedures of the Reserve Bank.
As in the past, the Reserve Bank's operations will be aimed at influencing the overall lending policies of banks, and also the demand for money and credit in the economy indirectly through changes in bank liquidity and interest rates in the money market by using monetary policy instruments, like open market transactions with specific regard to the repurchase agreement system.
The regular repurchase transactions (repo) between the Reserve Bank and banks will remain the main apparatus to regulate liquidity in the market. Fine-tuning measures will also be utilised to neutralise temporary fluctuations in bank liquidity and to steer money market interest rates and yields in the desired direction.
The instruments that will be used for fine tuning will consist of additional repurchase or reverse-repurchase transactions, sales or purchases of short-term Treasury bills, Reserve Bank debentures, adjustments in the asset portfolio of the Corporation for
— 23 — Public Deposits, the transferring of government funds between Tax and Loan Accounts at private banks and the Exchequer Account at the Reserve Bank, and foreign currency swaps.
At times longer-run adjustments may be needed due to structural changes in the liquidity needs of the money market, or because of changes in the monetary policy stance. These adjustments are usually made to increase or decrease the private banks' need for central bank money on a lasting or longer-term basis. In addition to repurchase transactions, outright sales or purchases of domestic securities and variable cash reserve requirements are and will still be applied to adjust the structural liquidity needs of banks (Mboweni, 2000:5).
2.6 INFLATION TARGETING MONETARY POLICY
The concept inflation-targeting enlighten the meaning of what inflation is. Inflation distorts investment and savings decisions, raise the risk premium on long-term interest rates and undermines the allocative efficiency of the price mechanism. The focus of monetary policy on the single objective of price stability is crucial to convince savers and investors that, in taking their decisions, they do not need to factor in a large inflation risk. To this end, monetary policy operates primarily on the demand side of the economy and in this sense the policy has an important but more indirect role in allowing the economy to achieve this longer-term growth potential. This involves ensuring the demand in the economy grows roughly in line with the capacity of the economy to meet the demand. The pursuit of price stability in the rest of the world and the success achieved by many countries in bringing their inflation rates down to low levels, has left South Africa with no alternative but to bring its inflation in step with that of the rest of the world (Van der Merwe, 1997:3).
2.6.1 Definition of inflation
Kaufman (1977:512) defines inflation as acceleration in the overall price level in the economy.
— 24 — Firstly, Inflation is best described as a sustained rise in the general level of prices. The operative words in this definition are "sustained", "rise" and "general level": inflation refers to the process or processes of rising prices rather than a state of high prices.
Described in this manner, inflation can be identified only by observing, over some fairly prolonged period, changes in some aggregate measures of prices, and not by observing changes in the price of a single specific commodity, product or service. Rates of inflation may be measured with regard to variety of sets of goods and services.
Secondly, inflation refers to the rate of increase in the average (normally a weighted average) of prices of the goods and services that are included in the price index or price indices concerned.
Thirdly, inflation has been stated to be a sustained rise in the general price level. A purely temporary rise in the price level that soon reverses itself, or a once-and- for-all rise in the price level over a relatively short period, will not normally be regarded as inflation (Meijer, Falkena & Van der Merwe, 1991:166).
2.6.2 Disadvantages of inflation
Some comments have already been made about the various disadvantages of inflation on the economy; inflation has many other disadvantages, such as:
• Distorting the allocation of resources and often directs the efforts of entrepreneurs and investors into hedging operations instead of productive activity; • Discouraging saving: people spend money now rather than save for investment and future consumption if the expected value is much less; • Discriminating against fixed salaried workers, pensioners and low-income earners who cannot protect themselves against the impact of inflation; and
— 25 — • Usually leading to an even more unequal distribution of income and wealth (Mboweni, 2000:2).
2.6.3 Defining the annual inflation rate, CPIX, core inflation and headline inflation
• The annual inflation rate: is the change in the Consumer Price Index (CPI) for all items of the relevant month of the current year compared with the CPI for all items of the same month in the previous year expressed as a percentage.
• CPIX: is the CPI excluding interest rates on mortgage bonds and is derived by excluding the interest rates on mortgage bonds from the basket of goods and services, which is used to compile the Consumer Price Index. In other countries in the world such as New Zealand, Sweden and Australia, which adopted CPIX as inflation targeting measure, different measures of the inflation rate have been derived and applied such as the Core index, and the CPI excluding interest rates on mortgage bonds. The CPIX are used as the official inflation targeting measure in South Africa
Core Inflation: The primary objective of calculating core inflation is to capture the underlying inflation pressures in the economy, i.e. the trend in the general price level which reflects the balance between aggregate demand and supply in the economy over the medium term. Core inflation is a measure designed in relation to the specific structure of a country's economy. Hence in the South African context, core inflation is derived by the change in the Core index of the relevant month of the current year compared with the Core index of the same month in the previous year expressed as a percentage.
The core index is derived by exclusions from the CPI on the basis that changes in their prices are policy.
Exclusions from the CPI to obtain the core index, and the reasons for exclusion are as follows —
— 26 — Fresh and frozen meat and fish: Prices may be highly volatile, particularly during and following periods of drought.
Fresh and frozen vegetables and fresh fruit and nuts: Prices may be highly volatile from month to month due to their sensitivity to climatic conditions.
Interest rates on mortgage bonds and overdrafts/personal loans: These are excluded due to their "perverse" effect on the CPI. A tightening in monetary policy to counter inflation pressures would cause interest rates to rise and be reflected in the interest cost component of measured inflation. This, in turn, could provoke a further tightening of monetary policy resulting in excessive movements in the inflation rate.
Changes in VAT (Value Added Tax): VAT is predominantly determined by government (fiscal policy).
Assessment rates: These taxes are predominantly determined by local government.
Headline inflation: The overall basket of products and services measured in the economy (Stats SA, 2001).
2.6.4 INFLATION TARGETING MONETARY POLICY
According to Johnson (1999:4) "The forward looking nature of an inflation targeting framework implies that the central bank must have access to both a decent inflation forecasting model and policy instruments that affect the inflation forecast with reasonable precision."
The adoption of an inflation target implies greater reliance on forward indicators of inflation and a continuous assessment of the relationship between the instruments of monetary policy and the inflation target. On 23 February 2000, the Minister of Finance, Mr. Trevor Manuel, announced in the annual budget speech that the government had decided to set an inflation target range of 3%-6% for the year 2002, measured by CPIX.
— 27 — The Reserve Bank has therefore formally adopted an inflation-targeting monetary policy framework.
This means that monetary authorities are now targeting the rate of inflation directly instead of following the preciously applied "eclectic" monetary policy approach in which intermediate objectives still played a prominent role (Manuel, 2000:6).
2.6.4.1 Specification of inflation targeting
• The inflation target has been specified as achieving an average rate of increase in the overall consumer price index, excluding mortgage interest cost, (the so- called CPIX) of between 3% and 6% for the year 2002.
• The authorities opted for a variant of the consumer price index because the headline or overall consumer price index is influenced directly by changes in the Reserve Bank's repo rate through its effect on interest rates. A reduction in the repo rate or a relaxation of monetary policy leads, with a short lag, to a decrease in the consumer price index signalling lower inflation, while an increase in the repo rate or a more stringent monetary stance leads, with a short lag as well, to an increase in the consumer price index signalling higher inflation. To overcome this problem, it was decided to exclude mortgage interest cost from the consumer price index for inflation targeting proposes.
The authorities also decided against using the so-called core inflation rate (i.e. the change in the overall consumer price index excluding the prices of certain food products, interest rates on mortgage bonds, overdrafts and personal loans, value-added tax and property taxes) for inflation targeting purposes. The measurement of core inflation has the advantage that it excludes prices directly affected by policy measures as well as some prices over which policy has no direct control and which can lead to misleading signals when these prices are affected by economic shocks. However, it does not exclude the impact of all these kinds of prices, such as changes in oil prices.
— 28 — 2.6.4.2 Advantages of inflation targeting
An advantage according to Kirkpatrick (2000:17) means benefit or asset. The following advantages are focussed on inflation targeting.
• Inflation targeting can improve the co-ordination between monetary policy and other macro-economic policies depending on the way the target is set and whether the target is consistent with other policy objectives.
• The setting of inflation targets should be a joint effort between the government and the central bank. Inflation targeting will be most effective when economic policies are well co-ordinated.
• The announcement of inflation targets clarifies the central bank's intentions and reduces uncertainty about the future course of monetary policy. Inflation targets will make monetary policy more transparent and make the central bank's intentions explicit in a way that should improve the planning of the private sector.
• Inflation targeting helps to discipline monetary policy and strengthens the central bank's accountability. If targets are not met the central bank has to explain what went wrong. This will lead to a better understanding on the part of the public on what basis monetary policy decisions were made (Fischer, 1997.3).
2.6.4.3 Disadvantages of inflation targeting
Kirkpatrick (2000:202) claimed that a disadvantage is a drawback or weak spot. Although inflation targeting has certain definite advantages when compared with other monetary policy frameworks, it could also have certain disadvantages:
• One of the limitations of inflation targeting is that it is a complicated approach to implement. Although all monetary policy frameworks should be forward looking, inflation targeting relies heavily on forecasts. Where inaccurate forecasts are
— 29 — made public it can obscure the central bank's objectives and reduce its credibility.
• Compared with other monetary policy frameworks there is also the risk that inflation targeting could lead to inefficient output stabilisation. This can occur particularly in the event of significant supply shocks, such as sharp changes in the price of oil (Mboweni, 1999:3).
2.7 MONETARY POLICY INSTRUMENTS
In order to attain the requisite level of market interest rates, central banks make use of various monetary policy instruments at their disposal. A monetary policy instrument is measuring tools used in the monetary policy framework. There are two types of policy instruments that can be distinguished, namely indirect measures and direct measures. Indirect policy (market-oriented) measures are actions taken by the central bank whereby it achieves its monetary policy aims by encouraging market participants to take particular actions as regards their lending and borrowing behaviour as a result of price and interest rate incentives or disincentives brought about in the financial markets.
More particularly, these incentives or disincentives arise out of technical intervention by the Central Bank in the various financial markets involving the buying and selling of specified financial claims such as government stock, Treasury bills, bankers' acceptances and foreign exchange in order to influence prices and therefore interest rates.
In South Africa the best-known examples of indirect (market-oriented) policy instruments include the following:
The accommodation policy of the Reserve Bank Open market transactions Buying and selling operations of the Reserve Bank in the spot and forward foreign-exchange markets
— 30 — Direct (non-market-oriented) policy instruments refer to those measures taken by the central bank that seek to attain the aims of monetary policy by means of certain rules prescribing the behaviour pattern of banks and possibly other financial institutions.
These instruments are usually associated with a suspension of market forces, involving either rigid behaviour rules or the fixing of certain variables. For the purpose of this research the focus will be on the Reserve Bank's accommodation policy as indirect policy measure, with specific regard to the newly introduced repurchase agreement system. The other instruments will not be discussed as it falls outside the scope of this research.
2.8 SUMMARY
In this chapter the focus was placed on the monetary policy and inflation targeting. The advantages and disadvantages of inflation targeting were discussed to show the purpose of monetary policy. In the literature the monetary policy showed a lack of transparency that under line the purpose of this research. The theoretical overview showed that the South African financial system was brought in line with the rest of the world in theory, but have to be applied in practise to show managerial effort in order to enhance transparency.
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—31 — CHAPTER 3 THE SOUTH AFRICAN RESERVE BANK'S MONETARY POLICY INSTRUMENTS
3.1 INTRODUCTION
Recent developments in the financial markets revealed a need for greater transparency and flexibility in the practice of monetary policy in South Africa. Under the previous monetary policy procedures, short-term interest rates seldom responded immediately to changes in the overall liquidity positions of banks. Conditions under which the old bank rate operated were a reflection of a closed economic environment where interest rates remained rigid for long periods of time. This did not accurately reflect liquidity conditions in the money market, with large fluctuations in the accommodation provided by the central bank seen on a daily basis.
The need consequently arose for a rate that would more accurately reflect the supply and demand of money (Delport, 1998:3). The changes in monetary policy in South Africa recognised the changing environment in which the Reserve bank must now operate, which is more globalise with larger and more volatile capital movements. Cognisance has been taken of the fact that large international capital movements can easily disrupt trends in all the major financial aggregates, either temporarily or for a longer period of time.
Preferably, the main monetary policy instruments should react quickly and sensitively to periodic changes in the underlying conditions in the financial markets in order to maintain or restore equilibrium in these markets. Interest rates should therefore be flexible and not constrained by rigid monetary policy controls (Van der Merwe, 1998:4).
— 32 — 3.2 INSTRUMENTS OF MONETARY POLICY IN SOUTH AFRICA
In order to attain the requisite level of market interest rates, central banks make use of various monetary policy instruments at their disposal. Two types of policy instruments can be distinguished, namely indirect measures and direct measures.
For the purpose of this script the focus will be on the Reserve Bank's indirect policy instruments, with specific regard to the accommodation policy. The direct policy measures will not be discussed as it falls outside the scope of this script.
3.2.1 OPEN MARKET OPERATIONS
Open market transactions involve the trading (i.e. purchasing or selling into the market) of public sector stock and other marketable securities by the Reserve Bank with the aim of changing liquidity conditions in the market (ABSA, 2000:17).
It is further stated (ABSA, 2000:17) that the Open market operations refer to the purchase or sale by the central bank in the market of any kind of asset in which it deals, whether it be government securities or other securities, bankers' acceptances or even foreign exchange. The aim behind these operations is to affect banking liquidity either positively or negatively. Open market operations, involving the purchase of securities by the central bank, are usually undertaken for the specific purpose of injecting cash reserves into the domestic banking system. In contrast, open market sales will be made for draining cash reserves from the banking system. Such operations will therefore affect the liquidity shortages.
