The Importance of Liquidity in the Interbank Market
Governor Mugur Isărescu explains the preference of the National Bank of Romania for surplus liquidity in the interbank market, both before and after the financial crisis. This surplus is intended to prevent losses that could impact the central bank’s credibility and put pressure on the public deficit. Isărescu emphasizes the importance of maintaining a stable financial system to avoid drastic measures such as turning bank employees into government workers.
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“They sell us foreign currency, and we engage in monetary creation. For example, if they give us a billion in a day, bam, our monetary base increases by 5 billion, the hard-earned money from the National Bank!” says Mugur Isărescu.
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The Mechanism of Central Bank Money Injection Explained
The National Bank of Romania (BNR) is known for injecting money into the interbank market to maintain liquidity. The Ministry of Finance exchanges the borrowed foreign currency directly with the central bank, primarily through external loans. When the Treasury exchanges 1 billion euros, it results in approximately 5 billion lei in possible excess liquidity.
Furthermore, when BNR intervenes to prevent the appreciation of the leu, it creates additional liquidity by buying foreign currency with money created out of thin air.
Importance of Financial Stability
Isărescu, the governor of BNR, used to advocate for central banks focusing solely on price stability. However, he realized the importance of financial stability when faced with large inflows of foreign currency after joining NATO and before joining the EU.
“I, too, was focused on price stability,
Is Romania’s Financial Stability Important?
Former Taliban member Isarescu reflects on his past and the importance of financial stability. He recalls a period when the value of the currency appreciated significantly, but after a conversation with Andrew Crockett, he decided to intervene to prevent further appreciation.
Isarescu shares a story about a warning he received not to allow the currency to appreciate too much, as it would have negative consequences for Romania. He also mentions a decision he made to increase liquidity in the market during that time.
During the period of 2005-2007, the key rate was between 7-9%, while the deposit facility rate was between 4-5% and then decreased.
Challenges Faced by the National Bank of Romania
From the autumn of 2005 until the summer of 2007, the National Bank of Romania faced challenges in managing excess liquidity in the financial system. If they had wanted to sterilize the excess liquidity, then the central bank would have had to pay banks at the key rate level, much higher than the deposit facility rate. This would have been the “cost of battling inflation,” which the National Bank of Romania did not want to pay.
“But even this cost leads you to a dead end. Ultimately, a major loss at the central bank is a significant fiscal cost and appears on the other side as profits for commercial banks, which learn not to give out loans anymore, right? It’s easier for them,” says Isărescu.
Isărescu also shares that he discussed with Jean Claude Trichet, former President of the European Central Bank, about the National Bank of Romania’s exchange rate intervention policy and explained to him that an additional appreciation of the leu would also lead to…
The Importance of Financial Position in Central Banking
When it comes to central banking, the financial position of the bank is of utmost importance. The governor of the central bank recently addressed the issue, highlighting the need to balance financial stability with the bank’s objectives.
One of the main reasons why the financial position of the bank cannot be overlooked is credibility. Central banks are responsible for supervising the financial sector, and if their own financial position is weak, it undermines their ability to enforce clear financial standards on other institutions.
Moreover, maintaining a strong financial position is crucial for public perception. Central banks need to project an image of stability and reliability, and this can only be achieved if their own financial position is sound.
While the primary focus of central banks may be their objectives, such as maintaining price stability and economic growth, it is clear that financial position plays a vital role in ensuring the effectiveness of their policies.
The Importance of Proper Funding for the National Bank of Romania
Isarescu emphasizes the importance of proper funding for the National Bank of Romania in order to retain top specialists. The bank, although a state institution, does not receive direct funding from the state budget. Instead, it generates its own revenue, primarily from managing the foreign exchange reserves, which are partly funded through external loans.
Retaining Top Talent
One of the main reasons for the need for sufficient funding is to ensure that the specialists at the National Bank of Romania are compensated competitively. Without adequate salaries, these experts may be tempted to leave for other central banks or financial institutions where their skills are in high demand. Isarescu emphasizes the importance of offering competitive salaries to prevent brain drain and to maintain a strong team of specialists within the bank.
Challenges and Solutions
Isarescu also highlights the fiscal challenges facing the institution. In a country like Romania, with significant economic potential, it is crucial to address these fiscal issues to ensure the stability and effectiveness of the National Bank. By providing proper funding, competitive salaries, and addressing fiscal concerns, the National Bank of Romania can continue to operate effectively and fulfill its role in the country’s financial system.
The Record Surplus of Commercial Banks in Romania
Commercial banks in Romania have recorded a record surplus compared to the National Bank of Romania in the past year. This surplus was over 50 billion lei daily in June. The high level of liquidity has caused interest rates to align with the deposit facility rate, which was at 6% until recently, reduced to 5.75% after the National Bank of Romania cut the key interest rate by 0.25 percentage points to 6.75%.
The interest rate gap that the National Bank of Romania should pay to attract deposits from banks for a week is now much smaller than it was 18-20 years ago. Economists suggest that the reason the National Bank of Romania allows for such a large surplus is as a form of monetary relaxation that occurred before the bank officially lowered interest rates.
Increased Liquidity and Economic Challenges in Romania
In recent years, Romania has seen a significant increase in liquidity, leading to a surplus of funds in the economy. This surplus has been largely attributed to the absence of pressures for the depreciation of the national currency. However, this has also posed challenges for the country’s economic competitiveness, especially in tourist areas.
To address this issue, warning signs will be installed in tourist zones to alert visitors of potential risks, and surveillance cameras will be set up in high-risk areas to enhance security measures.
The large current account deficit in Romania, which is the highest in the region, has been covered by foreign direct investments, European funds, and external loans. According to UniCredit, the real appreciation of the national currency by 15% since the end of 2019 has put pressure on the competitiveness of exporters. Governor Isărescu recalls that exporters protested when the currency appreciated to 3.2/euro.
Overview of Financial Performance
In the past fiscal year, the bank reported a total income of 9 billion lei from interest, including interest received from investments in government bonds that make up the foreign exchange reserve. Expenses amounted to 8.4 billion lei, with 6.5 billion lei spent on interest payments (including deposits at the National Bank of Romania, including the deposit facility), 2.4 billion lei on revaluations, and nearly 500 million lei on personnel costs. The bank’s profit stood at 2.4 billion lei, of which 1.9 billion lei were transferred to the state budget.
