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Central Bank of Brazil

The Central Bank of Brazil (BCB) has two main functions in the foreign exchange market: regulator and intervener. As a regulator, it establishes operational rules. As an intervener, it acts in the market to manage the stability of the system.

Role as Regulator and Supervisor

The BCB's regulatory function aims to create an orderly and transparent market environment:

  • Authorization and Supervision: The BCB is the entity that authorizes and supervises the institutions operating in the foreign exchange market (banks, brokers, etc.). A BCB license is mandatory for commercial activity in this market, and institutions are subject to its ongoing supervision.

  • Rule Definition: The BCB defines how operations should be processed and recorded. This includes customer identification requirements (KYC - Know Your Customer) and procedures to prevent illicit activities, such as money laundering and terrorist financing (AML/CFT).

  • Foreign Exchange Legal Framework: The sector's regulation is guided by Law No. 14,286/2021. Its objectives include simplifying operations, reducing bureaucracy, and aligning with international practices - this section will be elaborated in later topics.

Role as Intervener

Brazil adopts a floating exchange rate regime, but the BCB reserves the right to intervene in the market. The stated objective of BCB intervention is not to fix the exchange rate at a predetermined level. The actions aim to:

  • Control excessive price volatility.
  • Provide liquidity (currency supply) to the market during abnormal periods.

Interestingly, the BCB uses the same hedge tools that we will introduce in the Foreign Exchange Risk section to achieve the two objectives above.

Interpretation of BCB Actions

The interpretation of the BCB's intentions is a topic of debate in the market:

  • The Functional View (Official): The official position of the Central Bank is that interventions are technical in nature and aim to correct market dysfunctions, such as lack of liquidity or price movements unrelated to economic fundamentals.

  • The "Managed Exchange Rate" Interpretation: Frequent interventions to contain the appreciation of the Real may be interpreted by some market agents as a policy that favors exporters by keeping the exchange rate at higher levels.

  • Difference in Capital Controls: It is necessary to distinguish daily interventions from formal capital controls. Measures such as IOF taxation on capital flows, used in the past, are designed to manage the volume of capital entering or leaving the country, being a more direct form of control.

Conclusion

In summary, the Central Bank acts as regulator and supervisor of the foreign exchange market, while also using intervention instruments to manage liquidity and volatility. Its official mandate is to maintain the stability and functionality of the financial system.