3.2.1.1 Types of open market transactions
The bulk of open market transactions consist of transactions in government stock, the market for such securities being far larger than in the case of other securities such as Treasury bills. Long-term government stocks have been the main vehicles whereby the Bank has conducted open market transactions. There is only a limited market in short-
- 33 — term government paper, partly because banks keep such paper to comply with liquid asset requirements.
Special types of open market requirements are also conducted at occasions. According to Fourie et al, (1984.374) in a move to promote more active open market operations the Reserve Bank in June and July 1980 issued and sold roughly hundred (R100) million of its own interest-bearing securities into the market.
Apart from being issued at time of excess liquidity in the financial markets, the issue of Reserve Bank securities in the open-market maybe useful when the Treasury is needing to finance large budget deficits and is reluctant to make more paper available to the Reserve Bank so that the latter can sell it in the open market to drain liquidity in the system. During the last decade, open market operations have been extended to include repurchase agreements under which tenders on occasion are invited from the banks for the sale of assets to the Bank for temporary periods before being bought back. It can be said that transactions involving repurchase agreements can become the most important instrument in operations undertaken by the Reserve Bank in the future.
In addition, foreign-exchange swaps are executed occasionally to drain excess liquidity from the money market. Under this arrangement foreign exchange is sold spot to the banks for rand against a forward repurchase and is place on deposit with the Reserve Bank where interest is earned. In effect a portion of the banks reserves moves from a spot position to a forward position. Under different circumstances it is possible that the Bank will pump liquidity into the banking system by buying dollars on spot basis in return for rand, and selling the dollars on a forward basis in return for rand.
3.2.2 CASH RESERVES AS MONETARY POLICY
In the 1990's legislation permitted variations in cash reserve requirements for banks to be used along with open-market operations as a supplement of the Reserve Banks refinancing policies. Such requirements can vary considerably from one country to another.
— 34 — An increase in the cash reserve requirements against some or all the liabilities of banks (normally the short-term liabilities of the banks to the public) raises the bank's required minimum total cash reserves, thereby curbing the ability of banks to create more credit. Cash reserve requirements, however, are based on the liabilities of banks at certain dates or during a certain period, and such liabilities are only repurchase agreement by the banks at some future date.
Increase in cash reserve requirements are therefore likely to take effect only after a certain time lag, but nevertheless can be employed to squeeze the cash reserves of banks and curbed the growth in the money supply. Cash Reserve requirements underpin the effectiveness of monetary policy because it forces the banks to obtain the needed liquidity from the Central Bank whenever the volume of money and credit expands. Central Banks that apply cash reserve requirements use it mainly as a short- term money management instrument to avoid excessive volatility in interest rates on a day-to-day basis. The reserve base of the banks will be defined as: "The total liabilities of the banks as adjusted in the current calculations for capital and reserves" (Van der Merwe, 1997:26).
• less cash received under repurchase transactions with the Reserve Bank; • less deposits pledged as securities for loans granted; • less amounts owing by banks and mutual banks; and • less fifty percent (50%) of remittances in transit.
No interest will normally be paid on cash reserve requirements and banks will not be allowed to be in overdraft on these accounts at the end of the settlement period. The maintenance period of cash reserve requirements will be one month, starting from the fifteenth business day after the end of a specific month up to the fourteenth business day of the next month. In a case where a bank does not comply with the average minimum reserve requirement over the maintenance period, the Reserve Bank will have the right to impose a penalty on such a bank related to overnight interest rate on the marginal lending facility.
— 35 — Cash reserves will be held on a banks settlement account at the Reserve Bank. This account will also serve to make and receive payments. Intra-day loans will be allowed, provided they are adequately collaterised. Debit balances on this account at end-of-day will automatically be regarded as utilisation of the overnight marginal lending facility. Banks will also be able to deduct their holdings of domestic legal tender from their minimum cash reserve requirements, i.e. they can set off their average monthly value of volt cash from their gross required reserves.
3.2.3 TAX AND LOAN ACCOUNTS AS MONETARY POLICY INSTRUMENT
In discussing monetary policy instruments used by the Reserve Bank reference can be made to the tax and loan account, which are kept by the Exchequer with certain domestic private banks instead of being maintained by the Reserve Bank. They derive their name from the fact that they can be credited with the proceeds of taxes paid by the non-bank private sector to the government and with the proceeds of the government's borrowings from local private investors outside the banking system.
Tax and loan accounts are used partly for purposes of neutralising the impact on banking liquidity of inflows and outflows of funds related to government accounts. They allow payments by parties in the private sector to the government sector to be made without causing the banking system to lose cash reserves, and they allow payments by the government to private sector entities to be undertaken without boosting banking liquidity. This arises because tax and loan accounts are kept within the banking system and consequently payments by, say taxpayers to the government, will not effect banking liquidity if the cheques are deposited by the government in tax and loan accounts kept by the latter with private banks. This is in sharp contrast to the impact of such tax payments on banking liquidity if the cheques are placed by the government in its accounts which it keeps at the Reserve Bank.
Such accounts are classified as outside the established banking system. Before the tax and loan accounts were introduced in South Africa in 1993, large fluctuations in liquidity occurred on occasions as funds flowed in and out of government accounts which the government kept exclusively at the Reserve Bank.
— 36 — Tax and loan accounts have another role to play as well. Transfers from (or to) the accounts of the government with the private banks (or from) the government 's accounts with the reserve bank can be undertaken for purposes of neutralising the unwanted effects in banking liquidity brought about by factors other than the financial operations carried out by the government, such as receiving large tax payments from the private sector (Fourie et.al., 1998:341).
For instance, if the net gold and foreign exchange reserves fall significantly, thereby draining liquidity from the banking system, the government could arrange to transfer funds from its accounts at the Reserve bank to place in the tax and loan accounts which it keeps with the four main commercial banks. In the process banking liquidity is boosted, which offsets the previous loss of liquidity caused by the fall in the net foreign reserves.
3.2.4 RESERVE BANK ACCOMMODATION AS MONETARY POLICY INSTRUMENT
According to Fourie et al. (1998:315) the accommodation, which is granted by a central bank, could refer to all forms of credit extension made available by a central bank to parties in the economy, which include banks in the financial system. Central Bank accommodation, however, has conventionally been referred to credit, which is offered to banks at the so-called "discount window" of the central bank; in other words it has referred to the refinancing operations undertaken by the central bank at its discount window. Most central banks are an important source of short-term funds for banks and other depository institutions, especially the larger banks, which tend to borrow frequently to replenish their legal reserves.
Accommodation policy is a key instrument of monetary policy in South Africa and indeed is the dominant monetary instrument in use. It consists of deliberate variations in the terms and conditions on which accommodation is granted. Any such variation alters the stance of monetary policy. Variations in the quantity of liquidity provided to the market and the interest cost of accommodation clearly constitute the main way in which the terms and conditions of accommodation can be changed.
— 37 — The repurchase agreement rates are therefore varied to have an effect on the general level of interest rates in the economy, which in turn influences aggregate spending (and therefore inflation), prices, the money supply and the balance of payments.
3.2.4.1 The previous system: The bank rate
The most important indicator to economic participants for the direction and level of interest rates and lending used to be the official Bank rate. This was the rate set periodically by the Reserve Bank for the rediscounting by it of Treasury Bills.
The rates at which the Reserve Bank rediscounts other eligible securities such as Land Bank Bills were also based on the Bank rate. Banks were also allowed to consider the extend of overall accommodation provided by the Reserve Bank as an immediate indicator of the direction that rates were likely to follow over the immediate short-term. The financial press was allowed to repurchase agreement on communiqués directed by the monetary authorities as moral supporters to the banks or to the pubic at large.
By discount rate policy is meant: the setting by the central bank of the level of its rediscount rate (also known as the bank rate) at which it is prepared to rediscount eligible securities for the banks. If the central bank raises the bank rate, the credit that the bank obtain from the central bank by rediscounting eligible securities, become more expensive, which in turn forces the banks to raise their lending rates to the public.
This in turn causes a reduction in the demand for credit from the public, which also has an effect on the prevailing inflation trends in the country. A reduction in the bank rate by the central bank will have the opposite effect.
The extend to which and the conditions upon which the Reserve Bank provides financing to the banks are dictated by the objectives of prevailing monetary policy as set by monetary authorities, i.e. the Bank itself. The availability of consistent and controlled refinancing channels at the Reserve Bank's instance, in conjunction with open market operations conducted by the bank, sustain the orderly function of the money and capital markets, while simultaneously giving effect to monetary policy.
— 38 — The funds that banks can require from the Reserve Bank are restricted in terms of the following assets as collateral:
First tier assets It included all instruments with a maturity of up to ninety-one days, which included Treasury bills, Land Bank bills and government RSA stock. The rate applicable for discounting these securities was the bank rate.
Second tier assets It included all instruments with a maturity longer than ninety-one days, but not longer than three years. These instruments included Treasury bills and RSA stock (all assets that qualify as a liquid asset in order to comply with liquid asset requirements). The rate that was applicable for discounting these instruments was normally 1% to 1,5% higher than the bank rate. This rate was considered a penalty rate and was amended by the President of the Reserve Bank from time to time depending on the requirements of monetary policy.
The bank rate was the rate at which the Reserve Bank provided funds in the "last resort" to the banks. It was used as a monetary policy instrument in order to conduct a specific interest rate cycle and was therefore fixed for certain periods.
3.2.4.2 Reserve Bank as lender of last resort
When banks require cash balances, which are not obtainable from any other source, they may obtain such cash balances through the use of credit channels made available to them by the Reserve Bank (Kelly, 1993:295). Use of these credit facilities by the banks entails the rediscounting of treasury bills and Landbank bills by them at the Reserve Bank, or by obtaining overnight loans from the bank secured mostly by securities acceptable to the Bank for this purpose. Other avenues of accommodation or refinancing are also available at the Bank.
— 39 — Examples are the outright purchase of securities by the Bank and the placement of funds of the Corporation for public deposits with banks; sometimes by tender and varying the amount of Treasury bills offered at the weekly Treasury bill auctions.
3.2.4.3 Advantages of the bank rate accommodation system
Unlimited amount of liquidity without collateral available at the discount window that contributed to a confidence in the South African banking system.
Very simplistic system Easily understood Stability during short-term crisis/turbulent periods Rate was fixed — banks knew what cost of accommodation would be Less of an administrative burden than the current repurchase agreement system Brought relative stability in money market interest rates Easy to apply
3.2.4.4 Disadvantages of the bank rate accommodation system
Although the previous system of accommodation operated relatively efficiently, it became apparent that it had certain important disadvantages, such as:
• It made money market interest rates insensitive to liquidity changes; • The bank rate did not enable the Reserve Bank to provide clear signals to the market about its monetary policy stance. • The Reserve Bank did not receive clear signals from the market about their perceptions. • It discouraged the development of inter-bank trading in surplus funds. • Reserve Bank 's role was too neutral/noticeable for the globalisation process after the isolation era (SARB, 1999:3).
Under this system accommodation were extremely restrictive and the Reserve Bank believed that tight monetary policies should continue to be applied as well as the further
— 40 — restriction accommodation in order to gain a better control over the growth in the money supply.
3.3 THE REPURCHASE AGREEMENT
The traditional system of accommodation (Bank Rate system) introduced in May 1993 was replaced in March 1998 by a new more flexible set of accommodation facilities created in the form of regular repurchase transactions between the Reserve Bank and its banking clients (Regulation 19(4) of the Regulations Relating to Banks published in Government Gazette No. 17115, Government Notice No. R628, of 26 April 1996 issued by the Minister of Finance in terms of section 90 of the Banks Act (No.94 of 1990). This system is known as a repurchase agreement system, and is similar to the one in use by the bank of England and central banks in Italy, Germany and Australia (SARB, 1997:2).
3.3.1 DESCRIPTION AND USES
A repurchase agreement can be defined as a contract involving the simultaneous sale and future repurchase of an asset, most often Treasury securities. Typically, the seller buys back the asset at the same price at which he sold it, the original seller pays the original buyer interest on the implicit loan created by the transaction. Interest due on a repurchase agreement at maturity is at the stated repurchase agreement rate for the stated maturity of the repurchase agreement. Repurchase agreement-rate: The return earned on the repurchase agreement transaction expressed as an interest rate on the cash side of the transaction (Van der Merwe 1998:20).
According to Peterson (1994:895) a Repurchase agreement can be defined as follows:
"A transaction carried out under an agreement, in which one party sells securities to another, and, at the same time and as part of the same transaction, commits to repurchase equivalent securities on a specific future date, or at call, at a specified price. The term is often used to describe reversed repurchase agreements and transactions such as special repurchase agreements.
— 41 — Repurchase agreements can be seen as a loan of a security collaterised by cash, on a cash borrowing collaterised by cash." The following reasons can be discussed for introducing a repurchase agreement system in South Africa:
• The globalisation of the South African financial system with larger capital movements and increased volatility necessitated more effective monetary policy operational procedures. • Prior to the introduction of the repurchase agreement system, short-term interest rates did not immediately respond to changes in overall liquidity positions of banks, i.e. the size of the money market shortage did not have a significant influence on interest rates. Changes in interest rates were caused by expectations about changes in the Bank rate, rather than changes in market liquidity. The difference between the annual refinancing rate and the yield on assets serving as collateral contributed to insensitivity of money market rates to liquidity changes. Market interest rates did not give the regulatory authorities sufficient indications of changes in the underlying market conditions. The repurchase agreement rate has an impact on market rates as changes in costs or repurchase agreement transactions are taken as a signal of future interest rate movements. The repurchase agreement system sends certain signals to the market without the SARB changing the Bank rate. Tenders take place on a daily basis between banks and the Reserve bank. On days that the market is in a surplus, the South African Reserve Bank will withdraw liquidity by reverse repurchase agreements (sell financial assets with the obligation to repurchase them at a specific price on a future date on demand). Repurchase agreements will be done on a variable rate, but the South African Reserve Bank may, on occasion, choose to operate on a fixed rate basis. Allotments will be made at individual bidding rates tendered, i.e. a multiple rate auction (United States style). Higher interest rate level bids will be allotted
— 42 — priority and successive lower bids will be accepted until the total amount of liquidity is met (called Dutch auction). • The maturity of the tenders will normally be daily or weekly to ensure a large volume per transaction. • Changes in the repurchase agreement rate will also affect the deposit and lending rates of the banks.
