CHAPTER 4 & 5

Banko Sentral ng Pilipinas

& the Monetary Policy
Banko Sentral ng
Pilipinas
Chapter 4
Chapter 4 Outline
● Overview of the Philippine Financial Regulatory Agencies
● BSP Brief History and BSP Organizational Structure
● The Core Functions of the BSP
● Other functions of the BSP
Overview of the Principal
Financial Regulatory Agencies
of the Philippines
Objectives of Financial Regulation
● To ensure the soundness of the Financial System
○ Restrictions on entry
○ Stringent reporting requirements
○ Restriction on assets and activities
○ Deposit insurance
● To increase the information available to investors
○ Asymmetric Information – when one party in a transaction is in possession of more
information than the other
○ Adverse selection – asymmetric information about the type of people the contract
attracts that causes bias before entering into a contract
○ Moral hazard – asymmetric information about a change in behavior that causes a bias
after entering into a contract.
● To improve control of the Financial System
 Principal Regulatory Agencies of the Philippines
01
Banko Sentral ng Pilipinas
Examines the books of commercial banks that
are members of the system, sets reserve
requirements for all banks
03
Securities and Exchange
Commission
Requires disclosure of information, restricts
insider trading
02
Philippine Deposit
Insurance Corporation
Provides insurance of up to P500,000 for each depositor
at a bank, examine the books of insured banks, and
imposes restrictions on assets they can hold
04
Insurance Commission
Gives charter and examine the books of insurance
companies, impose restrictions on assets they can
hold, impose restrictions on branching
Overview of the Philippine Financial System

Source: https://www.bsp.gov.ph/Inclusive%20Finance/EFLP/Role_Students.pdf
Banko Sentral
ng Pilipinas
The Bangko Sentral ng Pilipinas (BSP) is the central bank of
the Republic of the Philippines. It was established on 3 July
1993 pursuant to the provisions of the 1987 Philippine
Constitution and the New Central Bank Act (RA 7653).

The BSP took over from Central Bank of Philippines, which

was established on 3 January 1949, as the country’s central
monetary authority.
BSP Organization Chart
 BSP Organization Chart
The Monetary Board
▪ exercises the powers and functions
of the BSP, such as the conduct of
monetary policy and supervision of
the financial system.
▪ Its chairman is the BSP Governor,
with five full-time members from the
private sector and one member from
the Cabinet.
The Governor
▪ the chief executive officer of the BSP and
is required to direct and supervise the
operations and internal administration of
the BSP.
▪ The BSP Governor acts as the Chairman of
the AMLC, which was created pursuant to
Republic Act No. 9160, otherwise known as
the “Anti-Money Laundering Act of 2001”
(AMLA)
▪ Dr. Felipe Medalla is the current Governor
of the BSP
 BSP Organization Chart
Monetary and Economics Sector (MES)
mainly responsible for the
operations/activities related to monetary
policy formulation, implementation, and
assessment
Financial Supervision Sector (FSS)
mainly responsible for the regulation of banks
and other BSP-supervised financial
institutions
Corporate Services Sector (CSS)
mainly responsible for the effective
management of BSP’s human, financial, and
physical resources to support the BSP’s core
functions
Payments and Currency Management Sector (PCMS)
mainly responsible for maintaining the safety
and integrity of the Philippine currency and
ensuring a well-functioning payments and cash
ecosystem that facilitates the economic activity
and supports long-run economic growth
Regional Operations and Advocacy Sector
mainly responsible for overseeing the
operations of the Financial Inclusion Office,
Economic and Financial Learning Office,
Consumer Protection and Market Conduct Office,
Strategic Communication and Advocacy, New
Clark City – Program Management Office, and
Regional Operations
Core Functions of the BSP
01 02
Price Stability Financial Stability
through the conduct by managing systemic risks
of monetary policy and promoting a secure and
reliable banking system by
ensuring the safe and sound
operation of banks and other
BSP-supervised financial
institutions (BSFIs)
03
Efficient Payments &
Settlements System
by providing channels
through which funds are
transferred among banks and
other institutions
Financial
Stability

https://youtu.be/O0P0yIQyqvI
Core Functions of the BSP
Financial Stability is about managing financial system
risks so that these risks do not create negative
consequences to the rest of the economy.

