Monetary Policy & Central Banking (Module) PDF

# MONETARY POLICY AND CENTRAL BANKING ## MODULE For classroom discussion only ## Monetary Policy and Central Banking The image shows a small, stylized man standing with his arms folded on a stack of gold coins. The central word is **"INFLATION"** in a large font that highlights its relevance. Sur...

# MONETARY POLICY AND CENTRAL BANKING ## MODULE For classroom discussion only ## Monetary Policy and Central Banking The image shows a small, stylized man standing with his arms folded on a stack of gold coins. The central word is **"INFLATION"** in a large font that highlights its relevance. Surrounding it are smaller words related to monetary policy and banking, including **"ECONOMICS"**, **"GOODS"**, **"CENTRAL BANK"**, **"INTEREST RATE"**, and **"MONEY SUPPLY"**. ## Chapter 1 - Bank and Banking Perspective ### Overview This course provides a better understanding of bank and banking perspectives in the Philippines. It covers various aspects, including: - Banking history in the Philippines, both past and present - Financial regulation of money - The nature of banking business - Types of bank operations - A clear understanding of banking perspectives ### Learning Objectives: At the end of the unit, students are able to: 1. Understand the bank and banking perspective. 2. Understand Philippine banking history and the current state of banking in the Philippines 3. Explain the importance of banking operations and the different types of banks. 4. Understand the economic significance of banks. ### Setting up Name: Course/Year/Section: Date: **Write your answers in the space provided after each question.** **Question:** 1. Give your understanding or insight about banking and how it may affect the landscape of Philippine history. 2. Differentiate domestic banks and international banks and their differences from each other. ## Lesson Proper ### Introduction #### Bank and Banking Perspectives Historical Perspective of the World * **2000 BC- Early banking practices started in Babylon:** Credit transactions were common, evidenced by tablets of clay. * **4th Century BC - Temples, public bodies, and private firms dealt in deposits and loaning of funds:** These institutions acted as early lenders and borrowers. * **2nd century A.D- Public notaries registered transactions:** This standardized the recording of financial transactions. * **8th century- Bank drafts and checks were in wide use in Assyria:** A more sophisticated financial system emerged with the introduction of drafts and checks. * **Medici family ushered in the 2nd period of Florentine financial power:** This period saw significant growth in banking and finance in Florence, Italy. * **16th Century - Ruled by Fugger Family, John's Laws financial system almost spelled ruin to France:** The Fugger Family's dominance in European finance and John's flawed financial system caused issues for France eventually leading to its downfall. ### Philippine Banking History #### Spanish Era * **16th century: Obras Pias, the first financial institution:** A religious institution that provided financial services with capital from pious Catholic sources. * **Banco Español – Filipino (1828) established a commercial bank:** This institution was partially financed foreign trade and provided general banking services. * **Opening of the Suez Canal (1869) led to accessibility of European markets:** This event facilitated trade and connection between the Philippines and Europe. * **Chartered Bank of India, Australia, and China established branches in the country:** This marked the expansion of international banking in the Philippines. * **Monte de Piedad (1882) established a savings bank:** This provided a platform for savings and deposit services. * **Banco Peninsular Ultramarino in Madrid – put up a branch in the Philippines in 1853:** This was the expansion of international banking to the Philippines from Madrid. #### American Era * **International Banking Corporation and the Guaranty Trust Company established branches in the Philippines:** This indicates the rise of modern banking following the American occupation. * **Postal Savings Bank was created:** This provided a crucial service for the public. * **Banks established after World War I:** Yokohama Specie bank (1919), China Banking Corporation (1920), Peoples Bank and Trust Company and the Mercantile Bank of China (1926). * **Upon the establishment of the Commonwealth, Netherlands Indische Handels bank opened (1973).** * **The Philippine bank of Commerce was the first private bank with genuine Filipino capital (1938).** * **In 1939 Bank of the Commonwealth, Philippine Bank of Communications and the government-owned Agricultural- Industrial bank commenced commercial banking operations.