3.3.2 ADVANTAGES OF THE REPURCHASE AGREEMENT SYSTEM
The new system of accommodation of the South African Reserve Bank provides a flexible framework for the implementation of monetary policy, which works indirectly through the management of liquidity in the money market. This enables monetary authorities to "guide" interest rate movements rather than to "control" them directly. It has the following advantages:
• A quicker response in short-term interest rates to changed liquidity conditions and an improvement in the transmission process of monetary policy. • Greater flexibility in money market interest rates with enough safety valves to prevent undue volatility in interest rates (reserve dependency safety buffer). • Greater transparency in monetary policy through various ways of signalling that can be used. • A further development in the inter-bank market. • Improved signalling-from the market to the South African Reserve Bank about underlying liquidity conditions. • More flexible options in the management of banks' liquidity positions (Van der Merwe, 1997:20).
3.3.3 THE MECHANICS OF THE REPURCHASE AGREEMENT SYSTEM
3.3.3.1 Background of repurchase agreements
On the 9th of March 1998, the new accommodation facility, based on repurchase agreements (repo's), was introduced by the Reserve Bank. The daily repurchase
- 43 - agreements entered into between the banks and the Reserve Bank will be conducted on the basis of a classic money market repurchase agreement (carry), where the supplier or seller of securities retains the right to any coupon payments. If a coupon payment is made to the buyer of the securities relating to stock involved in the specific repurchase agreement transaction, such coupon receipts should immediately be passed on to the cash taker.
This is prescribed by Regulation 19(4) of the Regulations Relating to Banks published in Government Gazette No. 17115, Government Notice No. R.628, of 26 April 1996 issued by the Minister of Finance in terms of section 90 of the Banks Act (No. 94 of 1990). The seller shall continue to reflect an asset of which it had been the outright owner sold by it in terms of a repurchase agreement. The seller will also indicate that the said security is subject to a repurchase agreement with the buyer. The buyer will record the security as an asset in its books as "Securities under repurchase agreements" until the seller repurchases the security in question. The repurchase agreement system also provides for the averaging of a marginal lending facility and cash reserves, since these facilities are available to banks to bridge their overnight liquidity needs.
3.3.3.2 Collateral and eligible securities
The Reserve Bank may use the following instruments in its daily repurchase agreement transactions. These securities are used by banks as collateral for cash received in the repo tender:
• Government bonds are fixed-interest bearing securities issued by the central government, and constitute evidence of debt of the Republic of South Africa and therefore represent a charge on the revenues and assets of the Republic.
• Treasury bills are short-term debt obligations of the central government and represent a charge on the revenues and assets of the Republic of South Africa. Treasury bills are issued at a discount to their face value.
— 44 — • Reserve Bank debentures: The yield on debentures is calculated on an interest add-on basis. As it is an interest-bearing instrument the face value includes interest. At this stage, the Reserve Bank issues debentures with a 28-day maturity by means of a weekly tender. The Reserve Bank, however, may decide to issue debentures for a period up to one year and the Bank has the discretion to redeem the bills prior to maturity.
• Land Bank bills represent a liability of the Land Bank, i.e. a debt obligation of the Land Bank. These bills are issued at a discount to their face value for the sole purpose of financing genuinely self-liquidating transactions, such as crops.
3.3.3.3 Procedures of daily repurchase transactions
The Reserve Bank will conduct the main repurchase agreement tender at 12:00. The final clearing auction can either be in the form of liquidity providing repurchase agreement or a reverse repurchase agreement where surplus liquidity is drained from the market. If, for whatever reason, the tender cannot be held at 12:00, it will be postponed until 15:00.
The Reserve Bank will, on a daily basis, provide yield to maturity rates on its wire services pages (Reuters: RBMR) for bonds acceptable for repurchase agreement transactions. These yields will be based on the most recent rates of bonds traded on screen. The Reserve Bank will also provide applicable discount rates for the valuation of bills and Reserve Bank debentures.
• Publication of the tender amount: The provisional amount of liquidity required by the market will be published by the Reserve Bank on its wire pages (Reuters: RBMQ) at around 11:30 daily. If, for whatever reason the Bank is unable to calculate and/or announce the tender at 12:00, it has the right to postpone the tender results until 15:00.
Invitation for bids: The Reserve Bank will publish a screen announcement for the invitation of bids for the repurchase agreement tender at 12:00. This
— 45 — announcement will have full details regarding the maturing repurchase agreements for the day; the maturity date; the liquidity requirement for the day; the amount on tender; whether it is a fixed or variable rate repurchase agreement tender; and the closing time of the tender.
• Submission of bids: A participant cannot cancel its bid once the tender has closed. The participants should phone the Reserve Bank's dealing room, usually within fifteen minutes after the announcement has been made. The maximum size of a participant's bid should not exceed the size of the amount on tender. In the case of any disputes, reference will be made to recordings of all telephone conversations. The minimum amount for bids will be R10 million and in denominations of R1 million.
• Acceptance of bids: In the case of a variable rate tender, bids will be allotted sequentially, by first allotting the highest rate bid in full, the allotting the second highest rate in full, until the total amount on offer has been allotted. In the case of a fixed rate tender, all bids will be included in the allocation. If the total amount of the bids received is equal to or less than the amount on tender, participants will receive the exact amounts they tendered for. In the event of the total amount of bids received exceeding the amount on tender, participants will receive a partial allocation of funds.
• Repurchase of securities: When the repurchase agreement matures, participants will purchase the same securities from the Reserve Bank than those that they have sold to the Bank in the first part of the repurchase agreement transaction.
The calculations of repurchase agreements by using "valuation haircut" and determining the margin deficit can be seen in Appendix A. The repayment of excess margin, margin transfers and retention of securities were also discussed in more detail (see Appendix A).
— 46 — 3.3.3.4 The marginal lending facility (MLF)
Should the Reserve Bank announce a repurchase agreement amount of less than its estimated money market shortage, which indicates that they see interest rates moving higher, some participants could find that they are still in need of cash. In order to bridge this short-term liquidity need, banks can utilise the marginal lending facility at their own initiative. Although no restriction is placed on the use of this facility, provided that the required collateral can be delivered, the advances will only be on an overnight basis or for a short period of time.
As discussed earlier, the marginal lending rate is currently fixed at 5% above the repo rate. This premium must be large enough to discourage banks from making extensive use of this facility. Any move in the repo rate will obviously lead to an increase in the marginal lending rate. Interest due on advances obtained under the marginal lending facility will be charged by debiting a banks settlement account at the start of the next working day (SARB 1997:3).
3.3.4 PROPOSED REFORMS TO THE REFINANCING SYSTEM OF THE RESERVE BANK
South Africa's central bank said it plans to change the way it lends money to banks and will lower its benchmark-lending rate, known as the repo rate, by up to 1.5%. In a letter to bank chief executives released by e-mail, the central bank did not say when it would cut the rate, currently at 12%, though bank executives will have until the 11 th of May 2001 to comment on the document.
The decision to lower the benchmark rate was part of an overhaul of a lending system it put in place in 1998, the Bank said. The new system will be designed to cut speculation against the rand, which has lost 6.8% of its value against the dollar since the beginning of 2001. "At this stage, we still have to discuss how much the rate will be cut", Callie Hugo, assistant general manager of the money and capital markets department said. "They (the banks) will pay 1% to 1.5% less on the daily repo auction."
— 47 — Still, in an accompanying document, the Bank said the change would purely be "an administrative adjustment" and it didn't expect commercial banks to automatically lower their rates in response. Once the rate has been cut, new measures are expected to see banks changing their lending rates automatically whenever the central bank changes the repo rate. The Central Bank' s various shortcomings had become apparent in the current system, including inflexibility in money market rates (Reuters, 2001).
3.3.4.1 Proposed adjustments to the current accommodation system
As could be expected with the implementation of a new accommodation system, certain shortcomings started to emerge since the implementation of the repurchase agreement system in March 1998. An efficient functioning of this system is essential for transparency in the South African economy.
In order to re-evaluate the monetary policy operational procedures, the Monetary Policy Implementation Committee (MPIC) was asked to conduct an extensive research on ways of improving the functioning of the accommodation system and of the money market. Some proposed adjustments include the following:
• The spread between the Reserve Bank's repo rate and the interbank overnight call rates in the market should be narrowed. The margin between the repo rate and interbank call rate should be reduced. The large gap causes only a limited amount of participants to compete in the daily auctions. The participation of a larger number of banks would allow the Reserve Bank to monitor liquidity problems more closely and remove perceptions of manipulation.
• The development of a benchmark interbank index that can serve as a reference rate for the interbank market. This could be calculated as a weighted average of all overnight-unsecured lending transactions in the interbank market. In the domestic market, the South African Futures Exchange (SAFEX) has recently introduced the Rand Overnight Deposit Rate (RODR) and the Johannesburg Interbank Agreed Rates (JIBAR) as benchmark rates. The calculation methodologies used by SAFEX however, proved to have some shortcomings.
— 48 — The calculation of a South African Overnight Index Average (SAONIA) could improve the price discovery process and also the general functioning of the interbank market. This would mean that all market participants would have to report the necessary rates to the Reserve bank on a daily basis. Only the weighted average rate would be announced and published to the market.
The introduction of a fixed repo rate: The main problem with a floating repo rate is that the banks do not participate in the signalling procedures in the way originally intended. A fixed repo system however, could restore stability in the domestic money market, because signalling by the central bank would be more effective. The Reserve Bank, as final provider of liquidity, can at any point in time determine the liquidity position of the market. The Bank should also know exactly what the level of interest rates should be in order to achieve inflation targets. From this point of view, a fixed repo system should provide an unambiguous signal to the market. The floating-rate system was originally introduced to improve transparency of monetary policy under the framework of informal inflation targeting. With a floating repo rate, the banks tender for a fixed amount, which is publicly announced prior to the main repo auction. With a fixed repo rate, interbank transactions can be encouraged by not pre-announcing the central bank's estimate of the market's liquidity requirements.
Open-market operations in money market instruments: Outright sales and purchases of government paper are, however, a very useful monetary policy instrument in the fine-tuning of liquidity in the money market. The Reserve Bank can for instance use Treasury bills in order to improve overall liquidity in the domestic money market, which is currently relatively illiquid. Open-market operations in money market paper conducted by the Reserve Bank could also improve overall liquidity management if the Bank more regularly operates in the domestic money market. Repurchase agreements with longer maturities can also be used to stimulate the interbank market.
— 49 — These proposals should considerably improve the current monetary policy operational procedures of the Reserve Bank. As part of an improved interest rate transmission mechanism, a fixed repo rate could be adopted in order to give unambiguous signals to the market. It can however, influence overall transparency of monetary policy because a fixed repo rate would remind allot of the traditional bank rate which was also a fixed rate.
3.4 SUMMARY
The Reserve Bank's monetary policy instruments were discussed in this chapter. However, the main focus was placed on the purpose, advantages and mechanics of the repurchase agreement, which replaced the traditional bank rate as monetary policy instrument. The old bank rate was known for its inflexibility and rigidity in practising transparent monetary policy. Furthermore, the proposed reforms of the central bank regarding the current refinancing system were also discussed.
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— 50 — CHAPTER 4 THE TRANSPARENCY OF THE REPURCHASE AGREEMENT AND MONETARY POLICY FRAMEWORK
4.1 INTRODUCTION
In the previous chapters the discussion was about the change in monetary policy from the old accommodation system (bank rate) to a more transparent accommodation system. The need for a direct monetary policy framework triggered the introduction of inflation targeting strategies as the Reserve Bank's task to ensure price stability in the country. The level of interest rates in a country can directly influence consumer demand, which in turn will impact on the inflation rate and inflation targets of the central bank. It is therefore important to keep both the repurchase agreement system and inflation targeting strategies as transparent as possible in order to achieve overall price and interest rate stability in a country.
After having brought inflation rates down to low levels, many central banks in industrial countries started to convey their policy intentions more clearly to the market. This shift towards greater transparency has been most evident in the United States of America, Australia, United Kingdom and Canada. The South African Reserve Bank has also committed themselves by increasing transparency through policy signals.
This greater transparency was supposed to increase the effectiveness of monetary policy because of its influence on interest rate expectations in an environment where the interest elasticity of demand for working balances of banks is relatively low. Signalling by the Central Bank can be successful because it is the monopolist supplier of liquidity to the market.
According to Van der Merwe (1997:12), increased transparency in accommodation could have certain disadvantages:
— 51 — • It creates a risk of delaying upward or downward adjustments in interest rates; • It may give markets clear targets to test the resolve of the authorities; • And it may make it difficult to reverse wrong policy decisions.
As discussed in previous chapters, under the previous monetary policy procedures (bank rate accommodation system) short-term interest rates seldom responded immediately to changes in the overall liquidity positions of banks. The correct signals were not always emitted, even at times when money market shortages increased to very high levels. Interest rates, the Reserve Bank's main operational variable of monetary policy, remained rigid for long periods of time compared to the official bank rate also remained fixed for long periods of time. This did not accurately reflect liquidity conditions in the money market, therefore the Reserve Bank's decision to change the accommodation policy to a more transparent policy by replacing the bank rate with the repurchase agreement (repo). It is also important to note that the efficiency of the Repo rate has a direct influence on the Reserve Bank's inflation targeting monetary policy framework.
