Bangko Sentral's Role in Monetary Policy

AE18-005 FINANCIAL MARKETS AND INSTITUTIONS
COLLEGE OF SAINT LAWRENCE, INC.

Balagtas, Bulacan
INSTITUTIONAL PHILOSOPHY
VISION
The College of Saint Lawrence will position itself as one of the leading institutions in providing
the highest standard of quality and affordable education to our students, to recognize and enjoy financial
and economic benefits and to develop responsible citizens of our society.
MISSION
 To strictly implement the Manual of Operation and Course Syllabus as prescribed by the
Department of Education (DepEd), Technical Education and Skills Development Authority
(TESDA) and Commission on Higher Education (CHED).
 To establish targets and objectives for all members of the Faculty and Students and provide
mechanisms to check its strict implementation.
 To update and revise the said Manuals periodically to ensure its relevance and effectiveness.
 To involve and consult with parents in making relevant decisions in the affairs and education of
our students.
 To provide students with a balanced educational experience through formal education and actual
apprenticeship in various establishments so that all acquired theories, ideas, concepts and skills
shall be blended well with practical work application and proper attitude.
 To focus the development program of Science and Technology in the field of Business, Education,
Electronics, Computer and Information Technology.
SUBJECT: FINANCIAL MARKETS AND INSTITUTIONS

COURSE/YEAR: BSA-II
COURSE TOPIC: CENTRAL BANKING AND THE EFFECTS OF ITS MONETARY
POLICIES IN OUR ECONOMY
PROGRAM OBJECTIVES:
During the chapter, the learners are expected to:
 Understand the New Central Bank Act
 Identify the qualifications of the members of the Monetary Board
 Explain how does the Bangko Sentral influences the Monetary Policy in our
economy
PROGRAM OUTCOMES:
After studying the chapter, the learners should be able to:
 Compute for the money supply and excess reserves.

 Explain the relationship of reserve ratio, inflation and discount rates to money
supply.
INTRODUCTION
On June 15, 1948, the Central Bank Act or the Republic Act No. 265 was approved. This Act
provides for the creation of the Central Bank of the Philippines, which finally opened its doors to
the public on January 3, 1949. The capital of the bank, as provided by the Act, shall be ten (10)
billion pesos, with the initial subscription coming from the liquidated assets of the Exchange
Standard Fund.
The Central Bank has the responsibility of administering the monetary, banking and credit system
of the Republic. Therefore the bank should have achieved the following objectives:
 Primarily to maintain internal and external monetary stability in the Philippines;
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 To preserve the international value of the peso and the convertibility of the peso into other
freely convertible currencies;
 To foster monetary, credit and exchange conditions conducive to a balanced and sustainable
growth of the economy; and
 To maintain price stability in the economy.
THE OLD MONETARY BOARD

The policy-making body of the Central Bank is the Monetary Board, which is composed of seven
members. The Chairman of the Board is also the Governor of the Central Bank. The other members
are: Secretary of Finance, the Director General of the National Economic Development Authority
(NEDA), the Chairman of the Board of Investments, the Secretary of Budget and Management, and
two appointed representatives from the private sector. The Chairman of the Old Monetary Board
has a term of six years while the representatives from the private sector have 4 years.
The person to be appointed to the Board must be a person of good moral character and of
unquestionable integrity and responsibility. You must also be competent in economics, banking,
finance, commerce, agriculture or industry. All members of the Monetary Board must be natural
born Filipino citizens.
THE NEW CENTRAL BANK ACT

Republic act 7653 is known as the New Central Bank Act. Section I of RA 7653 states that the
state shall maintain is Central Monetary Authority (CMA) that shall function and operate as an
independent body in the discharge of its mandated responsibilities concerning money, banking, and
credit. This established independent Central Monetary Authority shall be a corporate body known
as the Bangko Sentral ng Pilipinas hereafter referred to as Bangko Sentral.
The Bangko Sentral should be capitalized at fifty (50) billion pesos to be fully subscribed by the
Government of the Republic of the Philippines. Ten (10) billion of which shall be fully paid for by
the government upon effectivity of this Act and the balance to be paid for within a period of two (2)
years from the effectivity of this Act in such manner and form as the Secretary of Finance and the
Secretary of Budget and Management may thereafter determine.
The Bangko Sentral should provide policy directions in areas of money, banking and credit. It
should have supervision over the operations of banks and exercise such regulatory powers as
provided in this Act and other pertinent laws over the operations of finance companies and non-
bank financial institutions performing quasi-banking functions hereafter referred to ask quasi-
banks.
COMPOSITION OF THE NEW MONETARY BOARD OF BANGKO SENTRAL