** #### Japanese Era * **During the Japanese occupation, Filipino and Japanese-owned banks were given permission to operate:** Banks were mostly controlled by Japanese and Filipino interests. * **The Southern Development Bank opened a branch in Manila in (1942):** This institution acted as a fiscal agent for the Japanese government. #### Postwar Era * **Presidential Directive, Executive Order 96, invalidated all Japanese occupation deposits:** This measure aimed at recovering the economic situation after the war. * **Executive Order 48 paved the way for the reopening of the pre-war banks:** It marked the return of pre-war financial institutions. * **Rehabilitation Finance Corporation was created by virtue of Republic Act 85 On January 2, 1947 which took over the functions of the Agricultural Industrial Bank:** This institution focused on rebuilding the economy. * **In 1948 General Banking Act passed into law:** This provided comprehensive rules for banking institutions. * **The 1949 Republic act No. 265 known as Central bank Act was passed:** This established the central bank. * **In 1972, Presidential Decree no. 72 was issued amending Republic act no. 265 in attuned in changing economics.** * **In 1973 Constitution, Presidential decree no. 1801 designated central Bank of the Philippines as the central monetary authority which was adopted by the 1987 Constitution.** #### Philippine Banking Today * **Republic Act No. 7653 or the New Central Bank Act of 1993, governs Philippine banking today.** This act established the Bangko Sentral ng Pilipinas (BSP) as the central bank. * **The business of banking has changed irreversibly due to developments in technology:** E-Banking and E-money became significant aspects of banking services. * **The use of E-money can be divided into three groups:** * **Access devices:** Enable access to bank accounts for transactions without physical presence. * **Card-based products:** Cards with stored value. * **Prepaid software products or network money:** Funds stored and transferred electronically. * **Republic Act No. 8791 known as General Banking Law of 2000, institutionalized a certain mass of banking reforms in the Philippines:** This law regulated the organization and operation of banks, quasi-banks, and trust entities. * **Republic Act No. 9160 known as the Anti-Money Laundering Act of 2001, was passed into law on 29 September 2001:** This act aimed at preventing money laundering. * **On April 19, 2000 the Monetary Board approved the issuance of Circular No. 237, consolidating and clarifying all existing rules and regulations on mergers and acquisitions:** This circular further streamlined banking regulations. #### Bank mergers and consolidations are distinguished as follows: * **Merger:** Absorption of one or more corporations by another existing corporation which retains its identity. * **Consolidation:** The union of two or more corporations into a single new corporation. #### Banks shall refer to entities engaged in lending of funds obtained in the form of deposits #### Nature of Banking Business: "Banks make money out of other people's money" #### Principle of Banking Business * **A certain amount deposited will support several times as much in credit, known as the partial reserve system:** Banks can lend more than the deposits they hold. * **A greater portion of deposits in commercial banks arises out of the proceeds of loans:** Loans are a significant source of income for commercial banks. #### Types of Banks ##### As to ownership * **Privately owned:** Organized and capitalized by private citizens for profit. * **Publicly owned:** Organized by the state with sometimes a minimum private ownership. ##### As to place of Incorporation * **Domestic:** Incorporated under Philippine Laws. * **Foreign:** Incorporated under laws of other countries. ##### As to Structure * **Stock corporation:** Sells shares to the general public to raise capital. * **Non-stock Corporations:** Membership-based, like savings and loan associations ##### As to Function * **Commercial bank:** Receives demand deposits, gives out short-term loans. * **Trust company:** Deals with fiduciary activities like estates, guardianships, and executors. * **Savings Bank:** Receives funds from people seeking safekeeping and invests them in long-term investments. * **Rural Bank:** Caters to the needs of small farmers, businesses, and cooperatives. * **Development Bank:** Provides medium and long-term loans for economic development. * **Cooperative bank:** Furnishes credit to registered cooperatives. * **Investment Bank:** Assists government bodies and newly organized corporations. * **Central Bank:** The central bank of a country. Does not deal directly with the public. ##### As to Management: * **Unit Bank:** Independent ownership. * **Group Banking:** Holding company controls multiple banks. * **Branch Banking:** Head office and branches. * **Chain Banking:** Person/s controlling multiple banks. ## Chapter 2: Philippine Financial System ### Overview This lesson explores the Philippine Financial System, which comprises: - Different banking institutions - Nonbank financial intermediaries - Offshore banking units - Building and loan associations - Investment and brokerage houses - Finance companies ### Learning Objectives: At the end of the unit, students are able to: 1. Explain and analyze the Philippine Financial System. 2. Discuss the different components of a financial system, financial instruments and financial services. 3. Understand the instruments for the ultimate borrower and the financial intermediaries. 4. Understand the role and importance of the BSP. ### Setting up Name: Course/Year/Section: Date: **Write your answers in the space provided after each question.