The policy was approved as part of the CBI plan to implement new instruments in its monetary policy, regulate interest rates, curb inflation, and develop a regulated framework for controlling banks’ borrowings from the CBI.
OMO is a financial instrument through which central banks buy and sell securities in the open market to expand or reduce money supply.
Within the OMO, the CBI buys government bonds to increase the money base (cash reserves), thereby reducing inter-banking lending rates. Selling government bonds decreases the base money and raises interbank rates, Financial Tribune reported.
Within OMO, borrowing from CBI involves banks and credit institutions to hold government-issued bonds as collateral.
CBI head Abdolnasser Hemmati in an Instagram post on Tuesday said two major functions of the CBI is to decide monetary policy and oversee lenders’ performance.
He pointed to short-term interest rates as one of the essential means for implementing monetary policy, adding that within the OMO mechanism the CBI will be able to control interest rates.
Besides overseeing banks’ balance sheets via instruments like the capital adequacy ratio, Hemmati emphasized that the regulator aims to implement cautionary policies to keep a close eye on lenders.
The capital adequacy ratio (CAR) is a measurement of a bank's available capital expressed as a percentage of a bank's risk-weighted credit exposures. The capital adequacy ratio, also known as capital-to-risk weighted assets ratio (CRAR), is used to protect depositors and promote the stability and efficiency of financial systems around the world.
The cautionary polices are usually implemented in stable and non-critical conditions to prevent extreme behavior of economic players. The policy largely involves controlling banks’ capital, legal reserves and lending.
“Today central banks employ policy instruments to prevent manageable risks and hazards from turning into systemic economic risks,” he wrote.
Opportune Time
Hemmati noted that removing snags in the banking system and improving the economy via a transparent banking system is a CBI priority.
In another Instagram post on Friday, Hemmati forecast positive results for the OMO if the government regularly sells bonds in the market.
Kamran Nadri, a financial expert, believes the conditions have never been as favorable as now for the CBI to launch the OMO.
He said the market for government-issued securities is robust enough to launch the OMO because the government issued a bulk of securities in the previous years and plans to issue more in this fiscal (started March 21).
According to a report by Majlis Research Center in January, adding up the bonds which mature in the current fiscal (March 2019-20) (270 trillion rials / $2.1 billion) and the total bonds to be issued in the current year (910 trillion rials / $7.5 billion), as seen in the current budget law, there will be enough bonds in the market for the effective implementation of OMO.
The initiative is also enshrined in the current fiscal budget. As per the law, “in order to implement monetary policies and control interest rates and inflation, the CBI will launch the OMO and trade in Islamic bonds issued by the government. Banks can hold the bonds as collateral to borrow from the CBI”
In its analytical report, the influential parliamentary think tank, rated the measure as highly essential to regulate lending by CBI.
Referring to the existing procedures, the MRC complained that the CBI does not oblige lenders in need of liquidity to keep collateral with the CBI for inter-bank debt settlement.
On how OMO helps regulate interbank interest rate, the MRC says increase in the volume of bonds is tantamount to increase in the volume of borrowing, which in turn raises the interest rate on bonds.
When the interest rate of government bonds is higher than the interbank rate, banks with surplus cash reserves prefer to buy bonds instead of parking their money in the interbank market.
This is where central banks step in as the main purchasers of bonds in the secondary market.
Launching the OMO and purchasing bonds by CBI will naturally increase demand for such bonds that in turn reduce the yield of bonds and bring them closer to interbank borrowing rates.
The procedure ultimately reduces the borrowing cost and, thereby, facilitates the borrowing process.