The new system of accommodation was introduced to provide a flexible framework for the implementation of monetary policy, which works indirectly through the management of liquidity in the money market. This should have enabled monetary authorities to "guide" interest rate movements, rather than to "control" them directly (Van der Merwe, 1998:15).
4.2 THE TRANSPARENCY OF THE REPURCHASE AGREEMENT
There was great optimism in the financial markets when the Reserve Bank decided to replace the Bank rate by the repurchase agreement in March 1998. The Reserve Bank wanted to introduce a more flexible and transparent accommodation system that would provide more efficiently to the needs of the market.
Theoretically it was possible for the repo system to become a transparent, flexible and efficient monetary policy instrument, where interest rates were supposed to move freely according to market conditions and market forces. This however would have a direct
— 52 — influence on consumer demand, and therefore inflation. The repo was also implemented to operate in conjunction with the Reserve Bank's new monetary policy framework in which inflation targeting would form the main objective. However, over time it proved to have some disadvantages and shortcomings that influenced the proposed transparency of this system:
• Confusing signals are sent out by the Reserve Bank. Some economists also believe the repo system was implemented at too high levels above the commercial banks' call rates and the prevailing inter bank rate. It is still the case that these rates are about 2% below the repo rate. In the 1998 Asian crisis the South African market had been directly targeted by speculative trading where huge capital outflows were experienced and rands were sold which in turn impacted greatly on foreign reserves. During the crisis in 1998, the Reserve Bank tried to send out signals to banks for higher prime lending rates by increasing the repo rate. The purpose was to prevent too much capital outflow at that point in time. This did not succeed because huge amounts of capital left the country in any event. If there was a much quicker reaction between policy changes and interest rate fluctuations, this situation could have been prevented. It could take up to four days for an arbitrage gap between foreign exchange and the domestic money market to narrow down to safer levels (Mittner, 2000:3).
• There are a limited number of market players participating in the daily repo auctions. Economists like Dawie Roodt of PLJ Financial Services and Peter Worthington of JP Morgan believe that there are significant levels of manipulation involved in the daily tender process (Mittner, 2000:3).
A "cartel-like" behaviour exists between the four big banks when tendering for funds at the daily repo auction. The primary drivers behind this manipulation seems to be a limited number of participants that can comfortably set the direction of the daily repo tender. However, it is also true that the "cartel" will promptly react on any signals given by the Reserve Bank. In other words, if the Reserve Bank under-provides liquidity, the banks will tender higher at a certain
— 53 — discussed level, and if the Reserve Bank over-provides liquidity, the banks will tender at a lower level.
• In November 1999, the repo rate was "fixed" at twelve percent (12%), which shows some resemblance with the previous bank rate that used to be rigidly controlled by the Reserve Bank. The Bank, however, do not see the repo rate as fixed, they say that the banks are constantly tendering at the same interest levels for the provided liquidity. The question is whether the rate is also manipulated by the Reserve Bank (like the old bank rate) and whether it is allowed to move freely according to market conditions. Currently the Reserve Bank shows its preference of where interest rates should be by providing only the sufficient amount of liquidity to the market, and draining any excess liquidity from the market through open market transactions and therefore boosting the reserve dependency. With its introduction in 1998, the repo was allowed to float freely, and where banks could tender up to three decimal places, but after the 1998 crisis it became more restrictive (fixed). Economists like Worthington and Roodt do not believe that market forces determine the repo rate at this point in time (Mittner, 2000:4).
4.3 TRANSPARENCY OF INFLATION TARGETING
It was mentioned earlier that the level of interest rates, and more specifically the Reserve Banks' Repo rate can influence the inflation rate in a country. It is therefore important to look at transparency within the inflation targeting monetary policy framework, because if inflation targets are successfully achieved by the Reserve Bank, the level of interest rates could also remain stabile, which in turn would reflect a stable financial environment. If, however, the Reserve Bank does not succeed in achieving inflation targets, it could put pressure on interest rates, which can be used as an instrument to slow down consumer demand.
Currently the government is struggling to curb the annual increase in administrative prices, which in turn influence the inflation target rate CPIX (Consumer Price Index without mortgage loans). This has a direct effect on the Reserve Bank's inflation — 54 — targets, and if not controlled, could have a serious impact on inflation targets. The government could influence the transparency of inflation targeting and it is therefore important to look at the impact of administrative prices on the CPIX inflation target.
4.3.1 DEFINING ADMINISTRATIVE PRICES
Administrative prices are described as all prices which government determines by monopolies or legalised monopolies such as the Medical and Dental Council. Often these administrative prices are hidden forms of taxes such as the water and electricity rates that town councils collect (Van Tonder, 2000:1).
In South Africa we have an economy that still has many prices that are not set by normal market conditions. Many prices are set with only one supplier such as suppliers of electricity (ESKOM) that has to rely on that income stream to fund certain social economic functions. These prices are called Administrative Prices and cannot really be influenced by trying to dampen demand via interest rates. Even the Federal Reserve Bank in the US mainly uses an inflation measure that leaves out food and energy prices. South Africa has a more imperfect market than the US and most other developed countries but uses a wider inflation measure called CPIX, which only excludes mortgage rates.
It should also have excluded in order to make it realistically achievable administrative prices. Of the seventeen major inflation categories (CPIX) five have an administrative element of more than fifty percent (50%). One large sub category, running cost of motor vehicles, also has an administrative element of more than fifty percent (50%). All categories are described below with the administrative weighting as far as is possible given (King, 2001:6).
— 55 — Figure 4.1: Weights in the different inflation indices
CPIX Metro & Categories Core inflation Headline CPI urban Cigarettes 1.17 0.95 Fuel Power 4.03 3.98 3.11 Medical Care 7.74 6.54 5.95 Running costs 7.51 5.81 5.75 Communication 3.98 3.61 3.06 Education 2.65 2.05 2.04
Total out;of 100 27A5 .2346 20.86
(Source: King, 2001:8)
In the discussion of the research above-mentioned figure 4.1 will be explained in connection with inflation targeting.
4.3.2 DESCRIPTION OF CATEGORIES
Cigarettes This is the smallest category by weight and is made up of cigarettes, cigars and tobacco. Taxes however play a very large role in this category and make up more than half its value.
Fuel and power This includes electricity, which makes up more than ninety percent of this index. Gas and petroleum products also make up a small part of this category. All of these sub indices can be considered administrative prices as they are controlled by town or regional councils in the case of electricity and gas, while the Central Energy Fund controls petroleum product prices.
— 56 — • Medical care This category includes doctors and nurses fees, which make up slightly more than half of this category. These medical practitioners' fees are regulated for the most part by the Medical and Dental Council of South Africa. The same would largely also apply to Hospital and nursing home fees, which make up about 12% of this category. Furthermore about 20% is made up of contribution to medical aids, which is also regulated, and as the medical aid industry belong to one major industry grouping, they are often charging similar fees. Medical and pharmaceutical products are also often considered to be "monopoly pricing" because patents protect profits for many years. In addition, pharmaceutical products are often priced twice — once for the public sector and once for the private sector. The private sector then subsidises the public's cheaper prices and this is a classic hidden tax.
• Running costs of motor vehicles Petrol and diesel make up about 70% of this category. As taxes make up between 30% and 40% of the price of petrol (it differs depending on international oil prices) and diesel — that alone would make it a candidate for an administrative price. But further to this, in South Africa the wholesale price, transport price and accident insurance are also controlled for both petrol and diesel, and combined; these make up a further 11% to 14% of the price.
In addition, the retail margins of petrol are also controlled, adding another 7 to 9%. Moreover, part of the basic price is also set by the state such as insurance and shipping costs. Then the international price is set in Singapore, meaning that very little is demand driven. Other administrative elements relating to the running costs of motor vehicles are license and registration (set by the provincial governments), parking fees (often set by town councils or state controlled agencies such as the Airports Company) and insurance fees (partly set by state regulations). Together these make up nearly 10% of the weighting.
Further oil, grease and tyre prices are also related to international commodity prices. Tariff protection also plays a role in the price of tyres, and spare parts. These add up to
— 57 — around 15% of the weighting with an estimated 40% of this made up of factors that have an administrative factor included.
It is estimated that even with the higher oil price, of more than 50% of this category is administrated directly by the state and its agencies. When oil prices are lower (at say $20 a barrel), this could easily rise to above 60%.
Communication This category is made up of telephone rental and installation, telephone calls, postage and other post office expenses. These are all controlled at present by two state- controlled monopolies.
Education Nearly 96% of this category is made up of tuition and attendance fees set by state controlled agencies or regulated by the education department.
Further notes Some other categories have taxes such as car rentals from airports, which carry an 8% surcharge tax. Categories that fall within this administrative pricing monitor are aircraft tickets, train and bus transport, beverages, assessment rates (part of homeowner costs) and refuse removal.
Other prices such as sugar are also still controlled by legal monopolies and should in fact also be covered by our administrated prices monitor but for simplicity' sake this was left out.
Then there is value added tax, which is not covered by core inflation but would play a role in headline inflation and could at times increase the weighting by more than 10% (Valentine, 2000:1). The changes in price indices are shown in figure 4.2.
— 58 — Figure 4.2: Changes in prices indices
Percentage Change 0 2 4 6 8 10 12 14 16 18 20 22
Running Costs
Education
Household operation
Cigarettes, cigars and tobacco
Transport
Housing
Medical & health expenses
CP1X MU
Reading matter
Food
Fuel and power
Personal care
Non-alcoholic beverages
Communication
Alcoholic beverages
,,Furniture And Equipment
Clothing and footwear
Other
(Source: King, 2001:9)
4.3.3 THE EFFECT OF ADMINISTRATIVE PRICES ON CORE INFLATION
The administrative prices momentum index In order to measure the effects of administrative prices, two indicators had been developed, the first indicator is called the administrative prices momentum index, which measures the speed of increase in administrative prices in relation to core inflation.
Furthermore, for a simpler way of looking at the effect that administrative prices has on inflation, core inflation without administrative prices can be used. Administrative prices have a 27% weighting in the core inflation index.
The administrative prices momentum index gives a reading of how much of the total inflation momentum comes from administrative prices. So when administrative prices rise 50% above the normal core rate, then the reading would be 50, (similarly when the reading is 0, administrative prices are increasing at the same rate as core inflation). It
— 59 — does not mean that half of the inflation rate comes from the administrative prices, only that the 27% of administrative prices make up the total index, is adding roughly around 40% of the total core inflation rate.
So if the inflation rate were 8% in total, then 3% would be attributed to administrative prices and 5% to the rest. Thus if one left out administrative prices totally in this example, the inflation rate would be 5% and not 8%.
For April 2000 the administrative prices momentum index stands at 50.4%, which indicates that around 40% of the increases in inflation are coming from administrative prices. Effective core inflation would have been about 5.2% or about 3.6% less if not for these administrative prices.
• Core Inflation below 6% excluding administrative prices For April 2000 administrative prices increased by 13.2% which was the highest rate since 1997. This meant that they contributed 40.8% to the total core inflation rate, which was the third highest reading ever. It is also possible that these administrative prices are having a "knock-on-effect" in many other ways and could in fact be partly responsible for the rise in non-administrative inflation. An example would be the higher diesel prices that are starting to make themselves felt in other areas of the inflation index.
Furthermore, it is estimated that without the "knock-on-effect" that administrative prices had on the core inflation rate, this rate might have been closer to 4.5%. CPIX for metropolitan and other urban areas would have been about 5% without the negative effect of administrative prices. This would have allowed the Reserve Bank to have a more neutral interest rate stance and in fact even allowed the Repo rate to have declined closer to 10%, and a prime lending rate closer to 12.5%. The comparison between CPIX and administrative prices are shown below.
— 60 — Figure 4.3: Comparison between CPIX and administrative prices
percentage 14
12
10
8
j Jan-00 Feb-00 Mar-00 Apr-00 May-00 Jun-00 Jul-00 Aug-00 Sep-00 Oct-00 Nov-00 Dec-00
CPI X % y-o-y AcItnInf % y-o-y Demand side CPIX
(King, 2001:10)
Containing inflation without changing interest rates Administrative prices can be used to contain inflation without the need to increase interest rates. For example: If the town councils all agree that no price increases from Telkom or Eskom may be above 6%, or even better, 5%, and furthermore, all government tax increases on consumer goods are not allowed to be above the stated 6% target range. That would mean 21% of the core inflation index and 17% of the CPIX index would be guaranteed to be within the inflation target, which would make the monetary policy task of the Reserve Bank much easier.
Furthermore, the "knock-on-effects" from administrative prices would be limited and if administrative prices stay below 5% it is likely that the rest of the inflation index is at least 25% to 35% more likely to remain within the target range. Under these conditions it would be much easier to maintain lower interest rates and specifically a prime lending rate of about 12% over the long term. This in turn would increase the estimate of long- run economic growth from 3.3% to around 4.5%. The nature of the interest rate
— 61 — environment would also become less volatile which will promote investor confidence. Figure 4.4 indicates the implication of high administrative prices.
Figure 4.4: The implication of high administrative prices
10
9
7
„. 1997, ,1998 1999 2000, , 2001 Core ex Admin Core Inflation , ,,Target
(King, 2001:12)
4.4 A PROPOSED TRANSPARENCY MANAGEMENT PLAN
The proposed Transparency Management plan is illustrated in figure 4.5. The different management tasks performed by the Bank supervision (management) department to ensure transparency will form an integral part of the discussion.
