Examples of moral suasion

admin — Wed, 27 May 2009 11:50:04 +0000

Examples of moral suasion by central banks and bank regulators include the following:
Bailouts. A healthy domestic bank may be asked to rescue a smaller failing bank. Privately owned banks are better able to resist this particular pressure than state-controlled banks but may be given little option. A foreign-owned bank is much better placed to resist such coercion.
Lending restraints. The central bank may ask banks to restrain their lending to a particular sector, usually the real estate market. This may be done informally or through the imposition of a limit on the proportion of total loans that a bank can lend to a particular sector.
In Hong Kong, for example, the Hong Kong Monetary Authority effectively imposed a 40% limit on the proportion of loans that a bank could extend to real estate developers and investors and for residential mortgages in the mid-1990s. Rapid asset inﬂation had pushed property prices to the point where they were among the highest in the world. The prudence of this policy was shown when property prices reversed in the late 1990s and approximately 40% of mortgagors found themselves with negative equity.
Directed lending. The central bank may set loan growth targets for individual banks at an overall level, by economic sector or by group of customers. These targets are intended to support government policy whether economic or social. The following are just a few such examples
In Taiwan the ruling government has at times instructed banks to give preferential treatment to people and companies adversely affected by earthquakes. This may be wor thy but could have been addressed in a more equitable way by the government making direct grants to the affected par ties so that they could meet their ﬁnancial obligations.
In the US banks have to meet legislative requirements to lend to particular groups of people to support national housing policies and to prevent discrimination based on location. A high proportion of deposits gathered in a particular area, such as an inner city ghetto, must be lent out in that locale, for example.
In South Korea in the 1990s successive governments encouraged banks to lend to particular industrial groups and sectors. Banks were expected to support governments’ objectives to create and nurture national champions.
In some countries tax relief is given on part of the interest paid on home loans but is not given for rental expenses. This distorts the housing market by encouraging home ownership at the expense of those living in rented accommodation. In addition proﬁts made from an individual selling their primary residence are exempt from capital gains taxation which is applied to proﬁts made from trading other forms of assets.

DISCOUNT RATE AND OPEN MARKET OPERATIONS

admin — Fri, 27 Jun 2008 11:36:40 +0000

The most commonly used central bank tools are those of adjusting the discount rate, to affect the price of money, and buying and selling government bonds, to affect the level of money supply. The discount rate is the rate at which banks can borrow from the central bank. In practice the transmission mechanism is often through the interbank market. The Federal Funds rate, for example, is the rate at which US banks with cash and deposits with Federal Reserve banks in excess of their reserve requirements will lend to banks that have a shortfall:
Discount window. Banks that regularly borrow from the central bank will ﬁnd themselves being charged punitive rates. The discount window provides a mechanism for the central bank to inﬂuence the level of shor t-term interest rates through its role as the lender of last resort. Their ability to inﬂuence rates at the long end of the yield curve is more limited. The use of the discount window is highly visible.
Open market operations. The ﬁnal way in which central banks can inﬂuence money supply is through open market operations. If the central bank wishes to increase money supply then it intervenes to buy government securities. It does this by “printing” cash. If it wants to reduce money supply then it sells government securities. The effectiveness of open market operations is due to the effect of the money multiplier. The central bank has a very long lever.
The central bank can choose the term of the securities it buys or sells and while its effectiveness is limited in can inﬂuence yields at a particular maturity. Its action in terms of money supply and its impact at the short end enjoy considerable leverage but as just one more participant in bonds at a par ticular term it has no such gearing.

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Examples of moral suasion

DISCOUNT RATE AND OPEN MARKET OPERATIONS