Financial How does the BSP conduct financial supervision and

Stability
regulation?
1. Issuance of rules of conduct/standard of operations
2. Conduct of examination/regular investigation
3. Inquiring into solvency/liquidity
4. Risk profiling
 Efficient
Payments &
Settlements
System

https://youtu.be/vXLjmxcXboM
Core Functions of the BSP

Efficient
A payment system is a mechanism composed of rules,
institutions, people, markets and organizations that make
exchanges of payments possible. It facilitates the transfer

Payments & of money from a payor to a payee in order to effect a

payment transaction.

Settlements Payment systems provide the channels through which

funds are transferred among banks and other institutions

System to discharge payment obligations arising from economic

and financial transactions across the entire economy.
Core Functions of the BSP
Republic Act No. 11127, or the National Payment Systems Act
(NPSA) mandates the BSP to oversee payment systems in the
Efficient Philippines and exercise supervisory and regulatory powers
for the purpose of ensuring the stability and effectiveness of

Payments &
the monetary and financial system.

The BSP performs the following roles in the payments and

Settlements settlements system:

▪ Operator of the real time gross settlement system known as PhilPaSS

System
▪ Provider of credit facilities to banks as a lender of last resort
▪ Overseer of the payments and settlements system
▪ User of its own RTGS system
▪ Initiate changes/reforms for the payments system Philippine
Payments and Settlements System (PhilPaSS)
Core Functions of the BSP
RTGS or Real-time Gross Settlement System is a type of
Large-Value Payment System (LVPS) that enables the

Efficient transfer of funds between banks on a real-time basis. It

is a payment system which is now being offered by most
commercial and thrift banks to their clients as alternative
Payments & to check payments.

Settlements
PhilPaSS or Philippine Payment and Settlement System is
the name of the RTGS payment system in the Philippines.
PhilPaSS is owned and being operated by the Bangko

System Sentral ng Pilipinas (BSP). Banks and non-banks with

Quasi-banking functions under the BSP supervision are
granted access to PhilPaSS to facilitate electronic
interbank payments among themselves.
Core Functions of the BSP
Among the financial transactions accepted and settled in
PhilPaSS are the following:

Efficient ▪
▪
Interbank fund transfers
BIR & BOC Revenues for credit to BT

Payments &
▪ High-value Customer Payments
▪ ATM Network Settlements
▪ Check-clearing operations

Settlements ▪
▪
Foreign currency trading
Purchase and sale of government securities

System
▪ BSP’s open market operations
 Other Functions of the BSP
Bank of Banks/ Official Depository
Issuer of Money Lender of Last Resort and Advisor of
Only the BSP can issue legal The BSP transacts with banks
National Government
tender only, and gives loans when The NG maintains deposits
warranted with the BSP, while the BSP
advises the NG on borrowings

Manager Determination of the

of Official Reserves Exchange Rate Policy
The BSP manages the BSP is in-charge of the
country’s Gross International exchange rate policy
Reserve

https://www.bsp.gov.ph/SitePages/MediaAndResearch/MultimediaResources.aspx
https://www.bsp.gov.ph/Media_And_Research/Multimedia/Infographics/Infographics_6_Gross_International_Reserves_(GIR).pdf
 Other Functions of the BSP (cont.)
Gross International Reserves
Manager of Official
are external assets that can be used to pay external
Reserves obligations (such as imports, foreign loans, etc.) which are
managed by the BSP.

Examples include foreign-issued securities, gold, and

foreign exchange.

It does not include assets that are not liquid, such as land,
or assets owned by the national government.

The BSP maintains adequate international reserves to

meet the economy’s foreign exchange requirement

https://www.bsp.gov.ph/SitePages/MediaAndResearch/MultimediaResources.aspx
https://www.bsp.gov.ph/Media_And_Research/Multimedia/Infographics/Infographics_6_Gross_International_Reserves_(GIR).pdf
 Other Functions of the BSP (cont.)
Determination of the The BSP determines the country’s
Exchange Rate Policy exchange rate policy. The current policy
allows market forces to determine the
exchange rate.

