Discover the Central Bank’s Influence on Liquidity and Interest Rates through Open Market Operations and Repurchase Rates.
Indirect Monetary Policy Instruments
Open Market Operations
Open Market Operations (OMOs) entail the purchase and sale of government securities by the Central Bank and is the main policy tool for influencing the level of liquidity in the domestic financial system. On a daily basis, the Central Bank assesses market requirements with a view to either increasing or reducing the level of liquidity in the banking system. If liquidity is deemed to be short or insufficient, the Central Bank buys securities outright or engages in short-term collateralised lending through the repurchase facility, thereby adding liquidity to the system. Conversely, when the system is deemed to be long or there is too much liquidity, the Central Bank sells securities to the system, thereby reducing the level of liquidity.
In order to conduct these operations, the Central Bank has established a system of primary dealers as its main counterparties in the market. At present, the commercial banks are the main primary dealers. Securities issued in open market operations are mainly Government of Trinidad and Tobago treasury bills and treasury notes governed by statutory limits as outlined in the Treasury Bills Act Chapter 71:40 and the Treasury Notes Act Chapter 71:39. OMO securities are short-term in nature with maturities ranging from 3 months to 3 years. They are issued on an auction basis at market-determined interest rates.
Repurchase Rate (Repo Rate)
The repurchase rate or the ‘Repo’ rate is the Central Bank’s key policy interest rate used to influence the level of commercial banks’ interest rates. More importantly, changes in the direction of the Repo rate are intended as important signals to the market of the Bank’s policy direction. Each month, the Bank makes a determination, on the basis of developments in domestic and international conditions, whether or not to change the rate and an announcement of the rate is made. The Repo rate was first introduced in May 2002 at 5.75 per cent.
It is the rate the Central Bank applies to collaterized overnight financing provided to commercial banks in the form of repurchase agreements. Repurchase agreements can be overnight (Repos) or can be done in reverse (reverse Repo). The Central Bank uses repurchase agreements (Repos) to provide overnight financing to banks if they are unable to meet a temporary liquidity shortage through inter-bank borrowing. Conversely, the Bank may use reverse Repos to offset commercial banks’ temporary liquidity surpluses. In a repurchase agreement, the Central Bank purchases a security from a commercial bank with an agreement that the commercial bank repurchase the security at a higher price on a specified date. The repurchase rate is the rate at which the commercial bank will repurchase the securities from the Central Bank. In a reverse repurchase agreement, the Central Bank offers to take funds from the commercial banks through a sale of securities with an agreement to buy back the securities the following day. The ‘reverse Repo’ rate is set at 50 basis points below the ‘Repo’ rate.
Changes in the repurchase rate act as a signalling device. If the Central Bank wishes to ease monetary policy because of sluggish economic growth or lagging unemployment, it may opt to lower the Repo rate which would lead commercial banks to lower their lending rates thereby influencing the demand for credit by consumers and businesses and ultimately affect spending in the economy.