The powers and functions of the Bangko Sentral shall be exercised by the Bangko Sentral Board
composed of seven (7) members appointed by the President of the Philippines for a term of six (6)
years. The seven members are:
 The Governor of the Bangko Sentral who shall be the Chairman of the Monetary Board. The
Governor of the Bangko Sentral shall be head of a department and his appointment shall be
subject to confirmation by the Commission on Appointments. Whenever the Governor is
unable to attend a meeting of the Board, he shall designate a Deputy Governor to act as an
alternate provided that in such event the monetary board shall designate one of its
members as Acting Chairman.
 A member of the Cabinet is to be designated by the President of the Philippines. Whenever

the designated Cabinet Member is an able to attend a meeting of the Board, he shall
designate an Undersecretary in his Department to attend as his alternate.
 Five (5) members who shall come from the private sector all of whom shall serve full-time.
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QUALIFICATIONS OF THE MONETARY BOARD

The members of the Monetary Board must be natural born citizens of the Philippines, at least 35
years of age, with exception of the Governor who shall at least be 40 years of age, of good moral
character, of unquestionable integrity, of known probity and patriotism, and with recognize
competence in social and economic disciplines.
BANGKO SENTRAL NG PILIPINAS AS BANK OF ISSUE

The Bangko Sentral is the only bank authorized to manufacture and issue money. As the bank of
issue, it has the monopoly of note issue. Thus, anyone who makes money without the authority
given by the Bangko Sentral is guilty of counterfeiting.
Counterfeiting is the manufacture of money without due authority. This offense is a criminal
offence and is therefore punishable by law.
BANGKO SENTRAL NG PILIPINAS AS LENDER OF LAST RESORT

In case banks need funds for lending to their clients, they may avail of the rediscount facilities of the
Central Bank. Through the discount window of the central bank, banks may borrow funds by using
their notes and having them the rediscounted.
The Bangko Sentral charges interest on money lent to borrowing banks. When banks are distressed,
the Bangko Sentral comes to their rescue by lending to them extra ordinary loans so as to prevent
banks from losing the confidence of the general public.
DOMESTIC MONETARY STABILIZATION

Actions when abnormal movements occur in the monetary aggregates credit, or price level. -
Whenever abnormal movements in the monetary aggregates, in credit, or in prices endanger the
stability of the Philippine economy or important sectors thereof , the Monetary Board shall:
 Take such remedial measures as are appropriate and within the powers granted to the
Monetary Board and the Bangko Sentral under the provisions of Article I, Chapter III,
Section 63, of the New Central Bank Act ( RA 7653); and
 Submit to the President of the Philippines and the Congress, and make public, a detailed
report which shall include, as a minimum, a description and analysis of:
o the causes of the rise and fall of the monetary aggregates, of credit or of prices;
o the extent to which the changes in the monetary aggregates, in credit, or in prices
have been reflected in changes in the level of domestic output, employment, wages
and economic activity in general, and the nature and significance of any such
changes; and
o the measures which the Monetary Board has taken and the other monetary, fiscal or
administrative measures which it recommends to be adopted.
Whenever the monetary aggregates, or the level of credit increases or decreases by more than 15%,
or the cost of living index increases by more than 10%, in relation to the level existing at the end of
the corresponding month of the preceding year, or even though any of this quantitative guidelines
have not been reached when its judgment the circumstances so warrant, the Monetary Board shall
submit reports mentioned in this section and shall state there in whether, in the opinion of the
Board, said changes in the monetary aggregates, credit or cost of living represent a threat to the
stability of the Philippine economy or of important sectors thereof.
The Monetary Board shall continue to submit periodic reports to the President of the Philippines
and to Congress until it considers that the monetary, credit or price disturbances have disappeared
or have been adequately controlled.
INSTRUMENTS OF CENTRAL BANK ACTIONS

In order to maintain monetary stability within and out of the country, the Bangko Sentral
endeavors to control the expansion or contraction of the money supply, the level of credit, or
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any rise or fall in prices. Monetary authorities are empowered to institute a number of devices for
purposes of proper regulations of the volume of money supply. The devices may be as follows:
1. Control of legal reserve requirement
2. Control of discount and rediscount rates
3. Open market operation
4. Control of collateral's required
5. Imposition of portfolio ceiling
6. Minimum capital ratio
7. Margin requirements for L/C
8. Moral suasion
Some of these devices may be needed to induce expansion or contraction of money supply.
However, certain devices may only be applied to induce decrease in money supply such as the
imposition of portfolio ceiling and minimum capital ratio, and the control of maturities of bank
loans.
It is also noteworthy that most of these devices are directed toward the operation of the
banking system and is the biggest source of the expansion of money supply. As noted,
commercial banks can increase money supply, through their lending operation such that when
there is a need to decrease it, the institution of this monetary devices are intended to decrease the
lending operation of banks. Likewise, if there is a need to increase money supply, the devices are
intended to encourage the bank's lending operation.
LEGAL BANK RESERVE REQUIREMENTS