This flexibility ensures that the true

level of foreign exchange is reflected
and induces a more efficient allocation
of resources in the economy.

https://www.bsp.gov.ph/SitePages/MediaAndResearch/MultimediaResources.aspx
https://www.bsp.gov.ph/Media_And_Research/Multimedia/Infographics/Infographics_6_Gross_International_Reserves_(GIR).pdf
Project for Midterms
Create a Pamphlet Featuring BSP
Due date: October 14, 2022, Rubrics will be posted in eLearn
Must be PRINTED
At a minimum, it should contain the following information:
1. BSP Brief History
2. Core Functions
3. Other Functions
Seatwork
Watch the listed videos found in the following link:
https://www.bsp.gov.ph/SitePages/MediaAndResearch/Multimedia_PriceStab.aspx
1. Price Stability
2. Price Level and Inflation
3. Monetary Policy and Inflation Targeting
4. Monetary Policy Transmission Mechanism
5. BSP's Changing Approach to Monetary Policy
6. Issuance of BSP Securities

Once done, tick the checkboxes in Google Sheets (link to be posted in eLearn) to
signify completion.
End of
Chapter 4
Monetary Policy
Chapter 5
Chapter 5 Outline
● Price Stability and Inflation
● Monetary Policy
○ Effects of Stimulative and Restrictive Monetary Policy
○ Transmission Channels
○ Trade-off in Monetary Policy
○ Why a Stimulative Monetary Policy Might Fail
○ Monetary Policy Instruments
Core Functions of the BSP
01 02
Price Stability Financial Stability
through the conduct by managing systemic risks
of monetary policy and promoting a secure and
reliable banking system by
ensuring the safe and sound
operation of banks and other
BSP-supervised financial
institutions (BSFIs)
03
Efficient Payments &
Settlements System
by providing channels
through which funds are
transferred among banks and
other institutions
Core Functions of the BSP
RA 7653 as amended by RA 11211,
specifically tasked the BSP to promote

Price price stability conducive to a balanced

and sustainable growth of the economy
and employment.
Stability BSP’s primary objective is to maintain
price stability
Understanding
Price Stability
1. The “price” pertains to the general price
level.
○ The price we are referring to is NOT the
individual prices of different goods and
services. Rather, it is the general price level
consumed by a typical Filipino household in
the economy (meaning, the representative
price).
○ Hence, even if the prices of some
commodities increase substantially, as long
as the average price level is not changing
too rapidly, there is still price stability.
2. Price stability does not mean that prices are
not changing.
○ The average price level of the economy can
still move, but as long as it is not changing
abruptly, substantially, or unpredictably,
there is still price stability.
Therefore, price stability happens
when the price changes in the
general price level are minimal and
not erratic.
Why Price Stability
is Important?
● It increases certainty in decision-making of ● It preserves the purchasing power of
both households and firms money

○ When prices are low and stable, households and ○ When prices rise fast, the value of money erodes
businesses can arrive at better-informed faster. And consumers will be able to buy fewer
decision-making about their consumption, and fewer goods and services with the same
investment, saving, and production needs amount of money

○ When prices are stable manufacturers are ○ When inflation remains high, it means prices are
protected against risk related to the changing increasing sharply which in turn erodes
cost of raw materials and finished goods. significantly the value of money
Uncertainty is lessened and firms can price their
products competitively. Since risks like a sudden
rise in the cost of raw materials are reduced
How Does the BSP
Know Whether
Prices Are Stable
or Not?
Consumer Price Index (CPI)
● The CPI represents the general price level.
○ It is the average price of the standard basket of
goods and services consumed by a typical
Filipino family for a given period.
● The CPI is based on a survey periodically done by
the Philippine Statistics Authority (PSA).
○ The CPI basket is made up of a fixed set of items
that a typical Filipino family buys such as food
products, electricity, gas, and clothing.
○ The prices of these items are gathered regularly
by the PSA and consolidated in one price, the
CPI.
● The rate of change of the CPI from one period to
another is called inflation.
Inflation
● In the Philippines, inflation is computed as the annual percentage
increase in the CPI.
● It represents the rate of change in the general price level, NOT the
change in the general price level.
● Can accelerate or slow down
Computing Inflation using CPI:
Inflation represents the rate of change in the
general price level, NOT the change in the
general price level.
The inflation in Year 1:
Consider the following given:
(105.00 − 100.00)
= 𝟓%
○ CPI Now : PHP 100.00 100.00

○ CPI Year 1 : PHP 105.00 The inflation in Year 4, with Year 0 as base year:

(120.00 − 100.00)
○ CPI Year 2 : PHP 110.00 = 𝟐𝟎%
100.00
○ CPI Year 3 : PHP 116.60

○ CPI Year 4 : PHP 120.00

Computing Inflation using CPI:
Inflation can accelerate or slow down
The inflation in Year 1:
Consider the following given:
(105.00 − 100.00)
= 𝟓%
○ CPI Now : PHP 100.00 100.00

The inflation in Year 2, with Year 1 as base year:

○ CPI Year 1 : PHP 105.00
(110.00 − 105.00)
○ CPI Year 2 : PHP 110.00
105.00
= 𝟒. 𝟓𝟓%

○ CPI Year 3 : PHP 116.60 The inflation in Year 3, with Year 2 as base year:

○ CPI Year 4 : PHP 120.00 (116.60 − 110.00)

= 𝟔%
110.00
What Causes Inflation?
Cost-push inflation
● When overall prices rise due to an increase in
production cost and other factors of supply. When
supply goes down or when cost of production goes
up, prices increases significantly.
● These could be due to several reasons including
natural disasters, high oil prices, and taxes.
● The National Government usually addresses this
type of inflation
Demand-pull inflation
● When aggregate demand is significantly greater
than the aggregate supply for goods and services,
prices increase, and inflationary pressures build-
up
● In an economy, the individual prices of goods and
services generally rise over time depending on:
○ how abundant or scarce a good or service is
(SUPPLY)
○ how much demand there is for a good or
service relative to the supply of the good or
service (DEMAND)
● The BSP addresses demand-pull inflation through
monetary policy. But it cannot address cost-push
inflation which needs nonmonetary measures.
How Does the BSP
Achieve Low and
Stable Inflation?
 Policies Used to
Regulate Economic Activity

Fiscal Policy Monetary Policy

Deals with taxation and government spending A set of tools to promote sustainable economic
growth by controlling the overall supply of money
Carried out by the executive and legislative that is available to the nation’s banks, its
branches consumers, and its businesses

Carried out by the central bank

Monetary Policy
Refers to the BSP‘s actions and decisions geared to meet its
primary objective, to support stable prices that would
support economic growth.
Actions by a central bank to manage availability and cost of
money and credit to attain stable prices.
Implementing Monetary Policy

Restrictive Stimulative
The BSP decreases the money supply of funds in The BSP increases the money supply of funds in
the banking system to slow economic growth and the banking system to boost economic growth and
reduce inflationary pressure. increase inflationary pressure.

Also referred to as Contractionary or Also referred to as Expansionary or

Tight-money policy. Loose-money policy.

“Think of the monetary policy as the faucet.

The BSP is the person who controls the faucet.
The water represents the money supply.”
Effects of Restrictive Monetary Policy
In an economy with excessive inflation, the BSP can implement a
restrictive policy to reduce the money supply.
1. BSP decreases the money supply
2. Results in a net decrease in the quantity of loanable
funds.
3. Supply curve shifts to the left
4. The quantity of loanable funds demanded exceeds the
quantity of loanable funds supplied
5. The interest rate increase*
6. Cost of borrowing will be more expensive
7. Borrowers are discouraged to borrow money
8. Higher interest rate level increases the corporate cost
of financing new projects and therefore causes a
decrease in the level of business investment.
9. With lesser jobs, households have lower income
10. There will be less spending
11. Aggregate demand for goods and services decreases
12. Economic growth is slowed
13. Prices decrease
14. Inflationary pressures is reduced
*In addition, when interest rates increase, the rate of return of
investments increase. More people are encouraged to invest
than spend. This will also reduce aggregate demand and
ultimately, slow down economic growth and inflation.
Effects of Stimulative Monetary Policy
In an economy with slow economic growth, the BSP can implement a
stimulative policy to increase the money supply.
1. BSP increases the money supply
2. Results in a net increase in the quantity of loanable
funds.
3. Supply curve shifts to the right
4. The quantity of loanable funds supplied exceeds the
quantity of loanable funds demanded
5. Interest rates decrease*
6. Cost of borrowing will be cheaper
7. Borrowers are encouraged to borrow money
8. The lower interest rate level decreases the corporate
cost of financing new projects and therefore causes a
increase in the level of business investment.
9. With more jobs, households have higher income
10. There will be more spending
11. Aggregate demand for goods and services increases
12. Economic growth increased
13. Prices increase
14. Inflationary pressures increased
*In addition, when interest rates decrease, the rate of return of
investments decreases. People will be discouraged to invest
and therefore would spend instead. This will increase aggregate
demand and ultimately, increase economic growth and inflation.
Transmission
Channels of
Monetary Policy
Transmission Channels
of Monetary Policy
Refers to the process through which changes in the BSP’s monetary
policy, work their way to the economy by influencing the demand for
goods and services and ultimately, inflation.

