SBP uses both direct and indirect instruments to achieve monetary stability and ensure price stability through stable interest and foreign exchange rates. Direct instruments include interest rate controls and reserve requirements, while indirect instruments include open market operations using treasury bill and PIB auctions. SBP also intervenes in the foreign exchange market to maintain stability, ease speculative pressures, stabilize exchange rates, and fulfill policy objectives. It monitors commercial bank foreign exchange exposure using the foreign exchange exposure limit.

1. SBP Market Operations
And
Market Management
by,
Muhammad Arif
Senior Joint Director
Financial Markets Strategy & Conduct Department

2. 2
Functions of SBP
Like any other Central Bank, State Bank of Pakistan
has its roles and functions to perform.
State Bank of Pakistan Act 1956 requires the Bank
to "regulate the monetary and credit system of
Pakistan and to foster its growth in the best national
interest with a view to securing monetary stability
and fuller utilization of the country’s productive
resources".

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1st and foremost requirement for monetary stability is
ensuring price stability, which, in State Bank of
Pakistan, is achieved through stable Interest and
Foreign Exchange (forex) rates.
Stability in Interest rates and Forex Markets is
achieved through intervention in money market and
forex market, while nature of intervention varies in
both markets.
Functions of SBP Contd…

4. 4
Functions of SBP Contd…
To achieve desired interest rates, SBP uses
two types of instruments, namely:-
• Direct Instruments and
• Indirect Instruments

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Instruments of Monetary Policy
Direct Instruments:
These are direct controls on the financial prices
(interest rates) or quantities ( deposits or credits)
of financial institutions.
Indirect Instruments:
These influence the behaviour of financial
institutions by affecting initially the central bank's
own balance sheet or the pricing (interest rates) of
central bank facilities, and are used mainly in
liberalizing or liberalized financial systems.

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Direct Instruments
Direct instruments are typically directives given by
the central bank to control the quantity or price
(interest rate) of money deposited with
commercial banks (and sometimes other financial
institutions) and credit provided by them.
Examples of Direct Instruments are:
• Interest Rate Controls
• Credit Ceilings
• Directed Lending
• Statutory Liquidity Requirements

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Pros and Cons of Direct Instruments
• Advantages
• They are perceived to be
reliable, at least initially, in
controlling credit aggregates
or both the distribution and
the cost of credit.
• They are attractive to
government that wants to
channelize credit to meet
specific objectives.
• They may constitute the most
effective or practicable
approach in circumstances of
underdeveloped financial
markets or where the central
bank has inadequate
techniques of indirect
monetary control.
• Disadvantages
• Bank-by-bank controls hold
back competition in financial
markets which could benefit
both borrowers and
depositors.
• Selective credit controls-
credit controls on some
banks but not on favored
ones, distort markets and
impose a cost on society.
• Direct controls encourage
disintermediation into non-
controlled markets or abroad.
So, overtime, they become
less effective as lenders and
savers search for ways to
circumvent them.

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Reserve Requirements
Reserve requirements are the percentage of
commercial banks’ liabilities ( or some sub-set
thereof) which they are required to hold as reserves
at the central bank. An increase in reserve
requirements forces the banks to hold more
balances at the central bank.
Cash Reserve Requirement (CRR)
Under this requirement, banks are required to keep a
weekly average balance of 7% of their total demand
liabilities with the SBP, subject to daily minimum
balance of 6% of total demand liabilities.

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Statutory Liquidity Ratio
Commercial banks are required to keep some
fraction of their assets in the form of cash, Treasury
Bills (T-Bills) or other approved securities. This
fraction is called Statutory Liquidity Ratio. Its main
objective is to ensure that banks have sufficient
funds in the form of liquid assets. Currently this
ratio (excluding Cash Reserve Requirement) is
18% of time and demand liabilities.
Reserve Requirements contd…

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Indirect Instruments
SBP uses targeting monetary aggregates for its
monetary management function, So Indirect
instruments are used for controlling price or volume of
the supply of its own liabilities i.e. reserve money,
which in turn affects interest rates and the quantity of
money and credit in the whole banking system.
Examples of Indirect instruments are
• T-bill and PIB Auctions
• Open-Market Operations
• Discounting Facility
• Foreign Exchange Management

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T-Bill Auctions
• Treasury bills are sold through auction system
• The cut off yield is determined by the Auction
Committee, keeping in view monetary targets,
prevailing economic and financial conditions and
expected market response. The Six months’ T-bill is
considered the most important benchmark by the
money market and is considered to be the signaling
tool of SBP for interest rate movements.
• T-Bills are issued in 3, 6 and 12 months’ tenors.