Legal bank reserve refers to that portion of the banks deposit liability that cannot be available for
lending. Instead, it will have to be set aside as a reserve in the Bangko Sentral, vaults of the bank or
temporarily invested in government securities to meet the withdrawal needs of the depositors. The
control of the percentage of the bank reserve is a powerful and effective instrument that the
Bangko Sentral may use in order to effect an expansion or contraction of money supply.
During inflation, the objective of the Bangko Sentral is to decrease the volume of money supply.
In order to do this, it will increase the percentage of the legal reserve required on banks. This action
will give an effect of reducing the loanable funds of the banks because they will have to set aside a
bigger portion of their deposit liabilities as reserve to meet depositors' withdrawals. Furthermore,
this action decreases credit expansion.
During deflation, when money supply is insufficient, the percentage of legal bank reserve is
decreased to induce greater credit expansion. When the percentage of legal bank reserve is
decreased, the effect is an increase in investible funds, which may induce greater lending
operations and consequently, higher credit expansion.
PURPOSES OF IMPOSING LEGAL BANK RESERVE

1. As a monetary device for credit expansion and contraction
2. To protect the interest of depositors by not allowing the bank to use all the deposits for
lending operations
3. The pool of legal reserve deposits may be used by the Bangko Sentral to help banks in
financial distress.
4. The pool of legal bank reserve deposit may also be used by banks in their "inter-bank call
loan system". This system is one whereby, a bank with efficiency in its bank reserve
deposits could borrow from a bank with excess reserve deposits. The lending bank imposes
a percentage of interest.
5. The pool of bank reserve deposits is also utilized in the settlement of bank claims and
counterclaims against each other arising from the operation of checking account system
where the Bangko Sentral acts as the clearing house.
In order to control the volume of money created by the credit operations of the banking system, all
banks operating in the Philippines shall be required to maintain reserves against their deposit
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liabilities. Provided, that the Monetary Board may, at its discretion, also require all banks and/or
quasi banks to maintain reserves against funds held in trust and liabilities for deposit substitutes as
defined in this Act. The required reserves of each bank shall be proportional to the volume of its
deposit liabilities and shall ordinarily take the form of a deposit in the Bangko Sentral. Reserve
requirements shall be applied to all banks of the same category uniformly and without
discrimination.
LAWS COVERING LEGAL BANK RESERVES (RA 7653, Sec. 96 to Sec. 102)
Required reserves against peso deposit: The Monetary Board may fix and, when it deems
necessary, after the minimum reserve ratio to peso deposits, as well as deposit substitutes, which
each bank and/or quasi bank may maintain, and such ratio shall be applied uniformly to all banks of
the same category as well as to quasi banks.
Required reserves against foreign currency deposit: The Monetary Board is similarly
authorized to prescribe and modify the minimum reservation applicable to deposits denominated
in foreign currencies.
Required reserves against unused balances of overdraft line: In order to facilitate Bangko
Sentral control over the volume of bank credits, the Monetary Board may established minimum
reserve requirements for the unused balances of overdraft lines.
The powers of the Monetary Board to prescribe and modify reserve requirements against unused
balances of overdraft lines shall be the same as its powers with respect to reserve requirements
against demand deposits.
Increase in reserve requirements: Whenever in the opinion of the Monetary Board it becomes
necessary to increase reserve requirements against existing liabilities, the increased shall be made
in a gradual manner and shall not exceed four percentage points in any 30-day period. Banks and
other affected financial institutions shall be notified reasonably in advance of the date on which
such increases our to become effective.
Computation on Reserves: The reserve position of each bank or quasi bank shall be calculated
daily on the basis of the amount, at the close of the business day of the institution's reserves and the
amount of its liability accounts against which reserves are required to be maintained: Provided,
that with reference to holidays or non banking days, the reserve position as calculated at the close
of the business day immediately preceding such holidays or non banking days shall apply on such
days.
For the purpose of computing reserve positions of each bank or quasi bank, its principal office in
the Philippines and all its branches and agencies located therein shall be considered a single unit.
Reserve deficiencies: Whenever the reserved position of any bank or quasi bank, computed in the
manner specified in the preceding section of this Act, is below the required minimum, the bank or
quasi bank shall pay the Bangko Sentral 1/10 of 1% per day on the amount of deficiency or the
prevailing 90-day treasury bill rate plus three percentage points, whichever is higher: Provided,
however, that banks or quasi banks shall ordinarily be permitted to offset any reserve deficiency
occurring on one or more days of the week with any excess reserves which they may hold on other
days of the same week and shall be required to pay the penalty only on the average daily deficiency
during the week. In cases of abuse, the Monetary Board may deny any bank or quasi bank the
privilege of offsetting reserve deficiency is in the aforesaid manner.
If a bank or quasi bank chronically has a reserve deficiency, the Monetary Board may limit or
prohibit the making of new loans or investments by the institution and may require that part or all
of the net profits of the institutions be assigned to surplus.
The Monetary Board may modify or set aside the reserve deficiency penalties provided in this
section, for part or the entire period of a strike or lockout affecting a bank or a quasi bank as
defined in the Labor Code, for of a national emergency affecting operations of banks or quasi banks.
The Monetary Board may also modify or set aside reserve deficiency penalties for the rehabilitation
program of a bank.
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Inter-bank Settlement: The Bangko Sentral shall establish facilities for inter-bank clearing under
such rules and regulations as the Monetary Board may prescribe: Provided, that the Bangko Sentral
may charge administrative and other fees for the maintenance of such facilities.
The deposit reserves maintained by the banks in the Bangko Sentral in accordance with the
provisions of Section 94 of this Act shall serve as basis for clearing of checks and the settlement of
inter-bank balances, subject to such rules and regulations as the Monetary Board may issue with
such respect to such operation: Provided, that any bank which incurs over-drawings in its deposit
account with the Bangko Sentral shall fully cover said overdraft, including interest thereon at the
rate equivalent to 1/10 of 1% per day or the prevailing ninety-one- day treasury bill rate plus three
percentage points, whichever is higher, not later than the next clearing day: Provided, further, that
settlement of clearing balances shall not be affected for any account which continues to be
overdrawn for five (5) consecutive banking days until such time as the overdrawing is fully covered
or otherwise converted into an emergency loan or advance pursuant to the provisions of Section 84
of this Act: Provided, finally, that the appropriate clearing office shall be officially notified of banks
with overdrawn balances. Banks with existing overdrafts with the Bangko Sentral as to the
effectivity of this Act shall, within such period as may be prescribed by the Monetary Board, neither
convert the overdraft into an emergency loan or advance with a plan of payment, or settle such
overdrafts, and that, upon failure to comply herewith, the Bangko Sentral shall take such action
against the bank as may be warranted under this Act.
BANK LEGAL RESERVE REQUIREMENT AND ITS EFFECT ON BANKS EXIST RESERVES
AND MONEY SUPPLY
The kind of money held by the public in expandable form consists of notes and coins issued by the
Bangko Sentral and the net checking accounts in commercial banks which we sometimes called
deposit money. When calculating money supply, economist exclude all currencies held in banks,
currencies held by the government, and the checking account deposits of the government.
Example:
Total currency in the economy P 38 billion

