Excess liquidity management

Trade surpluses and growth in banks’ external funding can affect the level of local currency liquidity in the banking system through foreign exchange inflows and the Bank of Mongolia’s foreign exchange operations. However, these flows do not, by themselves, necessarily generate structural excess liquidity. The resulting liquidity position also depends on fiscal cash flows, the Bank of Mongolia’s foreign exchange interventions, open market operations, and other balance sheet factors. If excess reserves rise to a level that causes short-term interbank market rates to deviate from the policy rate target, they may weaken the monetary policy transmission mechanism. At the same time, delays in the availability of market data used to inform policy decisions constrain the timely assessment of the level, composition, concentration, and dynamics of excess liquidity in the banking system. Consequently, policy decisions may not adequately reflect prevailing market conditions in a timely manner, which could undermine the effectiveness of monetary policy implementation.

In line with the objective of enhancing monetary policy effectiveness under the Bank of Mongolia’s Medium-Term Strategy (2026–2030), the Bank of Mongolia aims to strengthen monetary policy transmission by further developing its policy instruments in accordance with international best practices, improving the management of excess liquidity in the interbank market. Specifically, information-sharing arrangements with institutions that influence the level of reserves in the interbank market will be streamlined, and an information system will be established to facilitate the timely collection, consolidation, and processing of data required for monetary policy decision-making. This will enable the prompt implementation of policy measures tailored to prevailing market conditions.

• Review and align the central bank’s policy instruments with international best practices and introduce the necessary reforms to enhance the effectiveness of monetary policy: Maintaining interbank market rates close to the policy rate, which serves as the operational target of monetary policy, is critical for improving policy implementation and strengthening the transmission of policy rate changes. Achieving this objective requires aligning the interest rates, maturities, frequencies, eligible counterparties, and collateral arrangements of central bank instruments with the operational target. In collaboration with international technical assistance experts, the Bank of Mongolia will assess its monetary policy toolkit and gradually introduce improvements to stabilize short-term market interest rates around the policy rate, support interbank market activity, and enhance the impact of monetary policy on the economy.
• Develop a system for ongoing, real-time monitoring and assessment of the level, composition, concentration, and dynamics of excess liquidity in the banking system: The system will incorporate daily short-term liquidity forecasts covering currency in circulation, Treasury Single Account flows, foreign exchange operations, seasonal patterns in payments and settlements, reserve requirement compliance, and banks’ demand for excess reserves. Forecast errors, structural shifts, and the concentration of reserves across banks will be analyzed regularly. These assessments will inform the choice of monetary policy operations and their size, maturity, and frequency. In particular, the Bank of Mongolia will progressively establish a data and analytical framework that enables the timely collection, integration, processing, and assessment of quantitative information on banking system liquidity, reserve movements, and the principal factors influencing reserve conditions.
• Utilize an optimal combination of instruments for managing excess reserves in the banking system: To absorb excess liquidity in the banking system while minimizing interest expenses and avoiding upward pressure on banks’ lending rates, a flexible combination of monetary policy instruments will be employed. In particular, reliance on short-term CBBs alone will be avoided by extending the maturity of securities and introducing a differentiated reserve requirement framework, whereby reserve requirement ratios vary according to the maturity structure of funding sources. In addition, excess liquidity and liquidity shortages will be managed through the use of an appropriate mix of policy instruments, including open market operations and standing facilities, in line with prevailing liquidity conditions in the banking system.

The implementation of these measures will enable the continuous, real-time monitoring of the level, composition, concentration, and dynamics of excess liquidity in the banking system, improve the accuracy of short-term liquidity projections, and facilitate the early identification of potential fluctuations and risks. Better liquidity forecasts will provide the information and analytical support needed to calibrate the size, maturity, and frequency of monetary policy operations to prevailing market conditions and to undertake timely fine-tuning operations when necessary.

This will strengthen the monetary policy transmission mechanism and help mitigate the risks of inflation, exchange rate volatility, and financial market fluctuations arising from excess reserves. As a result, the Bank of Mongolia will be able to utilize open market operations, standing lending facilities, and other policy instruments in a timely and data-driven manner, thereby more effectively achieving its primary objectives of maintaining inflation at the target level and safeguarding financial stability.