Rules vs currency speculation to reduce peso volatility — BSP

MANILA, Philippines — The Bangko Sentral ng Pilipinas expects the peso to be less volatile once the regulation against currency speculation takes effect.

According to BSP Governor Amando Tetangco Jr., the regulation that imposes higher capital charge on holdings by banks of non-deliverable forwards (NDFs), instruments meant for hedging but are believed to be used by banks for speculation, is expected to reduce speculative activities, thus trimming the peso’s volatility.

“…NDFs are being used by banks to exploit a view on the peso,” Tetangco said, adding that the higher capital charge, which would take effect in January 2012, would discourage purchase of NDFs beyond the need for hedging.

The BSP decided to impose a 15-percent capital adequacy ratio (CAR) requirement for NDFs held by banks. This new capitalization requirement for NDFs is higher than the 10 percent CAR for other risk-exposed assets of banks.

CAR is the amount of capital a bank must raise that is expressed in terms of percentage of the value of the risk-exposed assets.

NDFs, used for hedging, is an instrument that allows holders to buy a currency at a specified exchange rate and at a specified time in the future. This instrument is useful for businesses that regularly need foreign currencies, such as importers, as this helps shield them from losses resulting from exchange-rate volatility.

But while NDFs are meant for hedging, the central bank said the unusual rise in the volume of trading of NDFs over the past months indicated that these instruments have been used not solely for hedging but for currency speculation.

“NDFs have been rising but outright forward transactions have declined. This reinforces the view that there is more to NDF activity than just an intention to hedge,” Tetangco said.

Last September, the peso posted some depreciation after showing a general appreciating trend the previous months due to market reaction to the debt crisis in the Euro zone.

Although the central bank adopts a policy of allowing a market-determined exchange rate, the BSP has been intervening in the market to avoid even sharper volatility of the exchange rate.

But besides tempering volatility of the currency, Tetangco said, the regulation slapping higher capital charge on NDF holdings would help ensure stability of banks.

According to the BSP, NDFs expose banks to significant risk, and so an appropriate capital requirement should be imposed.

“In a sudden market reversal, such speculative activity especially if based on a largely one-way market view can be very de-stabilizing,” Tetangco said.