** **Question:** 4. Give some examples of financial instruments that you still remember from your previous basic finance studies and discuss their significance to the current banking system. ## Lesson Proper ### History Financial System * **The Financial System is like the heart of a human being. If it stops working, the person is dead; in the same way, if the financial system stops working, then the economy would collapse.** This illustrates the vital role of the financial system in an economy. * **Financial System is crucial to the allocation of resources.** It ensures the smooth flow of funds and resources. * **The Philippine Financial System is composed of banking institutions and nonbank financial intermediaries:** Includes commercial banks, specialized government banks, thrift banks, and rural banks, offshore banking units, building and loan associations, investment and brokerage houses, and finance companies. * **The Bangko Sentral ng Pilipinas (BSP) and the Securities and Exchange Commission maintain the regulatory and supervisory control.** The BSP is the central bank and plays a key role in overseeing the financial system, while the Securities and Exchange Commission regulates the securities market. * **The first credit institution in the Philippines, "The ObrasPias" started by** **Father Juan Fernandez de Leon in 1754 and ended in 1820.** This marked the beginning of formal financial institutions in the Philippines * **The "Banco Espanol-Filipino de Isabela II", the first Philippine Bank, was established in 1851:** Now known as Bank of the Philippine Islands (BPI), it is the oldest standing bank in the Philippines and in Southeast Asia. * **The "First Agricultural Bank of the Philippines" was established in 1906:** This institution played a crucial role in supporting agriculture and was eventually transferred to the Philippine National Bank. ### Financial System * **The financial system is a term used in finance to describe the system that allows money to go between savers and borrowers:** This is the primary function of the financial system to provide financial services to savers and borrowers. ### There are five mainly components of the financial system: 1. **Financial Markets:** These are the places where financial assets and services are created or transferred. They can be categorized into money markets and capital markets. 2. **Financial Instruments:** Assets that can be traded. 3. **Financial Institutions:** Organizations offering financial services. 4. **Financial Services:** Specific services provided by financial institutions. 5. **Money:** A medium of exchange. ### Key functions of the Financial Markets: 1. Assist in credit creation and allocation of credit and liquidity. 2. Serve as intermediaries for mobilization of savings. 3. Help achieve balanced economic growth. 4. Offer financial convenience. ### Financial Instruments * **Examples:** Cash, bonds, stocks, real estate, or items of value * **Represent:** Evidence of ownership, a contractual right, or a legal agreement * **Types:** * **Equity-based:** Ownership of an asset. * **Debt-based:** Represent a loan made by an investor to the owner of an asset. * **Foreign exchange instruments** ### Financial Institutions * **Organizations offering financial services.** * **Mobilize savings:** By directly or indirectly using financial instruments. * **Categorized into:** * **Regulatory:** Institutions like the BSP overseeing the financial system. * **Intermediaries:** Facilitate transactions between borrowers and lenders. * **Non-Intermediaries:** Provide specialized advisory services. * **Others:** Expand the range of services. ### Financial Services * **Services offered by financial institutions:** * **Banking:** Includes deposits, loans, mortgages, etc. * **Insurance policies:** Protect against risks. * **Pension Funds:** Long-term savings and investment plans. * **Asset Management:** Managing investments * **Liability Management:** Managing liabilities and debt. * **Ensure efficient capital allocation:** By identifying and satisfying the needs of both savers and borrowers. * **Contribute to:** * **Economic growth:** Improving the standard of living. * **Financial convenience:** Providing access to funds. ### Importance of Financial services * **Enable countries to improve their economic condition:** Increased production of goods and services, leading to economic growth. * **Benefit for individual economic growth:** Higher standard of living through improved choices in consumer products. * **Promote investment and savings:** Financial services create a conducive environment for both investors and savers. * **Minimizing risks:** Through insurance and other financial services. * **Maximize returns:** Offering credit, leasing opportunities, and factoring services. * **Economic stability:** Ensuring a steady flow of capital between businesses and individuals. * **Government financing:** By providing avenues for issuing bonds and other debt instruments. * **Expand activities of financial institutions:** By offering a range of financial products and services. ## Chapter 3: Bank Supervision and Examination ### Overview This chapter examines the efforts of the Bangko Sentral ng Pilipinas (BSP) in strengthening the banking system. Notably, it explores: - The strengthening of the legal and supervisory framework. - Enhancements in the BSP's organizational structure. - Improvements in its compliance with the Basel Core Principles. - The adoption of tools for banking supervision. **Key Points:** - The 1997 Asian financial crisis highlighted weaknesses in the banking system. - The BSP has worked to improve the practice of banking supervision across the Philippines. - The Basel Core Principles for Effective Banking Supervision provide guidelines for regulatory oversight. ### Learning Objectives: At the end of the unit, students are able to: 1. Understand and describe bank supervision and examination. 