Plus Total demand deposits in banks 130 billion
P168 billion
Deduct:
Currency in banks P 2 billion
Currency in Government 1 billion
Demand deposit of Government 8 billion 11 billion
Total Money Supply P157 billion
To increase money supply, banks either make new loans or buy fewer securities. To decrease
money supply, banks either make fewer loans or sell more securities to the public or accept
repayment of loans.
The amount that any commercial bank can increase in money supply is equal to its excess reserves
and is on a one-to-one ratio. The entire banking system increases money supply in an amount equal
to several times its excess reserves. What excess reserves one bank losses, is a gain by other banks.
Example:
Suppose PNB has the following statement and the record reserved imposed by the Bangko Sentral
is 20%.
Assets Liabilities
Reserve P 2,000 Demand Deposit P 9,500
Other assets 8,000 Net Worth 500
Total P 10,000 Total P 10,000
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Looking at the above statement, the PNB has an excess reserved of P100 (20% of P9,500 =P1,900.
P2,000 minus P1,900 = P100). Now PNB makes new loans on its excess reserves. The balance
statement of PNB is as follows:
Assets Liabilities
After the borrowers spends the P100 by writing out checks and after the checks are deposited in,
for example, SBTC, the PNB balance sheet is as follows:
Assets Liabilities
For simplicity, suppose that the check for P100 is deposited in SBTC. The SBTC, having been
required also to set a reserve of 20%, has the following statement before the checks are deposited.
SBTC bank statement is as follows:
Assets Liabilities
At this point, SBTC has no excess reserve. As the check of P100 is deposited in SBTC and it collects it
from PNB, SBTC has the following statement:
Assets Liabilities
Since SBTC has an excess reserve of P80, it can increase money supply by P80. The balance sheet is
as follows:
Assets Liabilities
Again the borrower now spends the money and issues a check against SBTC. SBTC statement of
condition is as follows:
Assets Liabilities
We just presume the spent money has found its way in another bank, for example, RCBC. The
statement of RCBC before money is deposited is as follows:
Assets Liabilities
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After the money has been deposited, RCBC’s statement is as follows:
Assets Liabilities
Reserve P 1,280 Demand Deposit P 6080
RCBC can now safely increase money supply by its excess reserve of P64. When RCBC increases its
loans by P64, it balance statement is as follows:
Assets Liabilities
As a result, money supply increases. Now let us break the chain and see where we started.
Excess Increase in
Banks
Reserve Money Supply
PNB P100 P 100
SBTC 0 80
RCBC 0 64
Total P 244
So far, money supply has been increased by P244 and it can still be further increased if the P64 is
spent and finds its way with the other banks. So how far can money supply be increased if the
original excess reserve were P100? Let us ask this question in another way. With a reserve of 20%,
from how many more pesos of demand deposit will P100 serve as the required reserve? The
answer is P500, because the P100 would be 20% reserve required for P500 in demand deposit.
The size of the multiplier is determined by dividing 1 by the required reserve ratio.
Reserve Ratio % Deposit Multiplier

