CENTRAL BANKING

Central Bank
- Government organization that is primarily responsible for the monetary affairs of a country.

Republic Act No. 265 - an act establishing the Central Bank of the Philippines, defining
its powers in the administration of the monetary and banking system, amending the
pertinent provisions of the administrative code with respect to the currency and the
bureau of banking, and for other purposes. It was established on June 15, 1948.

Goals of Central Bank:

- Maintaining low and stable inflation

- Low unemployment
- Rapid economic growth
- Stable exchange rate
- Coordination with fiscal policy

Bangko Sentral ng Pilipinas

- Established on July 3, 1993. Republic Act No. 7653, otherwise known as the New
Central Bank Act.
- Country’s independent central monetary authority.
- The BSP operates as an independent and accountable body that enjoys fiscal and
administrative autonomy, despite being a government corporation.

Functions of BSP

- Liquidity Management (monetary policy, money supply)

- Currency issue (guarantees Philippine peso as legal tender)
- Lender of last resort (extends loans, advances to commercial banks)
- Financial supervision (supervises banks and regulates firms with quasi-banking
functions)
- Management of foreign currency reserves (maintain sufficient international reserves
for stability)
- Determination of exchange rate policy (currently market oriented or floating exchange
rate)
- Other: Banker, Financial advisor, depository of Government agencies and GOCCs

BSP Monetary Board

- Exercises the powers and functions of the BSP, such as the conduct of monetary policy
and supervision of the financial system.
- The powers and functions of Bangko Sentral are exercised by its Monetary Board, which
has seven members appointed by the President of The Philippines. Under the New
Central Bank Act, one of the government sector members of the Monetary Board must
also be a member of the Cabinet designated by the President.
The BSP Monetary Board

Chairman

Benjamin E. Diokno - Former Secretary of Budget and Management

Members

1. Carlos G. Dominguez III - Secretary of Finance

2. Felipe M. Medalla - Former Secretary of NEDA
3. Peter B. Favila - Former Secretary of Trade and Industry
4. Antonio S. Abacan, Jr. - Former President of Metrobank
5. V. Bruce J. Tolentino - Former Deputy Director General of International Rice Research
6. Anita Linda R. Aquino - Former Board Member of the Philippine Deposit Insurance
Corporation

INTEREST RATE

- Interest rate is the price paid to borrow debt capital or in other words it is the cost of
Money.
- An interest rate is the percentage of principal charged by the lender for the use of its
money.
- It is being monitored by Bangko Sentral ng Pilipinas.
- It can speed up or slow down the economy.
● When interest rates are high, bank loans cost more. People and businesses
borrow less and save more. Demand falls and companies sell less. The economy
shrinks. If it goes too far, it could turn into a recession.
 ● When interest rates fall, the opposite happens. People and companies borrow
more, save less, and boost economic growth. But as good as this sounds, low-
interest rates can create inflation. Too much money chases too few goods.

"Interest Rate" can be defined in two ways:

1. Lending rate
- the fee charged for lending money.
- the range of interest (low to high) charged by financial institutions for lending
money. The lowest rate of interest that a financial institution, such as a bank,
charges is called the prime lending rate.
2. Borrowing rate
- the cost of borrowing money.

Other things that is being monitored by Bangko Sentral ng Pilipinas are:

1. Savings Deposit Rate

- interest rate that a bank pays depositors for the use of their money for the
period that the money is on deposit
2. Bank Average Lending Rate
- the weighted average interest rate* charged commercial banks on loans granted
during a given period.
3. Time Deposit Rate
- the interest rate that a financial institution pays depositors for interest-bearing
deposits with fixed-maturity dates as evidenced by a certificate of deposit.
4. Others

Such as Treasury bill (T-bill) Rate, Interbank Call Loan Rate, Overnight Lending
Facility (OLF) Rate, Overnight Deposit Facility (ODF) Rate, Philippine Interbank
Reference Rate (PHIREF), PHP BVAL Reference Rates, BSP Bills Rate, Term Deposit
Facility (TDF) Rate, and Overnight Reverse Repurchase (RRP) Rate.

Two main types of interest can be applied to loans are:

1. Simple interest
- is a set rate on the principle originally lent to the borrower that the borrower
has to pay for the ability to use the money.

Simple interest is calculated only on the principal amount of an investment. The

following formula can be used to find out the simple interest:

I = P×r×t

Where: I = amount of

interest P =

principal amount
 r = annual interest

rate t = time in

years.

2. Compound interest
- is interest on both the principle and the compounding interest paid on that loan.
- this is the most common type of interest.