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Procedure of Conducting Auctions
• Auction of MTBs are conducted on alternate
Wednesdays.
• Selected Financial institutions i.e. Primary
Dealers are allowed to access the auction.
• Two days prior to conducting of auction MTB
auction target is announced keeping in view,
Government borrowing position, SBP monetary
policy stance and money market situation.
• Two days prior to opening of bids a tender
Notice, inviting sealed bids in MTB auction, is
publicized in Newspapers and displayed on
Reuters.

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Procedure of Conducting Auctions
• Tender applications are dropped by the PDs in a
Tender Box upto 11.15 a.m. on Tuesday and
Wednesday. Sealed bids are opened on Wednesday
at 11.30 am.
• Computer generated detailed bid report is prepared.
After getting final decision from Committee a Press
Release of Auction Result, face value and discounted
value of amount offered and accepted along with
accepted cut-point and weighted average yields are
published.

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Pakistan Investment Bond (PIB) Auction
• PIB are issued in tenors of 3, 5, 10, 15, 20 and 30
years in auctions, according to the quarterly targets
given by MOF.
• PIBs are sold to meet the GOP long term
requirements and to provide benchmark rates to
the Capital Market Transactions.
• 15 days prior to the auction, targets are announced
on Reuters and sealed bids are invited.
• The 15 days period, i.e. from the day of
announcement to the auction day, is called short
selling period.
• Auction committee decides the cut-off yields.

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Open Market Operations (OMOs)
• Using computerized reporting system SBP monitors
the daily liquidity position of the market and on the
basis of those reports SBP either injects money to
the market by lending against collateral through
reverse repo transaction or by an outright
purchasing, or mops-up money from the market by
selling securities or by conducting repo transaction.
• OMOs are conducted on as and when market
desires. Is issued through Reuters and bids are
received through fax. Only banks are allowed to
participate in OMOs and T-Bill auctions.

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Discounting Facility (3-Day Repo)
• In Pakistan, SBP has extended a 3-day Repo facility
to scheduled and investment banks. This is an
overnight lending facility provided to banks, through
which SBP provides cash accommodation at a penal
rate (currently 10 %) to any needy bank by
undertaking a reverse repo transaction with it.
• Cash accommodation is normally for overnight,
however transaction period can be lengthened to 3-
days or more to cover occasional long week-ends.
• SBP also uses changes in discount rate primarily as
a way of signaling a change in monetary policy.

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Exchange Rate Management
In Pakistan, since 2000, free float regime
is in place i.e. Exchange Rate is
determined on supply/demand position of
the market.

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Factors requiring Ex. Rate
Management
• Appreciation / depreciation of rupee vs.US. $ in
interbank market
• Heavy Fluctuation in Forex market in interbank
• Market sentiments
• Heavy payment (Commercial and government)
• Unforeseen events

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Factors Affecting Exchange Rate
• Trade Activities (Imports & Exports)
• Foreign Investment (FDI)
• Home Remittances
• Market Saturation
• Political Factors

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Foreign Exchange Transactions
 Ready: settlement on the deal date: Pakistan
 Value Tom: Settlement on next day: Canada.
 Spot: Settlement usually in two working days:
International standard practice.
 Forward Settlement at some future date ahead of
the spot

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Foreign Exchange Transactions
Foreign Exchange Swaps
• Foreign exchange swaps involve the sale
purchase of foreign currency against domestic
currency with an agreement to reverse the
transaction at specified future date on mutually
agreed price.
• Sell/Buy Swaps are used to mop up surplus
Rupee liquidity from the market.
• Buy/Sell Swaps are used to inject Rupee liquidity
in the market.

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Foreign Exchange Transactions contd…
Forward Transactions
• Outright sale/purchase of a currency against
another, for settlement at a future date and at a
predetermined exchange rate.
• Forward rates are quoted as premium or
discount over spot rate and depend upon the
interest rate differential of the two currencies.
• Currency having higher interest rate is at
discount w.r.t. the currency with lower interest
rate similarly currency having lower interest
rate is at premium w.r.t. the currency with
higher interest rate.

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SBP’s Intervention in FX Market
SBP Intervenes
• To maintain stability in the Market
• To ease down market from speculative
pressures
• To Stabilize the Exchange Rate
• To fulfill Policy Objectives

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Foreign Exchange Exposure
• This is the possibility of a change in the share-
holders wealth of a bank arising from a
movement in the foreign exchange rate.
• There are three ways to calculate foreign
exchange exposure:
1. Net Open Position – Most liberalized method.
2. Summation of LONGS & SHORTS – Most
conservative method
3. Exposure Limit – Moderate Method

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Forex Exposure Limit (FEEL)
• SBP currently uses FEEL to monitor Forex
positions of commercial banks
• FEEL is calculated on higher of banks’
consolidated short or long positions as
maximum 15 % of their total paid-up capital.

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Other Forex Related Functions
Some other functions SBP performs in order to
better manage Forex market include:
• Off-Site Monitoring
• Daily Rates for Market
• Third Currency activity for GOP payments
• Reserve Management

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Thank You!