Open market operations are the main monetary policy instrument, through which the central bank buys or sells securities with financial institutions in the open markets, thereby influencing the amount of money in circulation and/or interest rates.
The Bank of Korea carries out open market operations mainly to steer the overnight call rate ― used in the adjustment of temporary surpluses or shortages of funds by financial institutions ― around the ‘Base Rate'. Along with this, the Bank can also maintain financial market stability by expanding its supply of liquidity to the markets through open market operations in times of financial turmoil.
These operations are conducted in three ways: through securities transactions, through the issuance and repurchase of Monetary Stabilization Bonds (MSBs), and through commercial banks’ deposits made in the Monetary Stabilization Account(MSA).
Securities transactions are employed to supply or withdraw liquidity in markets through the sale or purchase of bonds. When the Bank of Korea purchases bonds in the financial markets, liquidity (reserve money) is provided to the markets. When the Bank in contrast sells bonds, liquidity is absorbed from them. In order to limit credit risk involved and to retain the efficiency of open market operations, securities eligible for use in such transactions are confined to government bonds, government-guaranteed bonds, and securities specified by the Monetary Policy Board. Now the MSBs are only selected as an eligible bond by the MPB. In the wake of the Lehman Brothers' collapse in September 2008, MPB temporarily broadened* (from November 7, 2008 through November 6, 2009) the range of collateral eligible for open market operations in order to overcome the credit crunch.
* Debentures issued by banks and some special bonds (including those issued by Korea Land Corporation, Korea National Housing Corporation and the Small & Medium Business Corporation, and corporate bonds and mortgage-backed securities issued by Korea Housing Finance Corporation)
Meanwhile, there are two forms in securities transactions: outright transactions and RP (repurchase agreement) transactions. Outright transactions refer to operations where the central bank buys or sells eligible securities outright on the market. RP transactions are contracts under which the central bank sells (or buys) bonds with the condition that it will buy (or sell) them back after a specified period of time. Outright transactions are conducted only limitedly, since they are employed to provide or absorb liquidity permanently, and they therefore directly affect long-term market rates. For this reason, securities transactions focus mainly on RP transactions (mostly with 7-day maturities). Meanwhile, following the revision of the Bank of Korea Act in August 2011, the Bank can operate a securities lending and borrowing facility, which is enabling the Bank to not only enhance the efficiency of the liquidity management through flexible expansion of the volume of its RP sales, but also cope more effectively in the case of financial turmoil such as a credit crunch.
Monetary Stabilization Bonds, issued by the Bank of Korea, have relatively long maturities. They are thus used as a structural adjustment tool whose policy effects are long lasting.
Meanwhile, the Monetary Stabilization Account,utilized sinceOctober 2010, is a market-friendly term deposit facility. It is mainly used to fine-tune the reserve levels and to cope with unexpected changes in reserve supply and demand.