Compound Interest is calculated on the principal amount and also on the interest
of previous periods. The following formula can be used to find out the compound
interest:

A = P×(1 + r/n)^nt

Where: A = final amount including

interest P = principal amount

r = annual interest rate (as

decimal) n = number of

compounds per year t = number

of years.

How are Interest Rates determined?

● Market rates are generally determined by supply and demand in the money market.
● Market-oriented Interest Rate Policy: determined by the interaction of the supply
and demand.
● Under Special Circumstances: BSP can impose interest rates as warranted
under extraordinary economic and social conditions or crises.
● BSP only sets overnight rates, including the RRP rate, also known as key policy rate -
the interest rate which the BSP borrows from the banks to maintain price stability.

Why does the BSP allow the market to determine interest rates?
● The re-imposition of rate ceilings or limits may lead to distortions in the credit market.
● Banks may be discouraged to lend as interest rate ceilings imposed by the BSP may
not be enough to cover banks costs and risks.
● This may lead to limited loan products, stricter requirements and lesser loan approvals.
● Demand for rate ceilings may spread to other financial products such as micro finance
and consumer loans.
Factors That Influence The Rise And Fall Of Interest Rates

1. Inflation Rate - annual percentage increase in the average price of the standard
basket of goods and services consumed by a typical Filipino family for a given period.

High Inflation ➞ Low Value of Money ➞ High Lending Rate

Lenders will demand higher interest rates as compensation for the

decrease in purchasing power of the money they are paid in the
future.

2. Fiscal Policy Stance - how the government’s level of spending and taxation
impact aggregate demand and economic growth.

High Fiscal Deficit ➞ High Demand for Loans ➞High Lending Rate

When the government spends a lot more than it collects (fiscal deficit),
there will be a strong demand to borrow (demand for loans) to finance
the gap in the budget and this will result in upward pressure on
domestic interest rates (lending rate), particularly if the government
borrows from a relatively less liquid domestic market.

3. Other Factors
● Maturity Period of the Financial Instrument - those with long-term
maturity carry higher interest rates.
● Perception of Risks associated with the instrument - the higher
probability of incurring loss, the higher interest rates.
● Non-Performing Assets (NPAs) - banks with larger holdings of non-
performing assets are more cautious in their lending activities, and this will
likely increase the interest rates.

How Interest Rates Affect Spending: The Impact Of High Versus Low Interest Rates

➢ High Interest Rates can Slow Down the Economy

High ⬈ Low Spending ➡ Low Sales

Lending ⬇ ⬇
Rate ⬊ High Savings Low Productivity
 ● As the cost of borrowing in the banks increases, the consumer’s spending will
decrease. Increase in interest rate also encourages people to save.
● As the spending of consumers decreases, the sales will also decrease which
leads to the drop in the production of goods and other things offered to be
consumed.
● In conclusion, when there is less money circulation, the economy slows down.

➢ Low Interest Rates can Boost the Economy

Low ⬈ High Spending ➡ High Sales

Lending ⬇ ⬇
Rate ⬊ Low Savings High Productivity

● As the cost of borrowing in the banks decreases, the consumer’s spending

will increase and people will likely save less.
● As the spending of consumers increases, the sales will also increase which
leads to the high production of goods and other things offered to be
consumed.
● In conclusion, when there is more money circulation, there is a boost in
economic growth.

If Low Interest Rates Provide So Many Benefits, Why Aren’t They Kept Low All
The Time?
● Having very low interest rates for a long time can cause INFLATION.
The demand outstrips supply and prices rise when there is too much liquidity.
● A prolonged period of low interest rates encourages financial institutions to lend
more to business and households despite potential risks. This poses threats to
financial stability.

BSP’s role
The BSP’s key policy rate influences market interest rates.
● The BSP can either increase or decrease its key policy rate. This gives the market a
signal on the general level of interest rates.
● In mirroring the movement of the BSP’s key policy rate, the benchmark 91-day T-bill
rate also sets the direction for other rates, specifically, bank lending rates.
● Condition: Above-target inflation forecast or rising inflationary pressures due to
excess domestic liquidity.
BSP Action: BSP increases its key policy rate.
 Effects:
- ↑% Banks are encouraged to deposit in the BSP.
- ↑% Bank lending rates increase
- ↓ Less businesses and households borrow.
- ↓ Inflationary pressure ease
● Condition: Below-target inflation forecast or a need to increase liquidity in the
financial system.
BSP Action: BSP decreases its key policy rates.
Effects:
- ↓% Bank lessens their deposits in the BSP.
- ↓% Bank lending rates decrease.
- ↑ More businesses and households borrow.
- ↑ Economic activity is stimulated.
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