In the Philippines, monetary policy is transmitted through several

channels:
○ Interest rate
○ Credit
○ Exchange rate
○ Wealth
○ Expectations
Transmission Channels
1.) Interest Rate 2.) Credit
A change in the BSP’s policy rate, generally leads An increase in the BSP’s policy rate increases the
to adjustments in market interest rate in the same cost of borrowing. Borrowers will have higher
direction. interest expenses and lower net worth which will
moderate demand and inflation
An increase would discourage loan applications to
finance investments and consumption and so will
moderate demand and inflation
A decrease will stimulate demand
Transmission Channels
3.) Exchange Rate
An increase in the BSP’s policy rate will also
increase market interest rates in the Philippines
compared with other countries, all else being
equal.
This will make it more attractive to
peso-denominated assets to earn higher returns,
as well as encourage capital inflows and make
the peso appreciate.
A strong peso makes domestic goods more
expensive than foreign goods, thus, slowing
demand for goods produced locally.
The decline of overall demand for goods
produced in the Philippines and cheaper
imported goods due to peso appreciation
will moderate inflation
Transmission Channels
4.) Wealth
Any change in the BSP’s policy rate affects the
prices of assets such as stocks and real estate.
An increase in the BSP’s policy rate will reduce the
present value of future income from these assets
and the prices go down accordingly.
Lower asset prices reduce the wealth of owners
which will moderate demand and inflation.
5.) Expectations
An adjustment of the BSP’s policy rate influences
inflation expectation which in turn guide
businesses in setting prices and workers
negotiating wages.
An increase in its policy rate will be seen as a
signal that it is managing inflation. Inflation
expectations will then moderate toward the
inflation target.
Lagged Effects of Monetary Policy
There are three lags involved in monetary policy that can make the
BSP’s job more challenging.
○ Recognition lag – the lag between the time a problem arises and the
time it is recognized. Most economic problems are initially revealed by
statistics, not actual observation. Because economic statistics are
reported only periodically, they will not immediately signal a problem.
○ Implementation lag – the lag from the time a serious problem is
recognized until the time the BSP implements a policy to resolve that
problem.
○ Impact lag – The time between when the BSP adjusts the money supply
and when interest rates change (i.e., until the policy has its full impact
on the economy).
Trade-off in
Monetary Policy
Trade-off in Monetary Policy
Ideally, central banks would like to achieve both a very low level of
unemployment and a very low level of inflation.

The unemployment rate should be low in a period when economic conditions are
strong. Inflation will likely be relatively high at this time, however, because wages
and price levels tend to increase when economic conditions are strong.

Conversely, inflation may be lower when economic conditions are weak, but
unemployment will be relatively high.

It is therefore difficult, if not impossible, for central banks to cure

both problems simultaneously.
Why a Stimulative
Monetary Policy
Might Fail?
Why A Stimulative
Monetary Policy Might Fail?
1. Limited Credit Provided by Banks

Even if the BSP increases the level of bank funds, during a weak
economy banks may be unwilling to extend credit to some potential
borrowers; the result is a credit crunch.
While a stimulative monetary policy is
Banks provide loans only after confirming that the borrower’s future
cash flows will be adequate to make loan repayments. In a weak
normally desirable when the economy
economy, the future cash flows of many potential borrowers are more is weak, it is not always effective
uncertain, causing a reduction in loan applications and in the number
of loan applicants that meet a bank’s qualification standards.
If banks do not lend out the additional funds that have been pumped
into the banking system by the BSP, the economy will not be
stimulated.
Why A Stimulative
Monetary Policy Might Fail?
2. Low Return on Savings