4.4.1 THE BANK SUPERVISION (MANAGEMENT) DEPARTMENT
In 1985 a division for bank supervision was established within the Reserve Bank for the purpose of monitoring the foreign activities of the South African Bank institutions. For the purpose of this research, this division will also see to the proposed management that will bring transparency into the South African Financial system that is representative in the banking structure. The supervision (management) tasks undertaken was to extend and to include the international activities of banking institutions in order to facilitate closer co-operation between the supervising authorities.
— 62 — For the purpose of this research, this is the division that oversees the supervision (management) of the bank institutions in South Africa will also be responsible through different management tasks, to ensure transparency of the repurchase agreement and inflation targeting. It will be proposed that this department function in a overseeing position where transparency will be supervised in the Reserve Bank, South African banking institutions, private-, government- and corporate sector to ensure that the consumer will experience the transparency in everyday financial life.
The bank supervision department in conjunction with the Monetary Policy Implementation Committee must decide whether the repo rate should be a fixed or floating rate. A proposed transparency plan is shown below.
Figure 4.5: Proposed transparency management plan
South African Reserve Bank & Bank Supervision MPIC (Management)
South African Banks
Private Sector Corporate Sector
Private Sector Corporate Sector
1 The Consumer
When changing this rate continuously from floating to fix, will impact on transparency and efficiency of the repo system. If they formally decide to fix it, it will also influence
— 63 — transparency and move back to traditional rigid accommodation policy procedures (bank rate).
Management must research a viable and efficient repo system that can drive interest rates according to different market conditions. It is proposed that the bank supervision department form an integral management function to ensure transparency.
This can only be obtained through management tasks performed by the bank supervision department with an intercommunication strategy between the Reserve Bank and the Monetary Policy Implementation Committee with the bank supervision department.
4.4.1.1 The South African Reserve Bank
The South African Reserve Bank is responsible for the formulation and implementation of monetary policy, whereas the Government determines and implements fiscal policy. Monitory policy stays the full responsibility of the Reserve Bank. During 1985 the Reserve Bank created the bank supervision department for the purpose of monitoring. The Reserve Bank is responsible for interaction with the South African banks and indirectly to the consumer for transparency of the implementation of monetary policy through sound management.
4.4.1.2 The South African banks
The commercial banks, especially the four big banks — ABSA Bank, Standard Bank, First National Bank and Nedbank — that are currently operating in the form of a cartel, must manage their tendering decisions independently from each other in order to achieve a more market related repo rate at the daily auction.
The South African banks are the custodians of the general public's money. Transparency of financial legislation (repurchase agreement and inflation targeting) has to become part of an integral system through management tasks fulfilled by managers in the banks. The banking sector in conjunction with the bank supervision department
— 64 — must enlighten financial legislation, so that the clients (consumers) are aware of financial applications in the financial world.
4.4.1.3 The private sector
The private sector represent the business world not related to any governmental institution. Transparency of any financial applications is important for the internal —and external relationships that the private sector has in the financial world. The influence that the private sector as consumer can have on the image projected (internal and external) of financial legislation can help with the intercommunication between the bank supervision department for transparency.
4.4.1.4 The corporate sector
The corporate sector has to understand the measures taken to ensure transparency. The purpose of such transparency is that all the role players will understand the financial legislation and application of the repurchase agreement system and the inflation targeting that is the core in the financial institutions such as the South African Reserve Bank.
4.4.1.5 The government sector
The South African Reserve Bank upholds as the central bank the government's financial system. Transparent management in the government as well as in conjunction with the bank supervision department to ensure application of the financial legislation, can only enhance transparency. The efficient management of administrative prices could enhance transparency in the new monetary policy framework of inflation targeting.
4.4.1.6 The consumer
The purpose and reason for proposed transparency in this research, is the application of such transparency to open the financial workings to the consumer. The consumer is the end user of any financial product or process. Application of any financial legislation has
— 65 — to be transparent and understandable to the consumer in order to ensure satisfaction of the consumer. If the proposed management tasks are fulfilled by the bank supervision department, the consumer can be assured of transparency in the South African Reserve Bank. The consumer, as end user of financial institutions, has to be protected in the financial workings of an institution to trust his/her finances to such an institution.
4.5 A PROPOSED APPLICATION OF THE MANAGEMENT PLAN FOR TRANSPARENCY
The proposed management plan can be applied through management tasks such as supervision, monitoring, co-operation, control and co-ordination.
4.5.1 SUPERVISION
The role players in "the management plan for transparency" is the bank supervision department in conjunction with the South African Reserve Bank, the South African banking sector, the private-, corporate and government sector as well as the consumer. Though management tasks application and implementation of transparency can be possible, supervision as a management task can only be applied if the manager knows the system and the human resources to delegate and organise different tasks. These tasks that manifest in the financial institutions will ensure transparency.
4.5.2 MONITORING
When monitoring of transparency is part of the management tasks, it implies that the system, resources and human resources are in place with the correct procedures. Only then can monitoring as management tasks be fulfilling. A continuous monitoring of the institutions adherence to the legal requirements and other guidelines is important. The performance of an individual institution must be measured on an ongoing basis against developments in the relevant sector as a whole. Inspectors can be appointed to monitor financial institutions if there is any suspicion of wrong application. This monitoring can be a regular task and not only when there is a suspicion of any kind.
— 66 — 4.5.3 CO-OPERATION
To ensure that transparency is in place in all the financial institutions, co-operation between the role players is necessary. Co-operation as a management task involves human resources of all levels in the structure to enhance application of financial legislation.
An integrated communication between the bank supervision department, the South African Reserve Bank, the South African banking sector, private-, corporate- and government sector. The outcomes will be an enlightened and informed consumer that feels financially secured with, and in the financial environment in South Africa.
4.5.4 CO-ORDINATING
Co-ordinating of resources and information by the different role players can have as result transparency of financial legislation. The purpose of co-ordinating as management task is to pull together all resources and information that the role players can use to make the financial product and process transparent to the consumer.
4.5.5 CONTROL
Monitoring and control is two different management tasks. With monitoring tasks such as delegation and organising is involved. With control as management task, a system or measuring criteria has to be installed to enable the financial system to be applied and implemented. The purpose of transparency for the consumer in South Africa, is that the customer will be sure that the financial system in South Africa is sound and secure through good management (applying the fulfilment of managerial tasks) when he/she use a financial institution to secure his/her money.
— 67 — 4.6 SUMMARY
Administrative prices have contributed over 40% of the current core inflation rate, which far outweighs the 27% weighting in this index. Core inflation would have been 5.2% without these administrative prices in April 2000 well within stated inflation targets. CPIX would have been 5%. The "knock-on-effects" from administrative prices may in fact have added another 0.5% or more to inflation. The administrative prices momentum index reading has been over 50% for six out of the last seven months.
Constraining administrative prices does not require interest rate hikes. Limiting administrative price increases by co-option could make inflation expectation fade and could in fact help keep inflation below 6% quite quickly and easily. Curtailed administrated prices could help South Africa keep lower interest rates for longer periods of time, grow at least 0.5% quicker per year and reduce volatility in interest rate markets. This would help to build confidence and improve the South African investment rating, and also increase transparency (King, 2001:1).
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— 68 — CHAPTER 5 SUMMARY, FINDINGS AND RECOMMENDATIONS
5.1 INTRODUCTION
During the course of this research the importance of "transparency was constantly emphasised. In 1998 the financial markets adopted the new system with great optimism, believing that it would provide more flexibility in exercising monetary policy. However, over time it proved to have some limitations, which reminds a lot of the traditional Bank rate. Theoretically it was possible for the repo system to become a more transparent and efficient monetary policy instrument, where interest rates were supposed to move freely according to market conditions and forces. The overall level of interest rates in a country will trigger/contain consumer demand which, if not managed carefully, will put additional pressure on inflation and inflation targets.
High inflation in turn can lead to tighter monetary policy and therefore higher interest, pushing up the repo rate. This research proved to me, that there are still much to be done to achieve overall transparency in monetary policy. It also revealed some disadvantages of the current repo system:
It can be manipulated (by fixing the rate). At times it is as inflexible and rigid as the bank rate. Not sufficient market players, controlled by a cartel of four big banks.
The efficiency of the repo rate can also impact on government's ability to achieve their inflation targets. If government does not manage the effect of high administrative prices, this will lead to inflation rates that fall outside the parameters of 3% -6%, thus not achieving the objective of price stability. The need consequently arose for accommodation system that would more accurately reflect the supply and demand for money, hence the system of the repurchase agreement. The changes in monetary policy in South Africa recognised the changing financial environment in which the
-69- Reserve Bank must now operate, which is more globalised with larger and more volatile capital movements. The new system was developed to be used in conjunction with the new monetary policy framework of inflation targeting.
The transparency of the repurchase agreement as well as inflation targeting was discussed in this script. The importance of their inter-relationship was also pointed out. In order to contain inflation and achieve inflation targets, interest rates should not be allowed to decrease too quickly, but the repo rate was implemented to move freely according to market conditions. This again raises the concern of total transparency in this system. Furthermore the fixing of the repo rate by the Reserve Bank or the manipulation by the four big banks in the form of a cartel, reminds a lot of the old bank rate. The government also has a priority to control the increases in administrative prices which would impact directly on inflation targets and therefore causing that government does not achieve its objective.
5.2 SUMMARY
In the beginning of this research the fundamental bases were established to underwrite the title of this research: "The purpose and transparency of the repurchase agreement in the South African fi nancial system."
In the first chapter concepts that focus on the research path that was followed were defined. These definitions declare the focus of the research to ensure that a strategy of objectivity, truth and validity was followed. The research method was discussed and the criteria that were followed in order to establish validity for the research were pointed out.
In chapter two the spotlight was turned to monetary policy and inflation targeting as part of the new monetary policy framework. Monetary policy and monetary policy objectives were defined as well as the advantages and disadvantages of inflation targeting. In the literature the same aspects of the South African monetary policy showed a lack of transparency that underline the purpose of this research. The theoretical overview showed that the South African fi nancial system was brought in line with the rest of the
-70- world in theory, but still has to be applied efficiently in practice to show managerial effort in order to enhance transparency.
The Reserve Bank's monetary policy instruments were discussed in chapter three. However, the main focus was placed on the purpose, advantages and mechanics of the repurchase agreement, which replaced the traditional bank rate as monetary policy instrument. The old bank rate was known for its inflexibility and rigidity in practising transparent monetary policy.
The researcher discussed possible proposed management tasks in chapter four, that under line the supervision to emphasise and enhance the transparency of the repurchase agreement as well as inflation targeting.
5.3 FINDINGS
In chapter one, the objective that was stated was to: "ensure the purpose and transparency through effective management of the South African financial system and the monetary policy framework will compliment with monetary instruments e.g. repurchase agreement and inflation targeting."
Through the research some important findings were made which resulted through the following aims set for this research:
5.3.1 To ENSURE THAT TRANSPARENCY THROUGH EFFECTIVE MANAGEMENT OF THE SOUTH AFRICAN FINANCIAL SYSTEM WILL BE POSSIBLE
The proposed transparency management plan discusses the different management tasks performed by bank supervision (management) to ensure that transparency will form part of the discussion. Some findings in the literature will be the fundamentals for this research aim.
-71 — It was suggested that the department of bank supervision would function in an overseeing position where transparency will be supervised by the Reserve bank, South African banking institutions, and the private, government and corporate sector to ensure that the consumer will experience transparency in the everyday financial life.
It can be said that the South African banks are the custodians of the general public's money. Transparency of financial legislation must therefore become part of an integral system where managers in the banks perform management tasks. Intercommunication between the banking sector and the bank supervision department could enlighten financial legislation so that consumers are constantly aware of financial applications in the banking sector.
5.3.2 To DEFINE THE PURPOSE OF THE REPURCHASE AGREEMENT IN THE SOUTH AFRICAN FINANCIAL SYSTEM
In chapter three the repurchase agreement as new accommodation system of the Reserve Bank had been defined. A repurchase agreement can be defined as a contract involving the simultaneous sale and future repurchase of an asset, most often treasury securities.
The new system was introduced to provide a flexible framework for the implementation of monetary policy, which works indirectly through the management of liquidity in the money market. This enables monetary authorities to "guide" interest rate movements rather to "control" them directly. Some advantages of the repurchase agreement system are:
A quicker response in short-term interest rates to change liquidity conditions and an improvement in the transmission process of monetary policy.
Greater flexibility in money market interest rates with enough safety valves to prevent undue volatility in interest rates.
-72- 5.3.3 TO OBTAIN A BETTER UNDERSTANDING OF MONETARY POLICY WITHIN THE MONETARY
POLICY FRAMEWORK
The monetary policy was defined as decisions that are formulated and implemented by the monetary authorities (i.e. by the central bank, or by the Treasury and the central bank) in their various fields of operations, which are aimed at achieving certain ultimate objections with regard to the country's economy. These ultimate objections in turn are striven for by influencing primarily the volume or composition of domestic expenditure and output in an economy mainly through appropriate use of interest rates.
The primary objective of monetary policy is to protect the value of the currency and to achieve price stability in order to obtain a sustainable economic growth in a country. Price stability is achieved when changes in the general price level do not materially affect the economic decision-making processes. Stable conditions in the financial sector are achieved when there is a high degree of confidence that financial institutions and markets are able to meet contractual obligations without interruption or recourse to outside assistance.
The Reserve Bank has assumed a goal of maintaining inflation at a level that would be more or less in line with the average rate of inflation in the economies of South Africa's major trading partners and international competitors. In the current international inflation environment this translates into an inflation rate of between 1% and 5% percent per annum. It is important that the Reserve Bank enhances transparency for the effective operation of an inflation-targeting framework. Inflation can be described as a sustained rise in the general level of prices. Some disadvantages of inflation are the distortion of resource allocations, discouragement of savings and the discrimination of fixed salaried workers.
