Small banks crowded out of new auction-based repo market
The ability to crowd out smaller banks bidding in the Bank of Jamaica (BOJ) short-term liquidity auction for repurchase agreements, or repos, has manifested itself in the first few held since the central bank started them in October.
At the same time, demand is apparently so high that some deposit-taking institutions (DTIs) have expressed concerns that the volume offered is usually unpredictable and tends to be inadequate.
The BOJ said that since its transition to the market-determined rate for repos, five auctions have been conducted.
Chief financial officer of First Global Bank, Josephine Bennett-Darmand, who in August this year first raised concern about the potential of the bidding process to crowd out smaller banks, said there have been instances so far "when you go to auction and don't get anything".
In an interview with the Financial Gleaner on Wednesday, Bennett-Darmand said that has not always been the situation, but emphasised that "there are instances when you go and you get not even a dollar."
She explained that if banks "are in a bind" in terms of their need for Jamaican dollar liquidity, "you really going to have to bid very high". She suggested that one could examine what were the bids that got all the money at the auctions "versus the bids at the lower end of the spectrum, to see how wide that margin is for those who are able to get all they would have wanted."
First Global is the second-smallest of six commercial banks and the smallest in retail banking.
The banking executive said the auctions, as structured, "does lend some support to the argument that those with the strongest pockets would be able to get all of the funds if they were of a mind to so do, based on their needs. If you are not urgently in need of funds, then I imagine you would bid in some areas that you think is reasonable as to where the market in positioned".
She added: "But the learning would be that if you really need to get all of the funds you need, you really going to have to dig deep in your pocket to ensure that you receive the funds. The ability to crowd out, I believe, is still there. Nobody sees who is bidding necessarily, just the numbers coming in, the bid rates, so there is no discretion that is being applied, I imagine."
Asked if the BOJ believes that the repo auctions have created a market in which DTIs are essentially competing for funds available, the central bank said in emailed responses that the full amount offered through the short-term auction is priced on a competitive basis.
"Having observed the subscription amounts at each auction, the number of bids submitted by participants, the number of entities participating in the auction, as well as the range for the interest rate attached to bids, it can be concluded that the DTIs are competing for the funds available," the BOJ said.
The central bank added that "the auction amount is only available via competitive bidding. All entities, irrespective of size, compete on the same basis for the funds being auctioned".
However, it noted that institutions that are not successful in the weekly auctions are able to access liquidity through the overnight standing liquidity facility provided by the BOJ.
Nevertheless, Bennett-Darmand said that while the overnight standing facility works for a bank like First Global, "I imagine there is a limitation as to how much you can get from that facility. So everything is relative to what your needs are at a point in time."
Market determines rates
Essentially, the BOJ gives the market a free hand to determine interest rates at the auctions rather than the traditional method whereby the central bank dictates the borrowing rates.
"Yes, for the short-term repo auction DTIs state the amount and the interest rate that they are willing to pay for each amount, if successful. For the overnight standing liquidity facility, the BOJ continues to set the interest rate for liquidity accessed," the central bank said.
To date, the BOJ said, the smallest subscription amount it has offered is $3.3 billion and the largest $18.5 billion.
At the last auction on Monday, November 9, the BOJ invited applications for $6 billion in Jamaica dollar liquidity, but received 11 bids for $13.1 billion.
The highest submitted and successful bid was at interest rate of 9.57 per cent for $4 billion of the $6 billion. The lowest submitted bid was at interest rate of 7.95 per cent for $1 billion, while the lowest bid for full allocation was at interest rate of 9.0 per cent for $1.3 billion, according to the results posted on the BOJ's website.
The next auction for 14-day repurchases is scheduled for Monday, November 16.
As to whether the BOJ has received feedback relating to concerns smaller banks or other players might have about the auction, the central bank said that "while DTIs have generally welcomed the institutions' ability to indicate how much they are each willing to pay for their liquidity needs over a two-week horizon, some institutions have expressed the concern that the total volume offered by BOJ at each auction is not easily predictable and tends to be inadequate".
It added that "where the amount on offer is less than their expectations, it has tended to motivate each bidder to push rates upwards in order to have their needs satisfied with more certainty".
However, "we expect that the forecast of the liquidity needs of the system by both DTIs and the central bank will converge as experience with the allocation system grows," the BOJ said.
In the September 2015 report on Jamaica, the International Monetary Fund welcomed the BOJ's reduction in interest rates earlier this year, but said the lower policy rate has yet to transmit to higher private-sector credit, in part due to weak monetary transmission through an underdeveloped financial sector.
Credit growth is also likely hampered by a lack of price competition in the banking sector and the slow shift in banks' business model from lending to the Government towards greater private-sector lending, it said.
The report said the BOJ's enhanced liquidity operation, since last year, has improved banks' short-term liquidity condition and that its plans to begin regular auctions of the 14-day repos in October would further improve the certainty of liquidity provision and support credit creation.