40 2½
33 ½ 3
30 3½
25 4
20 5
16 2/3 6
15 6 2/3
10 10
Assume that the balance statement below is the consolidated balance statement from commercial
banks in the economy.
Assets Liabilities
Reserve P 35 billion Demand Deposit P 150 billion
Other assets 120 billion Net Worth 5 billion
Total P 155 billion Total P 155 billion
With a reserve ratio of 20%, the commercial banking system has an excess reserve of P5 billion. The
actual reserve of P35 billion is 20% of P175 billion. Thus, the commercial bank can increase its
money supply from P150 billion to P175 billion. The deposit multiplier is 5. For every peso of
reserve, the banking system can increase the money supply by P 5 billion.
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If the reserve ratio is 10% and the consolidated balance statement for the banking system is as
follows:
Assets Liabilities
The excess reserve is minus P5 billion and with a multiplier of 10, the banking system has to
decrease its money supply by P50 billion. Truly, the multiplier can work on either direction.
When banks have excess reserve, they increase money supply but when their excess reserves are
negative, they must reduce the money supply. As old loans are repaid, no new loans are made to
replace the loans. Borrowers pay off old loans by writing checks on their deposit accounts. This
decrease in the demand deposit accounts constitutes a decrease in money supply.
For example, the reserve ratio is 20% and the banking system has this balance sheet:
Assets Liabilities
The banking system has a negative excess reserve of P2 billion. The deposit multiplier is 5, so the
commercial banks must reduce money supply by P10 billion.
When a borrower repays back a loan of P10 billion as they become due, there will be a decrease in
other assets and demand deposit on the balance statement.
Assets Liabilities
The required reserve is now P18 billion and the excess reserve has risen from minus P 2 billion.
For every peso of excess reserves, an individual commercial bank can increase the money supply by
one and the commercial banking system by more than P1.
Whenever a single commercial bank loss of P500 in reserve and demand deposit because
borrowers have written checks which were deposited in other banks, the other banks gain P500 in
reserves and demand deposit.
Dividing 1 by the reserve ratio can form the size of the deposit multiplier. So the relationship
between the reserve ratio and the deposit multiplier is inverse.
Three devices are used by the Bangko Sentral to increase and decrease the size of excess reserve,
thereby controlling the money supply; that is, through changing reserve requirement, changing the
discount rate, and open market operation.
CHANGING RESERVE REQUIREMENTS

Example: The consolidated balance sheet of the commercial banking system is
Assets Liabilities
Reserve P 100 Demand Deposit P 400
Other assets 350 Net Worth 50
Total P 450 Total P 450
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If the reserve ratio is 25%, then the banking system has no excess reserve. If the reserve ratio is
decreased to 20%, then the commercial banking system has an excess reserves of P20, and can be
able to increase money supply by P100 from P400 to P500.
Suppose the Bangko Sentral where to increase the reserve from 25% to 30%. The commercial bank
would have a P20 reserve and therefore would decrease demand deposits from P400 to P333. An
increase in the reserve ratio from 25% to 30% will decrease the multiplier from 4 to 3 1/3%. In
brief, when the Bangko Sentral increases the reserve ratio, the excess reserve decreases, the
deposit multiplier decreases, and the money supply also decreases.
A decrease in the reserve ratio will serve to increase the excess reserve, the deposit
multiplier, and the money supply. The relationship between the reserve ratio and the
deposit multiplier, excess reserve, add money supply is inverse.
Now, under what condition with the Bangko Sentral wish to increase the money supply? The larger
the economy's money supply, the more total spending there is for final goods and services, and, the
smaller its money supply, the less total spending there is in the economy. The relationship is direct.
One cause of inflation is too much spending and the basic cause of unemployment is too little
spending in the economy.
CONTROL OF THE DISCOUNT AND DISCOUNT RATES ON LOANS

The Bangko Sentral extends credit to banking institutions for the following purposes:
 Using it as a device for credit control; and
 Increase the liquidity of the banks through credit, whenever necessary.
With the Bangko Sentral extends credit to banks, it imposes interest or discount rates, primarily, to
use it as a device for credit control, and secondarily, to earn income for the Central Bank.
During inflation, the Bangko Sentral increases the percentage of its rediscount and discount rates
on credits extended to banks. Its purpose is to discourage the banks from borrowing from the
Central Bank.
The effect is that the banks will have less loanable funds, which will limit their lending operations
and credit expansions.
During deflation, the Bangko Sentral decreases the percentage of discounts or interests on credit
extended to the banking institutions, which encourage the banks to borrow from the Bangko
Sentral. Increase in the banks loanable funds will enable them to expand their operations and
promote greater credit expansion.
INTEREST AND REDISCOUNT RATES (RA 7653 Sec. 85)