2. Identify the different bank supervision and examination authorities. 3. Evaluate the concept of bank supervision and examination. ### Setting up Name: Course/Year/Section: Date: **Write your answers in the space provided after each question.** **Question:** 1. Cite your arguments by describing the advantages and disadvantages of the BSP. ## Lesson Proper ### Banking Supervision * **The act of monitoring the financial performance and operations of banks to ensure their safe and sound operation and adherence to rules and regulations.** Bank supervision aims to protect depositors and maintain stability in the banking system. ### Banking Supervision in the Philippines **Legal and supervisory framework:** * **Republic Act No. 7653, the New Central Bank Act of 1993, authorized the Bangko Sentral ng Pilipinas (BSP) to exercise supervision over the operations of banking institutions and quasi-banks:** This provided a solid legal foundation for banking supervision. * **The General Banking Law of 2000 (R.A. No. 8791) supports the risk-based approach in banking supervision:** This shifted the focus from compliance-based to risk-based supervision. **Factors Contributing to the Shift to Consolidated and Risk-Based Supervision:** * **Complex banking groups and mixed conglomerates emerged, leading to regulatory arbitrage:** This raised concerns about loopholes in regulation. * **The need for a more risk-based approach to keep up with the growing complexity of banking**: As the financial system became more complex, a risk-based approach became crucial. * **Simultaneous demands for limited supervisory resources prompted a search for more efficient allocation:** This led to prioritizing supervisory resources for high-risk institutions. ### The Evolution of Supervisory Approaches in the Philippines * **Gradualist approach:** Consolidated supervision and a risk-based approach were implemented through a gradual process. * **Emphasis on data collection, process improvement, and staff training:** To ensure efficient and robust supervision. * **Shift to a risk-based supervision approach from a compliance-based one started in 1997:** The BSP focused on measuring and managing banks' risk exposures. * **The full shift to a risk-based approach occurred in 2005:** This marked a significant milestone in supervisory practices. ### Data Collection and Storage * **Financial Reporting Package (FRP):** Crafted for consistency with the Philippine Accounting Standards and Philippine Financial Reporting Standards. * **Data Warehouse System:** Provides easy access to all supervisory data. * **Bank Performance Reports (BPR):** Used for monitoring financial performance of supervised entities. * **Bank Early Warning System (EWS):** Generates forecasts of key bank performance variables. ### Overhaul of the Examination/Offsite Monitoring Process * **Complementation of on-site examination and off-site monitoring:** A balanced approach to ensure comprehensive oversight. * **Reports of Examination:** Provide updated assessments of banking units or groups. * **Interdependency and close coordination:** Working together across different units. ### Skill Sets and Training * **Emphasis on analytical skills and judgment:** To effectively assess risk and implement the new rating system known as CAMELS (Capital adequacy, Asset quality, Management quality, Earnings, Liquidity, and Sensitivity to market risk). * **Importance of critical thinking and sound judgment skills:** To identify potential threats and alert higher management. * **Training programs:** IMF, World Bank, and USAID. * **Encouragement of international certifications:** CFA, CIA, PRM, FRM, and CISA. * **Hiring of personnel:** From diverse discipline, including finance, statistics, and economics. ### Organization of the BSP Supervision and Examination Sector (SES) * **Responsible for carrying out the BSP's bank supervision:** This sector is undergoing reorganization to effectively implement the risk-based supervisory approach. * **New set-up: Major bank supervision processes are organized around specialist organizational formations, managed by overall supervisory relationship management teams.