Although the BSP’s policy of reducing interest rates allows for lower borrowing
rates, it also results in lower returns on savings.
This might encourage individuals to borrow (and spend) rather than save, which
could allow for a greater stimulative effect on the economy. However, some
individuals that are encouraged to borrow because of lower interest rates may
not be able to repay their debt. Therefore, the very low interest rates might lead to
more personal bankruptcies.
Furthermore, when interest rates are close to zero, interest income is close to zero,
and investors that rely on interest income have to restrict their spending. This
effect can partially offset the expected stimulative effect of lower interest rates.
Why A Stimulative
Monetary Policy Might Fail?
3. Adverse Effects on Inflation

A. Even if the central bank’s stimulative policy does not affect inflation and if
banks are willing to lend the funds received, it is possible that firms and
businesses will not be willing to borrow more money.
Some firms may have already reached their debt capacity so that they are
restricted from borrowing more money, even if loan rates are reduced. They
may believe that any additional debt could increase the likelihood of
bankruptcy. Thus, they may delay their spending until the economy has
improved.
Why A Stimulative
Monetary Policy Might Fail?
3. Adverse Effects on Inflation

B. Households that commonly borrow to purchase vehicles, homes, and other

products may prefer to avoid borrowing more money during weak economies,
even if interest rates are low.
Households who are unemployed are not in a position to borrow more money.
And even if employed households can obtain loans from financial institutions,
they may believe that they are already at their debt capacity. The economic
conditions might make them worry that their job is not stable, and they prefer
not to increase their debt until their economic conditions improve and their
job is more secure.
So while central banks hope that the lower interest rates will encourage more
borrowing and spending to stimulate the economy, the potential spenders
may delay their borrowing until the economy improves. But the economy may
not improve unless firms and households increase their spending.
Why A Stimulative
Monetary Policy Might Fail?
Because the effects of a stimulative policy could be disrupted by expected inflation, an
alternative approach is a passive monetary policy that allows the economy to correct
itself rather than rely on the central bank’s intervention.
Interest rates should ultimately decline in a weak economy even without a stimulative
monetary policy because the demand for loanable funds should decline as economic
growth weakens. In this case, interest rates would decline without a corresponding
increase in inflationary expectations, so the interest rates may stay lower for a
sustained period of time. Consequently, the level of business investment should
ultimately increase, which should lead to a stronger economy and more jobs.
The major criticism of a passive monetary policy is that a weak economy could take
years to correct itself.
The Monetary Policy
Instruments
 The Monetary Policy Instruments

Open Market The

Operations
Involves in the buying and selling of
government securities as well as
repurchase and reverse repurchase
agreements
Discount Rate
The rate of BSP’s rediscounting facility,
which the BSP can increase/decrease
depending on the monetary policy
stance.

Reserve
Requirement
Amount of money that banks are
required to keep in their vaults or
deposit with the BSP.
The Policy Rate
The policy rate is the rate at which the central bank will pay or charge banks for their
deposits or loans.

It is generally a short-term, often overnight, rate that banks charge one another to borrow
funds. When the central bank puts money into the system, the rate declines. Conversely,
when the central bank decreases the money supply in the system, the rate rises.

This rate will consequently affect the interest rates that banks apply to both borrowers
and depositors. It is one of the most important rates since It generally influences all other
interest rates in the economy.
Open Market
Operations
Monetary Policy Instruments
Open Market Operations
1.) BSP Purchase of Securities
In order to lower the policy rate, it purchases Treasury securities in the secondary market.

1. The BSP calls government securities dealers to obtain their list of securities for sale,
including the denomination and maturity of each security, and the dealer’s ask quote (the
price at which the dealer is willing to sell the security).
2. From this list, the BSP attempts to purchase those Treasury securities that are most attractive
(lowest prices for whatever maturities are desired) until they have purchased the securities
needed. The BSP receives and pay for those securities.
3. The bank account balances of the dealers increase and so the total deposits in the banking
system increase.
4. This increase in the supply of funds places downward pressure on the policy rate.
5. The BSP increases the total amount of funds at the dealers’ banks until the policy rate
declines to the new targeted level.
6. Such activity, represents a loosening of money supply growth
Open Market Operations (cont.)
2.) BSP Sale of Securities
In order to increase the policy rate, the BSP sells government securities
(obtained from previous purchases) to government securities dealers.