The Bangko Sentral shall collect interest and other appropriate charges on all loans and advances it
extends, the closure, receivership or liquidation of the debtor-institution notwithstanding
The monetary board shall fix the interest and rediscount rates to be charged by the Bangko Sentral
on its credit operations in accordance with the character and term of the operation, but after due
consideration has been given to the credit needs of the market, the composition of the Bangko
Sentral's portfolio, and the general requirements of the national monetary policy. Interest and
rediscount rate shall be applied to all banks of the same category uniformly and without
discrimination.
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CHANGING DISCOUNT RATES AND ITS EFFECT ON BANKS EXCESS RESERVES AND
MONEY SUPPLY
Example: Consolidated balance statement of the banking system:
Assets Liabilities
Other assets 450 billion Loans from CB 10 billion
Net Worth 40 billion
If the reserve ratio is 20%, the commercial banking system will have a zero excess reserve.
Supposing that the Bangko Sentral increases the discount rates from 2.5% to 3% as a result of
abnormal situation, commercial banks who wish to borrow from the Bangko Sentral decrease their
loans from P10 to P6 billion. When the commercial banks repay this P4 billion to the Bangko
Sentral, the commercial banks loans and reserved are decreased by P4 billion. The commercial
bank statement will now be as follows:
Assets Liabilities
Since the reserve ratio is still 20%, the commercial bank has a negative reserved of P4 billion. This
will therefore decrease the amount of demand deposit money in the economy from P500 to P480
billion.
If the Bangko Sentral lowers the discount rate from 2.5% to 2%, the commercial banks will increase
their borrowings to P13 billion. Their loans and reserve from the Bangko Sentral will increase by
P3 billion. Thus, their statement will be as follows:
Assets Liabilities
Because the reserve ratio is 20%, the commercial banks now have an excess reserve of P3 billion.
Thus, their demand deposit will increase from P500 billion to P515 billion ( P5 billion x 5).
OPEN MARKET OPERATION IN GOVERNMENT SECURITIES

This refers to the buying and selling of government securities by the Bangko Sentral for the
purpose of credit control. Government securities referred to evidences of indebtedness of the
government.
There are two purposes of government securities:
 To raise revenue
 To control credit
The Central Bank plays a significant role in the issue and placement of government securities. It
also maintains the security stabilization fund, which is a reserved intended to be used in the buying
and selling of government securities to stabilize the value and liquidity of such government
securities.
During inflation, the Central Bank will undertake the following remedies:
1. sell to the public government securities to absorb excess cash holdings and to
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2. sell to the banking institutions government securities, so as to divert investment in loans to

investment securities. The effects are: a decrease in available funds for loans, a decrease in
lending operations for banks, and a decrease in credit expansion.
During deflation, the sale of government securities to the banks decreases money supply by the
amount it would have increased if the funds have been used by the banks in their lending operation
where they undergo a multiplier effect.
PURCHASES AND SALES OF GOVERNMENT SECURITIES (RA 7653 Sec. 91)

In order to achieve the monetary policy, the Bangko Sentral may, in accordance with the principal
stated in Section 90 of RA 7653 and which such rules and regulations as may be prescribed by the
Monetary Board, buy and sell in the open market for its own account:
1. Evidences of indebtedness issued directly by the Government of the Philippines or by its
political subdivisions; and
2. Evidences of indebtedness issued by government instrumentalities and fully guaranteed by
the Government.
Evidences of indebtedness acquired under the provisions of this section must be freely negotiable
and regularly serviced and must be available to the general public through banking institutions and
the local government treasuries in denominations of a thousand pesos or more.
ISSUE AND NEGOTIATION OF BANGKO SENTRAL OBLIGATIONS ( RA 7653 Sec. 92)