** This structure aims to enhance efficiency and specialization in the supervisory process. * **Focus on:** * **Controls and accountability:** Ensuring proper oversight. * **Specialization and technical areas:** Focusing expertise in specific areas. * **Consistency in applying policies and regulations:** Enhancing clarity and uniformity. * **Timeliness in submitting reports:** Ensuring timely reporting. * **The new setup recognizes the specialized requirements of troubled banks and the need for risk-based supervision methods:** Tailored approaches according to a bank's risk profile. * **Coordination across units:** Through off-site relationship management, the on-site examination team, policy development, data management, etc. ### Other Supervisory Tools * **Bank Performance Reports (BPR):** Provide comprehensive financial performance data. * **Bank Early Warning System (EWS):** Generates projections of potential risks. ### Compliance with the Basel Core Principles for Effective Banking Supervision * **The 2002 IMF Assessment:** High compliance overall but areas for improvement. * **Key areas for improvement:** Strengthening legal protection for supervisors, enhancing information sharing, improving the conduct of consolidated supervision, and improving frameworks for corrective action and problem bank resolution. * **Legal protection:** Legislation to safeguard supervisors. * **Information exchange:** Collaboration with other local and foreign supervisory agencies. * **Standards for banks' risk management systems:** Guidelines on market risk management, liquidity risk management, IT risk management, and supervision by risk. * **Adoption of international standards:** Alignment with Basel II standards. ### The Adoption of International Standards - The BSP has actively monitored the development of Basel II since 1999. - BSP participated in the third quantitative impact study (QIS) of Basel II. - Internal revisions and adjustments for the eventual adoption of Basel II in the Philippines. - The BSP successfully adopted simple approaches under Pillar 1 of Basel II. - Pillar 3 guidelines were issued. - Exposure of the ICAAP guidelines for the purpose of operationalizing Pillar 2 by 2008. **Key Points:** * **Alignment with Basel II standards:** The BSP is committed to meeting international standards for bank supervision. * **Focus on capital adequacy and risk management:** Basel II emphasizes these areas. * **Support for a more robust financial system:** Basel II aims to improve the regulatory framework. ### Developmental initiatives * **The BSP has been actively involved in promoting the development of the Philippine financial system:** This includes capital market development, access to banking services, and financial literacy. * **Contributions:** * **To foreign exchange liberalization, promoting financial inclusion, and the development of the mobile banking market:** These efforts aim to strengthen specific areas of the financial system. * **The BSP also plays a role in enacting legislation:** * **Credit Information System Act:** To enhance a comprehensive credit information system. * **Payment System Act:** To modernize payments systems. * **Corporate Recovery Act:** To reform bankruptcy frameworks. * **Support for capital market development bills:** Such as the Personal Equity Retirement Act. ## Chapter 4 - Bank Credit Instruments ### Overview * **This lesson focuses on credit instruments:** These documents evidence the existence of a credit obligation that defines the responsibility of a borrower to a lender. * **Key features of credit instruments:** Defining debtor and creditor responsibilities, indicating the risk involved, and facilitating the flow of credit. ### Learning Objectives: At the end of the unit, students are able to: 1. Describe and understand the importance and features of credit instruments. 2. Understand the different concepts of credit instruments. 3. Analyze the different types of bank credit instruments. 4. Determine how negotiation is valuable in resolving disputes. ### Setting up Name: Course/Year/Section: Date: **Write your answers in the space provided after each question.** **Questions:** 1. General Acceptability: Explain what this means in the context of credit instruments. 2. Limited Acceptability: Explain what this means in the context of credit instruments. ## Lesson Proper ### What is Credit Instruments? * **Documents evidencing a credit obligation detailing debtor and creditor responsibilities** These instruments specify the amount owed, interest rates, and maturity dates. ### Features of credit instruments: 1. Evidence of debtor obligation or creditor claim. 2. Indicates risk associated with the collection of debt. 3. Reflects the debtor-creditor relationship. ### Functions of credit instruments: 1. **Enforceable claims:** Credit instruments provide legal documentation of the obligation owed, protecting both creditor and debtor. 2. **Facilitate exchange transactions:** They simplify and expedite transactions, like borrowing and lending, between individuals, businesses, and institutions. 3. **Minimize disputes:** By clearly outlining the terms of the agreement, credit instruments help to avoid misunderstandings and potential conflicts. 4. **Production and consumption:** Credit instruments contribute to economic activity by facilitating borrowing and lending. * **Corporations issue stocks and bonds for capital.** * **Consumers use book accounts, installment plans, and checks.** ### Types of Credit Instruments * **General Acceptability:** These instruments have a high level of acceptance across the economy. * **Credit money:** Generally accepted as a medium of exchange, such as bank notes or treasury certificates. * **Limited Acceptability:** These instruments have a more restricted use. * **Credit instruments for Investment Purposes:** Stock Certificate, Bond Certificates, Money Market Bills. * **Stock Certificates:** Represent ownership in a corporation * **Bond Certificates: Issued by government or corporations to raise capital.**