1. The securities are sold to the dealers that submit the highest bids.
2. As the dealers pay for the securities, their bank account balances are reduced.
3. The total amount of funds in the banking system is reduced by the market value of
the securities sold by the BSP.
4. This reduction in the supply of funds in the banking system places upward pressure
on the policy rate.
5. Such activity, is referred to as a tightening of money supply growth.
Open Market Operations (cont.)
3.) Trading of Repurchase Agreement
The BSP may wish to increase the aggregate level of bank funds for only a few days in
order to ensure adequate liquidity in the banking system on those days.

1. To increase the money supply, the BSP enters into a reverse repurchase
agreement. It purchases Treasury securities from government securities dealers
with an agreement to sell back the securities at a specified date in the near future.
2. Initially, the level of funds rises as the securities are sold to BSP.
3. It is then reduced when the dealers repurchase the securities.
Side Note: What is A Repo Agreement?
A Repurchase agreement (repo) is a form of short-term borrowing for dealers in government
securities with an agreement to purchase them back at a specified date in the near future.

▪ In a repurchase agreement, the seller is the borrower, while the buyer is the lender.
▪ The price paid to repurchase the security is higher than the original selling price. The difference
between the purchase price and the repurchase price is equivalent to interest
▪ The securities acts as collateral. If the seller is unable to repurchase the securities, the buyer has the
right to sell those securities in the market.
▪ To mitigate the risk of default, repurchase agreements are usually collateralized with securities with
a market value in excess of the amount paid for them.
For the party selling the security and agreeing to repurchase it in the future, it is a repo; for the
party on the other end of the transaction, buying the security and agreeing to sell in the future, it
is a reverse repurchase agreement.
Example: Repo Agreement
Person A needs cash for liquidity for a short period of time.
She has government securities with a market value of
Php 1,250,000. She enters a repurchase agreement with
Person B by selling the securities for Php 1,000,000, with a
condition to buy them back at Php 1,005,000 after 24 hours.
In Person A POV, the transaction is a repurchase agreement
while in Person B’s POV, it is a reverse repurchase agreement.
After the agreed period, Person A must buy back the
securities for Php 1,005,000. The Php 5,000 serves as the
interest income of Person B.
If Person A cannot repurchase the securities, Person B has the
right to sell those securities in the market. This makes the
securities a collateral. That’s why, the market value of the
securities sold (Php 1,250,000) is usually in excess of the
amount paid for them (Php 1,000,000).
How the Open Market Operation Affect
Interest Rates
Even though most interest rates are market-determined, the central bank can have a strong influence on
these rates by controlling the supply of loanable funds. The use of open market operations to increase
bank funds can affect various market-determined interest rates.
For example, if the BSP purchases securities:
▪ First, the policy rate may decline because some banks have a larger supply of excess funds to lend out.
▪ Second, bank rates decline. Banks with excess funds may offer new loans at a lower interest rate in order to
make use of these funds. These banks may also lower interest rates offered on deposits because they have
more than adequate funds to conduct existing operations.
▪ Third, yields of treasury securities decline. Because open market operations commonly involve the buying or
selling of Treasury bills, as the supply of the treasury securities decreases, the price increase, and ultimately
the yield decrease (recall the inverse relationship of price and yield).
▪ Fourth, as the yields on Treasury bills and bank deposits decline, investors search for alternative investments
such as other debt securities. As more funds are invested in these securities, the yields will decline.
 Open Market Operations

Dynamic
Operations
Are implemented to increase or
decrease the level of funds.
Defensive
Operations
Are implemented to offset the
impact of other conditions that
affect the level of funds.

For example, if the BSP expected a

large inflow of cash into
commercial banks then it could
offset this inflow by selling some of
its Treasury security holdings.
Rediscounting
Monetary Policy Instruments
Rediscounting
What is rediscounting?
Rediscounting is a privilege of qualified Bangko Sentral ng Pilipinas (BSP)-
supervised banks that have approved and active rediscounting line with the
BSP to obtain loans or advances from BSP using the eligible papers of its end-
user borrowers (EUB) as collaterals. It is a standing credit facility to help banks
meet temporary liquidity needs by refinancing the loans they extend to their
clients.

How does the rediscounting cycle go?