In order to provide the Bangko Sentral with effective instruments for open market operations, the
Bangko Sentral may, subject to such rules and regulations as the Monetary Board may prescribe
and in accordance with the principles stated in Section 90 of RA 7653, issue, place, buy and sell
freely negotiable evidences of indebtedness of the Bangko Sentral: Provided, that issuance of such
certificate of indebtedness shall be made only in cases of extra ordinary movement in price levels.
Said evidences of indebtedness may be issued directly against the international reserve of the
Bangko Sentral or against the securities which it has acquired under the provisions of Section 91 RA
7653 or may be issued without relation to specific types of assets of the Bangko Sentral.
The Monetary Board shall determine the interest rates, maturities and other characteristics of said
obligations of the Bangko Sentral, and may, if it deems it advisable, denominate the obligations in
gold or foreign currencies.
Subject to the principal stated in Section 90 of RA 7653, the evidences of indebtedness of Bangko
Sentral to which this section refers may be acquired by the Bangko Sentral before their maturity,
either through purchases in the open market or through redemptions at par and by lot if the
Bangko Sentral has reserved the right to make such redemptions. The evidences of indebtedness
acquired or redeemed by the Bangko Sentral shall not be included among its assets, and shall be
immediately retired and cancelled.
OPEN MARKET OPERATION, AND ITS EFFECT ON BANKS EXCESS RESERVE AND
MONEY SUPPLY
The government buys government securities from the commercial banks or the general public
(individuals and business firms). When they sell securities, they are purchased by the same group.
Example: Balance statement of the commercial banking system (Reserve Requirement is 25%)
Assets Liabilities
Suppose the Bangko Sentral buy securities from the commercial banks for P10 billion. The other
assets of the commercial bank will decrease by P10 billion, and the Bangko Sentral will pay the
12
commercial banks for their securities by increasing the reserve by P10 billion. The balance
statement will be as follows:
Assets Liabilities
The commercial banks' excess reserve is now P10 billion and they can increase the money supply
by P40 billion. But if the Bangko Sentral sells P5 billion worth of government securities to
commercial banks, there will be a P5 billion decrease in their reserved and an increase in their
other assets. Thus, their balance statement would be as follows:
Assets Liabilities
The commercial banks have a negative reserved of P5 billion. Thereby decreasing money supply by
P20 billion ( 5x4=20). If the Bangko Sentral buy securities from the commercial banks, both their
excess reserves and money supply increase. If Bangko Sentral sells securities to commercial banks,
their excess reserves and money supply decrease. They sell by simply raising the prices. The
Bangko Sentral will pay for these securities until the commercial banks find it profitable for them to
sell. If the Bangko Sentral wishes the commercial banks to buy, the lower their prices.
The general public can also buy and sell in the open market.
Assets Liabilities
The Bangko Sentral buys securities worth P10 billion from the general public and pays for them in
checks drawn on the Bangko Sentral Account. The public deposits their checks in demand deposits
in various commercial banks. The demand deposits are now P910 billion, having increased their
demand deposit by P10 billion. They can now increase the reserved of the commercial bank by P10
billion.
Assets Liabilities
With a 25% reserve ratio, the commercial banks have an excess serve of P7.5 billion, and can
increase money supply by another P30 billion (7.5x4=30).
If the Bangko Sentral sell securities to the public and pays for them in checks written with
commercial banks, they collect P5 billion from the commercial banks by decreasing their reserve by
P5 billion.
Assets Liabilities
The commercial banks have now in negative excess reserve of P3.75 billion and will decrease
money supply by P15 billion (3.75x4=15).
13
The net effect of the sale of 5 billion in securities to the public is a 15 billion contraction in the
money supply.
The effect upon the money supply is the same as the sale of P5 billion in securities to the
commercial banks.
To eliminate inflationary pressures, the Bangko Sentral may increase reserve ratio, discount rates,
and buy government securities in the open market.
During unemployment in the economy, the Bangko Sentral tends to decrease the reserve ratio,
discount rates, and buy government securities in the open market.
CONTROL OF THE COLLATERAL REQUIRED ON BANK LOANS

The Bangko Sentral has the power to impose conditions or requirements on the securities against
the loans extended by the bank. This in effect increases the loan value of the collateral.
During inflation, the Bangko Sentral may increase collaterals required and loans, which in effect
decreases the loan value of the collaterals. This may discourage public borrowings from the banks,
and decrease credit expansion.
During deflation, the Bangko Sentral may decrease collaterals, which may be an incentive to
borrowers.
REQUIRED SECURITY AGAINST BANK LOANS ( RA 7653 Sec. 106)

In order to promote liquidity and solvency of the banking system, the Monetary Board may issue
such regulations as it may deem necessary with respect to the maximum permissible maturities of
the loans and investments which the banks may make, and the kind and amount of security to be
required against the various types of credit operations of the banks.
IMPOSITION OF PORTFOLIO CEILING

This refers to the upper limit that the Bangko Sentral may place on the loans and investment of
banks. It is instituted only during inflation. It is a direct limitation on the volume of loans, and
investments that banks may extend. Such restrictions may not be instituted during deflation. To do
this, the Bangko Sentral sets a date and whatever is the total amount of loans and investment the
bank has on that date is its limit.
PORTFOLIO CEILINGS (RA 7653 Sec. 107)

Whenever the Monetary Board considers it advisable to prevent or check an expansion of bank
credit, the Board may place an upper limit on the amount of loans and investments which banks
may hold, or may place a limit on the rate of increase of such assets within specified periods of time.
The Monetary Board may apply such limits to the loans and investments of each bank or to specific
categories thereof.
In no case shall the Monetary Board establish limits, which are below the value of the loans or
investments of the banks on the date on which they are notified of such restrictions. The
restrictions shall be applied to all banks uniformly and without discrimination.
MINIMUM CAPITAL RATIO