Therefore, the adoption of an inflation target implies greater reliance on forward indicators of inflation and a continuous assessment of the relationship between the instruments of monetary policy and the inflation target.
-73- On 23 February 2000, the minister of Finance, Mr. Trevor Manuel announced in the annual budget speech that the government had decided to set an inflation target range of 3%-6% for the year 2002. The benchmark inflation rate would be the CPIX (Consumer Price Index without mortgage loans). The Reserve Bank has therefore formally adopted an inflation-targeting monetary policy framework.
5.3.4 To ELEVATE THE SOUTH AFRICAN FINANCIAL SYSTEM THROUGH TRANSPARENCY
A proposed management plan (figure 4.5) can be applied through management tasks such as supervision, monitoring, co-operation, control and co-ordinating.
5.3.4.1 Supervision as application
The role players in the "management plan for transparency" is the bank supervision department in conjunction with the South African Reserve Bank, the South African banking sector, the private-, corporate and government sector as well as the consumer. Through management tasks, the application and implementation of transparency can be possible. Supervision as a management task can only be applied if the manager knows the system, resources and human resources to delegate and organise different tasks. These tasks that manifest in the financial institutions will ensure transparency.
5.3.4.2 Monitoring as application
When monitoring as application for transparency is part of the management tasks, it implies that the system, resources and human resources are in place with the correct procedures. The performance of an individual institution is also measured on an ongoing basis against developments in the relevant sector as a whole. Inspectors are appointed to monitor financial institutions if there is any suspicion of wrong application. This monitoring can be a regular task and not only when there is suspicion of any kind.
-74- 5.3.4.3 Co-operation as application
To ensure that transparency is in place in all the financial institutions, co-operation between the role players is necessary. Co-operation as a management task involves human resources on all levels in the structure to enhance application of financial legislation. An integrated communication between the bank supervision department, the South African Reserve Bank, the South African banking sector, private-, corporate- and government sector.
5.3.4.4 Co-ordinating as application
Co-ordinating of resources and information by the different role players can have as result transparency of financial legislation. The purpose of co-ordinating as management task is to pull together all resources and information that the role players can use to make the financial product and process transparent to the consumer. The role players at the end of the day work and process the consumer's money in the monetary system used in South Africa.
5.3.4.5 Control
Monitoring and control is two different management tasks. With monitoring tasks such as delegation and organising is involved. With control as management task a system or measuring criteria has to be installed to enable the financial system to be applied and implemented.
The purpose of transparency for the consumer in South Africa, is that the consumer will be sure that the financial system in South Africa is sound and secure through good management (applying of managerial tasks) when he/she use a financial institution to secure his/her money. Therefore the security that transparency of any financial legislation will be enhancing, applied and implemented, with control in place.
-75- 5.4 RECOMMENDATIONS
During the course of the research some interesting aspects regarding monetary policy were enlightened. The need for a direct monetary policy framework triggered the introduction of an inflation targeting strategy as the Reserve Bank's task to ensure price stability in the country. The Government announced the benchmark of inflation to be the CPIX (Consumer Price Index without mortgage loans) and the targets to be between 3% and 6% to be achieved at the end of 2002.
The level of interest rates in a country can directly influence consumer demand which in turn, will impact on the inflation rate and inflation targets of the Reserve Bank. Therefore it is important that the repurchase agreement (repo) as monetary policy instrument is operating efficiently in the financial markets and system. Some recommendations for future research include the following.
5.4.1 Whether the repurchase agreement rate should be fixed or floating in order to improve transparency?
5.4.2 The cartel-like behaviour of the four big banks in the daily repurchase agreement tender, and the limited amount of market players tendering for liquidity at the Reserve Bank.
5.4.3 The validity of the benchmark for inflation targeting namely CPIX.
5.4.4 The comparison between the South African central bank accommodation system with that of other developing countries.
5.5 CONCLUSION
Under the repurchase agreement system, interest rates are somewhat more flexible than under the traditional bank rate accommodation system and it brought about various advantages, which did not exist under the previous system. Interest rates will continue to influence economic growth and also consumer demand (inflation). If administered
-76- prices are controlled and carefully managed, the government will improve its chances to achieve its inflation targets of between 3% and 6%.
Although there are a lot to be learned from other countries when practising monetary policy, it is important to state that South Africa is moving in the right direction. The desirability of creating a more flexible interest rate environment is partly due to the process of financial liberalisation, which is underway, as well as the reintegration of the South African economy with the world economy. Therefore, total transparency should always remain the priority of any central bank.
This underline the importance of transparency as promised in the Constitution of 1996, within the South African financial system. It is surprising to experience that political promises come true in the new millennium. The South African economy has a bright future if the road of transparency is followed.
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— 80 — APPENDIX
APPENDIX A February 1998 — Operational Notice APPENDIX I Timetable for daily repo operations APPENDIX II Examples of screen announcements APPENDIX III Repo tender APPENDIX IV Final clearing reverse repo tender APPENDIX V Margin transfer to the South African Reserve Bank APPENDIX VI Terms and conditions pertaining to the issuance of South African Reserve Bank debentures APPENDIX VII Reserve Bank structural reverse repos APPENDIX VIII Cash reserve and cash reserve contra accounts APPENDIX A
February 2001
INTRODUCTION
This Operational Notice explains the processes involved for participation in the Reserve Bank's repurchase transactions (repos).
Background
The present accommodation facility, based on repurchase agreements (repurchase agreements), was introduced by the Reserve Bank on 9 March 1998. The repurchase agreement market involves three very similar types of transactions, namely the classic (or American style) repurchase agreement, the buy/sell-back, and securities lending.
Although the vast majority of transactions referred to as "repurchase agreements" in the domestic market are in reality buy/sell-backs (or carries), the repurchase agreements entered into between the Reserve Bank and the banks will be conducted and booked on the basis of a classic money market repurchase agreement where: The cash taker (i.e. supplier or seller of the securities) retains the right to any coupon payments. If a coupon payment is made to the cash provider (i.e. buyer of the securities), relating to the stock involved in the specific repurchase agreement transaction, such coupon receipts should immediately be passed on to the cash taker. Failure to do so would constitute an event of default.
The system also provides for the averaging of cash reserves and a marginal lending facility. These facilities are available to banks to bridge overnight liquidity needs. This Operational Notice clarifies the procedures which will govern participation in the Reserve Bank's repurchase agreement transactions. It should be read in conjunction with the Master Repurchase Agreement (Master Agreement), which is based on the International Securities Market Association Agreement (ISMA Agreement) by which all transactions referred to in this Operational Notice are governed and which must be signed by all participants in the Reserve Bank's repurchase agreement operations. In the event of any conflict between this Notice and the Master Agreement, the latter prevails.
The Reserve Bank may from time to time amend this Operational Notice which should be regarded as a guideline for the accommodation policy. The Reserve Bank will endeavour to give reasonable notice of any amendments, but reserves the right to introduce any amendment with immediate effect, if necessary. The Reserve Bank may also vary the operational timetable or vary or omit any of the procedures described on any particular day if deemed necessary. These repurchase agreements should therefore be considered direct buy and sell transactions, but the underlying coupon interest remains with the original seller of the securities.
As prescribed by Regulation 19(4) of the Regulations Relating to Banks published in Government Gazette No. 17115, Government Notice No. R.628, of 26 April 1996 issued by the Minister of Finance in terms of section 90 of the Banks Act (No. 94 of 1990), the seller shall continue to reflect an asset of which it had been the outright owner sold by it in terms of a repurchase agreement as such an asset in its monthly balance sheet (form DI 100) opposite the relevant asset category, at the value at which that asset appeared in the accounting records of the seller prior to the sale thereof. The seller will, however, indicate that the said security is subject to a repurchase agreement with the buyer (counterpart) so as not to mislead potential creditors or investors and because this accounting procedure is designed for practical and risk weighting purposes. The buyer will record the security as an asset in its books as "Securities under repurchase agreements" until the seller repurchases the security in question.
I. ELIGIBLE SECURITIES
1. In its repurchase agreement/reverse repurchase agreement transactions to Influence liquidity, the Reserve Bank may use the following instruments (irrespective of their outstanding maturates):
Government bonds Treasury bills Reserve Bank debentures Land Bank bills
2. Definitions
Government bonds are fixed-interest bearing securities issued by the central government under the Public Finance Management Act (No 1 of 1999) and constitute evidence of debt of the Republic of South Africa and therefore represent a charge on the revenues and assets of the Republic.
Treasury bills are short-term debt obligations of the central government and represent a charge on the revenues and assets of the Republic of South Africa. The issuing of Treasury bills is governed by the Public Finance Management Act (No 1 of 1999). Treasury bills are issued at a discount to their face value.
Reserve Bank debentures are issued by the Reserve Bank in terms of the South African Reserve Bank Act (No 90 of 1989) for monetary control purposes. The yield on debentures is calculated on an interest add-on basis. As it is an interest bearing instrument the face value includes interest. At this stage, the Reserve Bank issues debentures with a 28 day maturity by means of a weekly tender. The Reserve Bank, however, may decide to issue debentures for a period up to one year and the Bank has the discretion to redeem the bills prior to maturity.
(iv) Land Bank bills are issued by the Land Bank under the Land Bank Act, (No 13 of 1944), and represents a liability of the Land Bank, i.e. a debt obligation of the Land Bank. These bills are issued at a discount to their face value for the sole purpose of financing genuinely self-liquidating transactions, such as crops.
Repurchase transactions
As part of its daily activities the Reserve Bank will conduct the main repurchase agreement tender at 12:00. If, for whatever reason, the tender cannot be held at 12:00, it will be postponed until 15:00.
If necessary, a final clearing auction will be held just prior to the end of the day cycle as prescribed by the South African Multiple Option Settlement System (SAMOS). The final clearing auction can either be in the form of liquidity providing repurchase agreement or a reverse repurchase agreement where surplus liquidity is drained from the market. Holders of eligible assets should have full title over the assets offered for repurchase agreements and these assets may not become redeemable during the life of the repurchase agreement transaction for which they are used. Therefore, securities offered for repurchase agreement or provided in the event of a margin call should not mature on or before the maturity date of the specific repurchase agreement transaction.
The Reserve Bank will, on a daily basis, provide yield to maturity rates on its wire services pages (Reuters: RBMR) for bonds acceptable for repurchase agreement transactions. These yields will be based on the most recent rates of bonds traded on screen. The Reserve Bank will also provide applicable discount rates for the valuation of bills and Reserve Bank debentures.
Coupon payments received on securities that are offered for the repurchase agreement would be paid over to the supplier (seller/cash taker) of the securities on the interest payment date.
The marginal lending facility
The marginal lending facility is available as a last resort to banks to bridge overnight liquidity needs, e.g. to meet their cash reserve requirements or unforeseen shortages of liquidity in the daily or intra-day settlement. This facility will be secured against the collateral of all government bonds, Treasury and Land Bank bills and Reserve Bank debentures. It will be required that these loans are covered by at least 105 per cent of the market value of securities pledged. Although no restriction will be placed on the use of the marginal lending facility, provided the required collateral can be delivered, the maturity of advances should be overnight to enable banks to meet shortages of liquidity in the daily or intra-day settlement.
It is the objective to normally keep the end-of-day outstanding balance on this lending facility relatively small and the banks should use this facility only on an infrequent basis. The marginal lending facility forms an integrated part of SAMOS. In terms of this system all registered banks are eligible to open settlement and loan accounts at the Reserve Bank, in order to participate in the interbank settlement process. Banks that opted not to open SAMOS settlement accounts will not have direct access to Reserve Bank liquidity, but via its sponsoring bank (settlement bank). Payments in this system can only be made if a bank has sufficient funds in its settlement account. Such funds can be obtained through inter-bank transfers, repurchase transactions, other types of liquidity-creating instruments of the Reserve Bank, or the marginal lending facility.
Transfers made up to 17:00 in window 1 and 2, the system that the South African Reserve Bank uses in the repurchase agreement, are deemed to be final and irrevocable. The settlement of payment clearinghouse batches is settled the following morning. At any time during the business day, banks may access the marginal lending facility automatically if funds are required on their settlement accounts to effect a payment, provided sufficient underlying assets are available to be pledged as collateral to the Reserve Bank. At the end of the settlement cycle date, the banks' unsettled intra-day debit position with the Reserve Bank will automatically be considered as recourse to the overnight marginal lending facility.
The marginal lending rate is set at a specified spread above the latest determined repurchase agreement rate. The Reserve Bank will inform the market of any changes in this regard.
II PROCEDURES FOR REPURCHASE AGREEMENT
1. Publication of tender amount
The Reserve Bank will announce the provisional amount of liquidity required by the market on its wire services pages (Reuters: RBMQ; see Appendix II) at around 11:30. A revised amount could be announced at 12:00 (or at 15:00 in the case of a delayed auction).
A final clearing amount could also be announced towards the end of the day cycle. Depending on the market position immediately before the final window of the day, the Reserve Bank can either provide liquidity to the market via a repurchase agreement or drain excess liquidity via a reverse repurchase agreement.
The Reserve Bank could postpone the 12:00 main repurchase agreement until 15:00 if, for whatever reason, the Bank is unable to calculate and/or announced the tender amount in time. The market would be informed by the Bank of any decision in this regard on its wire services pages (Reuters: RBMQ; see Appendix II).
2. Invitation for bids
The Reserve Bank will normally conduct the main repurchase agreement auction at 12:00. The Reserve Bank will publish a screen announcement in the form of Appendix II. This announcement will state amongst others:
the maturing repurchase agreement transactions for the day; the maturity date; the liquidity requirement for the day; the amount on tender; 0 whether it is a fixed or variable rate repurchase agreement tender; and the closing time of the tender. When a fixed rate tender is to be held the tender rate will also be disclosed.