A bank extends loans to EUBs who execute credit instruments [i.e., promissory
notes (PNs), drafts or bills of exchange (BX)] in favor of the bank. The bank
rediscounts the credit instruments of its EUBs by endorsing the same in favor
of the BSP. The BSP, in turn, lends the bank an amount equivalent to a certain
percentage of the face amount/outstanding balance of the EUB’s credit
instrument.
Rediscounting
What is the role of rediscounting in our monetary system?
The BSP uses its rediscount facility as an instrument to influence the volume of credit in
the Financial system and to act as the:

1) short-term safety valve for the banking system when the aggregate supply for
reserves fall short of demand; or
2) when banking institutions meet an unexpected shortage of reserves or funding for
their temporary liquidity needs.

The rediscounting window does not aim to compete with the existing rediscounting
facilities in the market.

Rediscounting is the second monetary policy tool or instrument used by the BSP to
control the level of bank reserves (and thus the money supply or interest rates).

The discount rate is the rate of interest central banks charge on loans to financial
institutions. The BSP can influence the level and price of reserves by changing the
discount rate it charges on these loans.
Rediscounting
What is the Lender of Last Resort Principle?
The concept of LOLR generally refers to the role of central banks as providers of liquidity to
individual banks and the banking system as a whole when liquidity cannot be obtained from
market sources.

A key principle of LOLR is that depository institutions should exhaust other possible sources
of funding first before going to the central bank. For rediscounting, the LOLR principle is
implemented through provision of loans exclusively for the purpose of meeting short-term
liquidity needs of the banks, which are appropriately priced based on changes in BSP’s
monetary policy goals and/or movements in the market interest rates.
Reserve
Requirement
Monetary Policy Instruments
Reserve Requirement Ratio
What is a Reserve Requirement?
The third monetary policy tool available to the central bank to achieve its
monetary targets.

Reserve requirements determine the minimum amount of reserve assets (vault

cash plus bank deposits at central banks) that depository institutions must
maintain by law to back transaction deposits held as liabilities on their balance
sheets.

What is the Reserve Requirement Ratio?

The reserve requirement is usually set as a ratio of transaction accounts.

A decrease in the reserve requirement ratio means that depository institutions

may hold fewer reserves (vault cash plus reserve deposits at the central bank)
against their transaction accounts (deposits). Consequently, they are able to
lend out a greater percentage of their deposits, thus increasing credit
availability in the economy.
 The Monetary Policy Instruments

Open Market The

Operations
Involves in the buying and selling of
government securities as well as
repurchase and reverse repurchase
agreements
Discount Rate
The rate of BSP’s rediscounting facility,
which the BSP can increase/decrease
depending on the monetary policy
stance.

Reserve
Requirement
Amount of money that banks are
required to keep in their vaults or
deposit with the BSP.
Notes
▪ Inflation and economic conditions have a direct relationship.
▪ Inflation and unemployment rate have an inverse relationship.
▪ Economic conditions and unemployment rate have an inverse relationship.
▪ Clarification regarding the Expectations Channel:
▪ When the BSP implements stimulative monetary policy, some households and business increase their
inflationary expectations. This will encourage them to spend now when prices are relatively low, hence,
aggregate demand increase and ultimately, inflation.
▪ When the BSP implements restrictive monetary policy, some households and business decrease their
inflationary expectations. This will encourage them to invest/save now when interest rates are high, hence,
aggregate demand decreases and ultimately, inflation.
Notes
▪ When inflationary pressures are high (low) the BSP would likely implement restrictive
(stimulative) monetary policy.
▪ When economic conditions is weak (high), the BSP would likely implement stimulative
(restrictive) monetary policy.
▪ When the BSP implements stimulative (restrictive) monetary policy, the money supply
increases (decreases).
▪ Monetary Policy Instruments:
▪ To implement stimulative (restrictive) monetary policy, the BSP purchases (sells) government
securities in order to decrease (increase) the policy rate.
▪ To implement stimulative (restrictive) monetary policy, the BSP may increase (decrease) their
rediscounting line in order to increase (decrease) in the money supply.
▪ To implement stimulative (restrictive) monetary policy, the BSP may decrease (increase) the
required reserve ratio in banks, in order to increase (decrease) in the money supply.
End of Chapter 5
Source: https://www.bsp.gov.ph