It is the maximum ratio that the combined capital account of surplus may bear on the bank's
corporate assets. The Bangko Sentral requires 10% of the risk assets of a bank as its minimum
capital. Thus, total assets minus non risk assets = risk assets.
Section 108 of RA 7653 states, that the Monetary Board may prescribe the minimum ratios which
the capital and surplus of the banks must bear to the volume of their assets, or two specific
categories thereof, and me either said ratios whenever it deems it necessary.
14
MARGIN REQUIREMENTS AGAINST LETTERS OF CREDIT (RA 7653 Sec. 105)

The Monetary Board may at any time prescribed minimum cash margins for the opening of letters
of credit, and may relate the size of the required margin to the nature of the transactions to be
financed.
MORAL SUASION
This is more of a psychological approach in which the Bangko Sentral may use its persuasive power
to make the banks follow or support credit policies without direct imposition of restrictions. There
are cases when the Bangko Sentral shies away from imposition of credit restrictions because of
possible unfavorable repercussions such that, the Bangko Sentral may just use their influence
among banks for voluntary support of a credit policy. For instance, during the imposition of free
floating exchange rate in 1970, the central bank was able to avoid buying and selling of US $ at very
high speculative rates. The banks agreed among themselves to limit their trading in foreign
transactions to an agreed foreign exchange rate.
OTHER MONETARY POLICIES TO STABILIZE BANKING OPERATIONS

a. Bangko Sentral may fixed maturities in bank loans for the purpose of credit control or as a
means of payment.
b. Bangko Sentral may also fix the maximum interest that the bank may pay on deposit
substitutes for the purpose of preventing competition among banks in attracting depositors.
c. Bangko Sentral may establish priorities for bank loans especially with respect to funds,
which has been borrowed from the Bangko Sentral.
d. Bangko Sentral makes periodic examination of the bank's accounting records and requires
banks to submit their financial statement at the end of every quarter.
e. Bangko Sentral looks into the character and integrity of the banks incorporators and
members of the board as well as the top ranking executives of the banks.
BANGKO SENTRAL AS A FISCAL AGENT

As a fiscal agent of the government, the Bangko Sentral has the following functions:
1. To be the official representative of the government to financial entities;
2. To be the depository banker of the government;
3. To be the financial advisor of the government; and
4. To manage public debts.
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Bangko Sentral's Role in Monetary Policy

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Bangko Sentral's Role in Monetary Policy

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AE18-005 FINANCIAL MARKETS AND INSTITUTIONS

COLLEGE OF SAINT LAWRENCE, INC.

SUBJECT: FINANCIAL MARKETS AND INSTITUTIONS

 Compute for the money supply and excess reserves.

THE OLD MONETARY BOARD

THE NEW CENTRAL BANK ACT

COMPOSITION OF THE NEW MONETARY BOARD OF BANGKO SENTRAL

 A member of the Cabinet is to be designated by the President of the Philippines. Whenever

QUALIFICATIONS OF THE MONETARY BOARD

BANGKO SENTRAL NG PILIPINAS AS BANK OF ISSUE

BANGKO SENTRAL NG PILIPINAS AS LENDER OF LAST RESORT

DOMESTIC MONETARY STABILIZATION

INSTRUMENTS OF CENTRAL BANK ACTIONS

LEGAL BANK RESERVE REQUIREMENTS

PURPOSES OF IMPOSING LEGAL BANK RESERVE

Total currency in the economy P 38 billion

After the money has been deposited, RCBC’s statement is as follows:

Reserve Ratio % Deposit Multiplier

CHANGING RESERVE REQUIREMENTS

CONTROL OF THE DISCOUNT AND DISCOUNT RATES ON LOANS

INTEREST AND REDISCOUNT RATES (RA 7653 Sec. 85)

OPEN MARKET OPERATION IN GOVERNMENT SECURITIES

2. sell to the banking institutions government securities, so as to divert investment in loans to

PURCHASES AND SALES OF GOVERNMENT SECURITIES (RA 7653 Sec. 91)

ISSUE AND NEGOTIATION OF BANGKO SENTRAL OBLIGATIONS ( RA 7653 Sec. 92)

CONTROL OF THE COLLATERAL REQUIRED ON BANK LOANS

REQUIRED SECURITY AGAINST BANK LOANS ( RA 7653 Sec. 106)

IMPOSITION OF PORTFOLIO CEILING

PORTFOLIO CEILINGS (RA 7653 Sec. 107)

MINIMUM CAPITAL RATIO

MARGIN REQUIREMENTS AGAINST LETTERS OF CREDIT (RA 7653 Sec. 105)

OTHER MONETARY POLICIES TO STABILIZE BANKING OPERATIONS

BANGKO SENTRAL AS A FISCAL AGENT

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