3. Submission of bids
Bids for funds are irrevocable once the tender has closed. A participant commits itself to entering into a repurchase agreement transaction up to the amount specified in the bid(s) submitted at the close of the tender.
As specified in the invitation (Reuters: RBMQ; see Appendix 11), participants in repurchase agreements should call the Reserve Bank's dealing room (telephone 012=313-4952/7) with the details of their bids, usually within fifteen minutes after the invitation for bids. Participants must state the total amount of funds for which they wish to apply and, if applicable, the repurchase agreement rate (to the nearest 0,01%) at which they wish to bid. The type of securities to be sold to the Reserve Bank should not be specified during the submission of bids but only after the announcement of results.
The minimum amount for bids will be R10 million (and thereafter in multiples of R1 million). The maximum total size of a participant's bid should not exceed the size of the amount offered on tender. In the event of a dispute, reference will be made to recordings of telephone conversations. All telephone conversations received and made from the Reserve Bank's dealing room are recorded. 4. Acceptance of bids and announcement of results
Variable rate tender: Bids will be allotted sequentially (American style), by first allotting the highest rate bid in full, then allotting the second highest rate in full and so on, until the full amount on offer has been allotted. Partial allotment(s) may be made to the tendered(s) whose bid(s) is/(are) at the cut-off rate.
Fixed rate tender: All bids received will be included in the allocation. If the total amount of the bids received is equal to or less than the amount on tender, participants will receive the exact amounts they tendered for.
In the event of the total amount of bids received exceeding the amount on tender, participants will receive a partial allocation at the fixed repurchase agreement rate specified by the Reserve Bank in the invitation.
The Reserve Bank will normally announce the result of each auction within fifteen minutes of the closing of the tender (Reuters: RBMQ; see Appendix II), stating amongst others:
the total amount of funds on tender; the total amount applied for; the total amount allotted; the highest and lowest bids; the weighted average repurchase agreement rate or fixed repurchase agreement rate if applicable; and the total amount of outstanding repurchases agreements.
Participants must then telephone the Reserve Bank's dealers to obtain confirmation whether the full amount of their bids had been accepted or, if not, their partial allotment. The Reserve Bank reserves the right to reject individual bids and to accept individual bids in part.
5. Sale and repurchase transactions
Participants will receive cash to the exact value of an accepted repurchase agreement bid, but to protect the Reserve Bank against credit and market risks the banks must provide the Reserve Bank with securities with an adjusted value ("haircut valuation").
The adjusted value means that the value of the securities divided by an appropriate ratio as set out below, must at least be equal to the total repurchase price (the repurchase agreement bid or purchase price plus the repurchase agreement interest). In the following example bonds with different maturity can be compare. Comparison of bond maturity Bonds with residual maturity longer than 10 years: 1,035 Bonds with residual maturity between 1 and 10 years • 1,025 Bonds, debentures and bills with residual maturity of up to 1 year: 1,010
These margins may be changed at any time at the discretion of the Reserve Bank.
(I) Government Bonds
Bonds are valued at the yields released by the Reserve Bank on its wire service page (Reuters: RBMR). These yields are based on the most recent yields on bonds traded on screen.
(ii) Treasury Bills
Treasury bills are valued at the previous Friday's tender discount rates. There are two maturity bands with corresponding rates. In figure 3.2 this is shown as example,
Discount rates
91 days : Previous Friday's tender for 91 day.Treasury bills discount rate: 92 -'182 days : PieVidus'Fiiday';. tendeilbi:18idaYti:Caanry bid; diacOunt•
Land Bank bills
Although Land Bank bills are not government guaranteed and, therefore, arguably carry a higher credit risk compared with Treasury bills, they normally trade on par with Treasury bills in the secondary market. It has therefore been decided to value Land Bank bills on the same basis as Treasury bills.
Reserve Bank debentures
Reserve Bank debentures are valued at the previous Friday's Treasury bill yield rates. The same two maturity bands as explained in 5.iii above are applicable.
Example of yield rates
• 1r 91 days :Previous iriday; tender for'91 daYTreastiiy bills yield 92 -482 ,days — : Prvious Friday's" tanderlor'182' day TreasiirybillS yield': (v) Repurchase agreement maturity
The repurchase date is set on the day that the securities are bought (or sold) by the Reserve Bank. Should the repurchase date be declared a public holiday after the tender took place, the second leg of the tender in question will take place on the next business day after the public holiday. In this event no interest would be paid for the additional period.
Details of underlying securities
For either the 12:00 or 15:00 repurchase agreement auctions participants should, within 30 minutes after the publication of the tender results, fax the Reserve Bank details of the type of securities to be sold to the Reserve Bank.
The fax should include the signatures of two authorised signatories. As there is a time constraint after the final clearing repurchase agreement / reverse repurchase agreement, participants should within 10 minutes after the announcement of the tender results, fax the Reserve Bank details of the securities to be sold to or bought from the Bank. Examples of the format and the information to be are included submitted via the taxes returned in Appendices III and IV.
Delivery confirmation
Final details of securities to be delivered in respect of auctions held at 12:00 should be sent by fax or through SWIFT to the Financial Instrument Register (FIR) using the form in Appendix III within one hour after the announcement of results. In the case of a 15:00 auction, participants should fax or sent via SWIFT to the FIR details of securities (also using the form in Appendix III) not later than 16:00. As there is a time constraint involved during a final clearing repurchase agreement/reverse repurchase agreement held at around 8:45 the next day, details of the securities to be delivered should be sent by fax or via SWIFT to the FIR before the closure of the final SAMOS window, using either the form in Appendix III or the form in Appendix IV. Failure to accurately disclose the securities to be delivered under a transaction will constitute an Event of Default and can result in a penalty charge and/or the cancellation of the transaction by the Reserve Bank.
Liquidity absorbing operations
Structural reverse repurchase agreements (selling of securities under repurchase contracts by the Reserve Bank) and the issuance of Reserve Bank debentures may be used to drain liquidity from the market. Market participants will be requested to offer cash to the Bank on a tender basis (see Appendix VI and Appendix VII). Offers will be ranked and allotted in ascending order and should be expressed as a rate to the nearest 0,01%. The Reserve Bank again reserves the right to reject individual tenders and to accept individual tenders in part.
9. Emergency procedures
If the aforementioned procedures cannot be followed for whatever reason, the Reserve Bank reserves the right to change the procedures as deemed necessary. The market would be informed accordingly on the wire services pages.
Ill DELIVERY AND SETTLEMENT OF SECURITIES
Delivery
(1) All banks that wish to make use of the repurchase agreement facility will be required to utilise a FIR account at the Reserve Bank's Settlement Division in Johannesburg. All securities to be used for repurchase agreement transactions should either be physically delivered to the Settlement Division (in the case of bills) or transferred to the Reserve Bank's safe custody account in the Central Depository (in the case of bonds).
(iii) All bond trades must settle through SAMOS or via the participating bank's settlement agent. Deliveries of securities to be sold to the Reserve Bank following the 12:00 auction should be available in the FIR account within one hour after the announcement of the tender results. Securities to be sold to the Reserve Bank following a 15:00 auction should be available in the FIR account before 16:00.
Securities to be sold to the Reserve Bank following a final clearing auction should be available in the FIR account before the closure of the final SAMOS window.
Details of deliveries should conform exactly to details given in Appendix III. South African Reserve Bank debentures acquired via final clearing reverse repurchase agreements from the Reserve Bank would be treated in an immobilised format; i.e. no physical debentures will be issued.
Settlement
Provided that sufficient securities have been secured through the Central Depository or the FIR, the Reserve Bank and the participants will transfer the funds within one hour via SAMOS. Banks that do not participate in the SAMOS system must settle through their settlement banks. IV MARGIN MAINTENANCE
General
In order to provide for potential losses, the Reserve Bank will use two calculations to cover the risk. A "haircut valuation" will be calculated on each security sold to the Reserve Bank and the Bank will also use a daily mark-to- market revaluation of securities which it is due to deliver on the sell-back leg of outstanding repurchase agreements and also of equivalent margin securities.
"Valuation haircut"
Reserve Bank will apply a "valuation haircut" on securities it acquires in repurchase agreement transactions. In figure 3.4., the appropriate margin ratios are as follows:
Margin ratios
i. bonds wit, ,an outstanding maturity shorter than 1 year. - 1',010 :, _Onvernnient bonds:With an outStanding-inaiuritY betiveen:Ijand 10 yeara: , 1,025 POvernmentbonds with an ontStandingmaturitylonger than 10 year& ' - 1;035:- Treasury., bills: , , 1,010` LandBank bill& . . 1,010: Reserve Bank debenture& 1,010,
Calculation of Margin Deficit
(i) The Reserve Bank will mark-to-market each bank's repurchase agreement portfolio on a daily basis. The total of the values will be compared with the total repurchase price for all repurchase agreements outstanding with a participant. (ii) The Reserve Bank will normally call for margin if the total market value falls below the total repurchase price by an amount equal to or greater than a "call trigger amount" which the Reserve Bank will determine and may change at its discretion. Additional margin should take the form of either security having an adjusted value at least equal to the margin deficit or the Reserve Bank can call for a cash deposit. Either the cash or the additional securities will be taken into account in future mark-to-market revaluation's. In figure 3.5. the Margin deficit is shown.
Margin deficit
Margin deficit When ,TOtal Market ValUe'< Taal RePurahiSe Price
'Example.
where,Total Repurchase Pncejs:
Purchase.price r(repurchase ageeerhent allotment F.1350 , 000,000 Ihtereit (at repurchase agreement tender rate) R 7 142 oat) Total Repurchase. Price (sell-back cash cdnsideratiph R350 142 000 A-
and Total.Market Value is: , Value of bonds soici to the Bank ; R201 336 488 Vatue of Treasury Pine Aold to the, nk •-; F. 424 081 Total MarlcetValue R344 760:569 B
ThUs,''MargiriDeficit IS: Total Market Value (A) 8344 750 569 Total Repurchase•Price (sell-baok price) (B) R350"142'000 Margin Deficit (A) 7 (B) R 5 381-431
The call trigger amount has, for the time being, been set at R5 million. In this example, therefore, the Reserve Bank would require margin securities to be delivered having a total market value of at least R5 381 431.
The Reserve Bank will advise participants by 09:30 of the exact amount of any margin securities to be delivered. 4. Repayment of excess margin
If the total value of securities exceeds the total repurchase price for all repurchase agreements outstanding with a participant by an amount equal to or greater than the "call trigger amount", the Reserve Bank will at the request of the participant credit its settlement account at the Reserve Bank with an amount no greater than the margin excess. The participant should request the Reserve Bank by telephone by 09:30 of such a repayment of excess margin.
If a margin call is made by the Reserve Bank, details of the securities to be delivered to the Bank should be confirmed by fax by 10:30 on the day of the call. Appendix V will be used. The Reserve Bank reserves the right to reject the composition of any proposed margin transfer.
All securities to be provided as margin securities, as part of a margin transfer, should be delivered by 11:00 to the FIR at the Reserve Bank's Settlement Division in Johannesburg.
5. Margin Transfers
Securities provided to the Reserve Bank as the result of a margin call will become a margin pool and will be taken into account in subsequent revaluation's of securities. Such margin securities will not have a fixed date for redelivery to the participant.
Where bills are provided as margin securities, the maturity date of such bills must be at least one day later than the maturity date of the longest repurchase agreement outstanding with that participant (regardless of the type of securities held by the Reserve Bank in connection with that repurchase agreement). (iii) Bills held by the Reserve Bank in the margin pool which are due to mature will be returned to the participant one day before maturity and, where necessary, the Reserve Bank will require replacement securities to maintain margin requirements.
6. Retention of Securities
( 1) Where the delivery by the Reserve Bank of equivalent securities at the maturity date of a repurchase agreement would create a margin deficit in respect of continuing transactions which, in the Reserve Bank's opinion, is excessive, the Reserve Bank reserves the right to make a margin call and satisfy the call by retaining some or all of the securities due to be delivered. Retained securities may subsequently be delivered when the Reserve Bank has received sufficient other margin securities.
(ii) When no repurchase agreements remain outstanding with a participant, all securities provided as margin will be returned through the relevant settlement system (FIR). Timings for the return of such securities will be the same as those for maturing repurchase agreement transactions listed in section V below
V REPURCHASE OF SECURITIES
When a repurchase agreement transaction matures, participants will purchase securities from the Reserve Bank equivalent to those that it has sold to the Reserve Bank in the first leg of the repurchase agreement.
On or after receiving payment (via SAMOS) the Reserve Bank will deliver to the participant securities equivalent to those sold to it. When a repurchase agreement transaction matures and no other repurchase agreements with that participant remain outstanding, any additional margin provided by that participant will be returned. In cases where one or more repurchase agreements with a participant are outstanding, the Reserve Bank will, if necessary, make a margin call and, until sufficient margin securities are delivered, satisfy the call by retaining equivalent securities.
(South African Reserve Bank Repurchase Operations in the domestic money markets, Operational Notice February 2001). On the morning of maturity, the Reserve Bank will inform participants by telephone by 09:30 of the amount of any securities due to be returned that day which it intends to retain as part of the margin maintenance arrangements.
Participants repurchasing bills should pay the repurchase price to the Reserve Bank through SAMOS by 11:30 on the day of maturity. The Reserve Bank will deliver, via the FIR (explain the external don't understand first the explanation then the abbreviation), free of consideration securities equivalent to those sold after cash has been received. a.
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a) c. Appendix II EXAMPLES OF SCREEN ANNOUNCEMENTS
PROVISIONAL LIQUIDITY REQUIREMENT REUTERS PAGE: RBMQ Estimated time of release: 11:30 FIGURE 1
Date The provisiorialiqindity requirement for today (including maturing repos of R. amounts to Rte- •
MAIN REPO TENDER REUTERS PAGE: RBMQ Estimated time of release: Invitation at 12:00 and/or 15:00 and results at around 12:20 and/or 15:20 FIGURE 2: Invitation (variable rate tender) FIGURE 3: Results (variable rate tender)
Date. :Date; ' _ The final liquidity requirement for todayfincluding maturin ..,:rhe,final: liquidity•requirernentifor today (including maturing repos of R remains unchanged at R repoS. of R remains-unchanged at R Around 'of variable rate repo' operationsis -Minted Repo results': • :•"" '
Total amount on tender = R million. Total amount :allotted = R - million. Maturity date= . Total amount received. R million. The closing tiinefor bidiis "ilighest fate = ° !Lowiest rate Average repo. rate = Outstanding repos now total R
te Date The final liquidity requirement fcir. today (including maturing thefinaFliqiiiditY reqUireinent for today (including inaturing repos ofR. ' remains unchanged at R repos'of remains unchanged at It' 'million: A round `of flied rate repo operation.1 is invited Repoxesubs;
TiitariiniOunf'on'tender = - • total allOtted million. Maturity' date = • 2 Repo rate-= °/ RepOrrate=..,. The closing time for bids is ...Outstandinirepos now total R million:
3. FINAL CLEARING REPO / REVERSE REPO REUTERS PAGE: RBMQ Estimated time of release: Invitation at around 08:35 and results at around 08:50
FIGURE 6: Invitation FIGURE 7: Results
Date ' Date Bids for a'final clearing repo f reverse repo are invited for " Tender results of final cleating repo / reverse repo for value value date, . „, • dates . Total amount on tender =R million , Totalamount,allotted million. At a rite of Total amount'received = R million Maturity date = The closing time for bids is ASSET VALUATION RATES REUTERS PAGE: RBMR Estimated time of release: Normally between 11:00 and 12:00 FIGURE 8 Date ' The following rates will be applicable.for valuation purpose in the event of a repo tendenat
8162 R157,4_ Q-91,dit5`ts topatirriti, R174 R186 92-182 days to maturity 8175 it 180 RE. P CPI R150 R184 R177
LIQUIDITY REQUIREMENT REUTERS PAGE: RBMSA01 Estimated time of release: 11:30 FIGURE 9 SARB note and coin liability 4Date R Late it million The' final' liquidity requireinent for Date amounted tc;It „which,consists
Repo (main) . Repo (final clearing) - Marginal lending facility Cash ieserve contra withdraWat Cash reserve contra, deposit = Liquidity requrequiredired Total repos otitstanding:. Daily repo (main ÷ final clearing) 'Longer term reverse repo`;
Special notice:
SUMMARY PAGE OF ALL MONEY AND CAPITAL MARKET WIRE PAGES REUTERS PAGE: RBMM FIGURE 10 Description Updated ' Special auctions , e-,5RE5.1v,ISA02,> 41111914190: &Witch AuctiOn InVitationthesultS
APPENDIX III REPO TENDER DATE
Contact Name : Attention : Money Market Pta Attention: Money Market Jhb
Contact tel no : Fax : (012) 313 4278 Fax : (011) 240 0835
REPOS BETWEEN : AND THE SOUTH AFRICAN RESERVE BANK
We refer to the Reserve Bank's telephone confirmation that, as a result of the acceptance of bids under the round of repo operations specified above, we are to enter today into the following repo transaction(s) with the Reserve Bank.
Summary of Bids Bid Purchase Price Repo Maturity Repo Rate Repurchase Price Allocation First Bid Second Bid Total < A+B+C
Particulars of securities to be transferred to the South African Reserve Bank:
Government Bonds Type Nominal YTM Value Haircut ratio Adjusted Value
Total A
Treasury / Land Bank Bills Type Nomina Days to Mat Mat Date Disc Rate Value Haircut Adjusted value
Total B
SARB Debentures Non, Mat value Days to Mat Mat Date Yield Value Haircut Adjusted value
Total C
Total A+B+C Please note : the total of all assets (adjusted value) must be greater than the repurchase price.
AUTHORISED SIGNATURE 1 AUTHORISED SIGNATURE 2
NB: If insufficient room available on this form, please fax additional forms.
APPENDIX IV
FINAL CLEARING REVERSE REPO TENDER
Contact Name : Attention : Money Market Pta Attention: Money Market Jhb
Contact tel no : Fax : (012) 313 4278 Fax : (011) 240 0835
REVERSE REPOS BETWEEN : AND THE SOUTH AFRICAN RESERVE BANK
TENDER DATE: TIME OF ROUND:
VALUE DATE:
We refer to the Reserve Bank's telephone confirmation that, as a result of the acceptance of bids under the round of reverse repo operations specified above, we are to enter today into the following reverse repo transaction(s) with the Reserve Bank.
Summary of Bids Reverse Bid Reverse Repo Sell Price Repo Sell Back Price Allocation Maturity Date Rate First Bid
Second Bid
Particulars of securities to be transferred to (buyer).
Asset
Type Nominal Maturity Date Yield To Value Maturity SARB Debenture
AUTHORISED SIGNATURE 1 AUTHORISED SIGNATURE 2 APPENDIX V Contact Name : Attention : Money Market Pta Attention: Money Market Jhb Contact tel no : Fax : (012) 313 4278 Fax : (011) 240 0835
MARGIN TRANSFER TO THE SOUTH AFRICAN RESERVE BANK
FROM:
PARTICULARS OF SECURITIES TO BE TRANSFERRED TO THE RESERVE BANK
Government Bonds TYPE NOMINAL Ytm VALUE
Treasury / Land Bank Bills
DAYS TO DISCOUNT TYPE NOMINAL VALUE MATURITY RATE
AUTHORISED SIGNATURE 1 AUTHORISED SIGNATURE 2
NB: If insufficient room available on this form, please fax additional forms. APPENDIX VI TERMS AND CONDITIONS PERTAINING TO THE ISSUANCE OF SOUTH AFRICAN RESERVE BANK DEBENTURES
1. TERMS AND CONDITIONS Debentures are issued and transferred in multiples of R5 000 000. Debentures are issued by the South African Reserve Bank ("the Bank") at par, and are transferable. The holders of debentures shall be deemed to be exclusively entitled to all benefits and rights arising therefrom and the Bank shall not be obliged to recognise the right of any other person in or to these debentures or to record any such right. The Bank undertakes to redeem the debentures at par on the redemption date against delivery of the respective certificate or against the rendering of such evidence of the loss or destruction thereof together with such indemnity as may be required by the Bank. The date of issue shall be deemed to be the date as from which interest is payable thereon as set out on each certificate. The interest redemption on debentures, at the rate as set out on the certificate, shall be payable in arrears to the holder or last transferee on the redemption date. The interest payment shall be calculated according to the actual number of days from the issue date based on a 365-day year. The interest of the debentures as well as capital thereof shall be transferred by the Bank to the credit of the holder or last transferee, and shall be deemed to have been received by the holder or last transferee if it has been so transferred. Certificates must be returned to the Johannesburg branch of the Bank or to the Bank's head office at Pretoria for redemption preferably not later than one day prior to the redemption date. Transfer of certificates may be effected by signing the record of transfer at the back of the certificate. Save for the transfer signatures referred to above (if any), certificates are issued without any alteration or amendment and no alteration or amendment on the certificate shall be enforceable against or be recognised by the Bank.
2. SCREEN ANNOUNCEMENT REUTERS PAGE: RBMN Estimated time of release: Invitation normally at around 8:00 on the morning of the tender. Results at around 11:00.
FIGURE 1: Invitation Date Tenders are invited for 11250 million 213'daY SARK Ciebentires. Issue Date Settlement Date: (via SAMOS) MantritYDate: Minimum bid is limited to R5 million, thereafter bids must be submitted in,multiples of R5 million. Bids will be ranked and allotted in ascending order and should be 'expressed as a rate to the nearest 0.01%. Kindly submit bids to Pta MM telephonically at 012,313 4952/7 before 10:00. Results will.be published at approximately 11:00. FIGURE 2: Results Date Tenders are invited for R250•million 28,day SAlt.13 debentures: Issue Date: Settlement Date: (via 'SAN 10§) Maturity Date: Tender restlts: - Total amount allotted million: Total amount received million. Average rate Outstanding 4:lebentures novVtotal R. million.
PLEASE NOTE THAT FIGURES 1 AND 2 ARE ILLUSTRATIONS. THE RESERVE BANK RESERVES THE RIGHT TO AMEND THE CONTENTS OF ANY PAGE AT ITS DISCRETION. APPENDIX VII RESERVE BANK STRUCTURAL REVERSE REPOS
BACKGROUND Since 29 April 1999 the Reserve Bank has been involved in longer term (28 day maturity) reverse repo transactions. These transactions take place against the selling of government bonds to drain liquidity from the market.
CONDITIONS Longer term reverse repo transactions are also booked on the basis of classic money market repos where the cash taker retains the right to any coupon payments. If a coupon payment is made to the cash provider, with respect to the security involved in the specific repo transaction, such payment should immediately be passed on to the cash taker. Failure to do so would constitute an event of default.
SCREEN ANNOUNCEMENTS REUTERS PAGE: RBMP Estimated time of release: Invitation normally at around 10:00 on the working day before the tender. Results at around 10:30.
FIGURE 1: Invitation • The following reverse repo auction amounting to R m against.w
' the selling Ofg-' ' eandueted on ' , for: Settleinent on •
(T+3) and maturing on ' ''(_ays). Minimuni bid IS' • , fOr million, thereafter, bids must lie in ; multiples of Rl million. 7 Bids shotildVe expressed as a rate to the nearest 0,01%. Submit bids to the Pia MM telephonically 'at 012319 4952/7 before 10:00.12esults will be. announced (RBMP) at approximately ; 10:30: Please note that in-terns of the established convention classic iniineYnierkeerepoi: the coupon' interest on - is payable to the supplier of the. StOelc'(i:e1SARB):
FIGURE 2: Results The follOwing reverse repo auction amounting to 'in against the selling of Re's wil•be conducted on for settlement (T+3) and maturing on ,,,C days). Minimurn.bid is., limited for R million, thereafter bids must be in multiples of RI million. Tender Results: ,
Total amount , allotted .= R million.: Total amount received = R. million. Average reverse repo .rato = % Outstanding day reverse repos now total R million.- . "
PLEASE NOTE THAT FIGURES 1 AND 2 ARE ILLUSTRATIONS. THE RESERVE BANK RESERVES THE RIGHT TO AMEND THE CONTENTS OF ANY PAGE AT ITS DISCRETION.
4. SARB STRUCTURAL REVERSE REPO TRANSACTION FORM
SOUTH AFRICAN RESERVE BANK STRUCTURAL REVERSE REPO TENDER
Contact Name : Attention : Money Market Pta Attention: Money Market Jhb
Contact tel no : Fax : (012) 313 4278 Fax : (011) 240 0835
REVERSE REPOS BETWEEN : AND THE SOUTH AFRICAN RESERVE BANK
TENDER DATE: TIME OF ROUND:
VALUE DATE:
We refer to the Reserve Bank's telephone confirmation that, as a result of the acceptance of bids for the reverse repo operations specified above, we are to enter today into the following reverse repo transaction(s).
Summary of Bids Reverse Bid Reverse Repo Sell Price Repo Sell Back Price Allocation Maturity Date Rate First Bid
Second Bid
Bond Nominal Type Yield to maturity Market Value (Rm)
PLEASE NOTE THAT THE SUPPLIER OF THE STOCK RECEIVE THE COUPON. Coupon interest to be paid to the SARB on amounts to R Al the above figures are checked and confirmed.
Bank Official Bank official
SARB Official SARB Official APPENDIX VIII CASH RESERVE AND CASH RESERVE CONTRA ACCOUNTS
BACKGROUND The Cash Reserve Contra Account (CRCA) system was introduced by the South African Reserve Bank (SARB) with effect from 20 March 1998 to provide banks with greater flexibility as far as their daily liquidity management is concerned. In essence, the introduction of this set of accounts enables the banks to comply with the statutory cash reserve requirements on an average basis over each maintenance period.
Final clearing auctions were introduced to further enhance the efficiency of the repo-based accommodation system. Final clearing auctions are conducted when a relatively large liquidity imbalance occurs in the market owing to a sizable and non-intentional over- or under provision of liquidity by the SARB at the main (repo) auction. The CRCAs may be used for "fine-tuning" operations should the Bank not offer a final clearing auction or if a bank prefers not to participate in such a final clearing auction.
CONDITIONS In terms of the existing arrangements, banks first have to make a withdrawal from the CRCAs before they are allowed to deposit any funds on the CRCAs. This restriction can create problems when the market is in surplus owing to an over-estimation of the daily liquidity requirement by the SARB, for it implies that those banks which are in surplus can not deposit such surpluses on their CRCAs if they have not withdrawn funds at an earlier date. Banks may, however, be granted permission by the SARB to deposit surpluses on their CRCAs even though no withdrawals have been effected earlier on, provided that such deposits will be drawn down on the following working day.
AGREEMENT OF PLEDGE In terms of section 10(1)(f) of the South African Reserve Bank Act, 1989 (Act No 90 of 1989 — the "SARB Act"), the Reserve Bank is not allowed to grant unsecured loans or advances. Banks are consequently obliged to provide the necessary security before utilising their CRCA facilities. This can be effected by signing an Agreement of Pledge, obtainable from the Money and Capital Market Department in Pretoria.
1 A maintenance period starts on the 15th working day of a month and ends on the 14th working day of the following month.
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