Appendix I. Selected Figures
Appendix II. Chronology of Key Measures Taken by Central Banks
Asset Backed Security
Bank of Canada
Bank of England
Bank of Japan
Collateralized Mortgage Obligation
European Banking Federation
European Central Bank
Federal Home Loan Bank
Federal Reserve Bank of New York
Long-term refinancing operation
Ministry of Finance
Main refinancing operations
Open market operations (a transaction undertaken at the initiative of the central bank)
Primary Dealer Credit Facility
Purchase and resale agreement
Reserve Bank of Australia
Reserve Bank of New Zealand
Residential Mortgage Backed Security
Reserve maintenance period
Standing facility (a transaction available at the initiative of a commercial bank)
Structured investment vehicle
Securities Lending Facility
Swiss National Bank
Term Auction Facility
Term Securities Lending Facility
Baba, Naohiko, Frank Packer, and Teppei Nagano T. 2008, “The Spillover of Money Market Turbulence to FX Swp and Cross-Currency Swap Markets.” Bank for International Settlements Quarterly Review (March).
Bagehot, Walter, 1873, Lombard Street.
Chailloux, Alexandre, Simon Gray, and Rebecca McCaughrin, 2008 “Central Bank Collateral Frameworks: Principles and Policies,” IMF Working Paper 08/XXX (Washington: International Monetary Fund) (forthcoming).
Committee of the Global Financial System, “Central Bank Operations in Response to the Financial Turmoil,” CGFS Paper, No. 31. http://www.bis.org/publ/cgfs31.htm
Flannery, Mark J., 1996, “Financial Crisis, Payment System Problems, and Discount Window Lending,” Journal of Money, Credit and Banking, Vol. 28, No. 4 (November, Part 2).
Goodhart, Charles, and Gerhard Illing, 2002, “Financial Crises, Contagion, and the Lender of Last Resort, a Reader,” Economic Notes, Vol. 32, Issue 3.
Jacome, Luis, Kotaro Ishi, and Peter Stella, “Legal Constraints to Making Central Bank Operational Frameworks More Flexible,” IMF Working Paper 08/XXX (Washington: International Monetary Fund) (forthcoming).
Lönnberg, Ake, and Peter Stella, 2008, “Issues in Central Bank Finance and Independence,” IMF Working Paper 08/37 (Washington: International Monetary Fund).
McAndrews, James, Asani Sarkar, and Zhenyu Wang, 2008, “The Effect of the Term Auction Facility on the London Inter-bank Offered Rate,” Federal Reserve Bank of New York Staff Report No. 335 (July).
Taylor, John B., and John C. Williams, 2008, “A Black Swan in the Money Market,” Federal Reserve Bank of San Francisco Working Paper (April).
Other than during the first few days of the market turmoil in August 2007.
Most major central banks target the very short-term unsecured interbank rate (measured e.g., by the weightedaverage of actual overnight interbank trades, or by the BBA Libor quotations); but they may operate in the wider money markets to achieve this e.g., the Fed’s repo operations with nonbank Primary Dealers.
The Swiss National Bank practice of targeting the 3 month interbank rate, while operating predominantly through short-term repo, arguably worked very well in these circumstances. Some central banks indicated that the increase in term rates reduced or eliminated the monetary policy need to tighten (short-term) policy rates.
The United Kingdom and Australia are clear exceptions to this generalization. In the United Kingdom, the ceilings for voluntary remunerated contractual reserves were increased in May 2008 (in practice the ceilings are rarely restrictive; the previous ceilings had permitted a large increase in voluntary reserve holdings from September 2007).
The UK practice of operating a range around a central (voluntary) reserves target adds flexibility; and this flexibility can be further increased by widening the range (as was done in the UK).
In some circumstances the central bank might need to simplify the minimum access requirements.
Averaging means that, within the reserves maintenance period, banks can be relatively indifferent between funds today and funds tomorrow. If there is an end-of-day constraint, T+0 rather than T+1 may make a significant difference.
Evaluating several hundred bids against different collateral pools and at varying market prices (the tranching approach) would be a much more complex process than, say, ranking the same number of bids by the interest rate bid against a single collateral pool. Moreover, the back-office task of dealing with several hundred transactions for same-day settlement would be more onerous than dealing with up to 20.
Gresham’s law is commonly stated: “Bad money drives out good,” that is, when there is a legally determined rate of exchange between two currencies which does not equal the market determined relative values, agents will present the currency less valued by the market (bad money) when making official payments.
The issue of central bank collateral frameworks is discussed more extensively in Chailloux, Gray, and McCaughrin, forthcoming IMF Working Paper, “Central Bank Collateral Framework: Principles and Policies.”
While in principle a Ministry of Finance will normally recapitalize a central bank if need be, in practice this can take a long time—in some cases decades; and the impairment of the central bank’s balance sheet clearly inhibits the implementation of policy in some countries. See Lönnberg and Stella (2008).
The administrative costs of utilizing nonsecuritized collateral can be a significant factor in this.
There is an analogy with the benefits of Gresham’s law in a bimetallic standard. An upward shock to gold prices in a gold standard regime would lead to deflationary pressures as the only way for the value of the numeraire to rise is for prices to fall. The alternative use of silver dollars as numeraire allows prices to remain stable mitigating deflationary pressures. Naturally, gold would be hoarded or traded at a premium to the official gold/silver fixing and over time a shortage of silver dollars as means of payment might require monetary policy action. If the government continued to make payments in gold and receive revenues in silver at the parity, hidden deficits would arise and eventuality the parity would have to be changed.
The Eurosystem comprises the ECB itself, plus the National Central Banks of euro area member countries.
In some cases the use of an appropriate haircut may have an impact on the type of collateral offered; but this is unlikely to be substantial where a very wide definition of collateral is accepted. If a bank can effectively pledge its loan book to the central bank, it is unlikely to face a collateral constraint. But with a narrower collateral definition, or if the administrative costs of using less liquid collateral are passed on to the borrower, the ability of or incentives for banks to provide lower quality assets may be reduced.
The ECB falls into this case. However, while it does not set counterparty or collateral limits, in practice it may find that no one counterparty accounts for a substantial part of its lending (because it operates with several hundred counterparties), whereas central banks operating with 10-20 counterparties would have to be more concerned about such limits.
The bulk of required reserves are met by holdings of vault cash.
In a reserve averaging system, if a bank overfulfills its reserve requirement before the end of the maintenance period, then, since it cannot hold negative balances and the excess reserves are not remunerated, they cause an opportunity loss. The excess is sometimes referred to as “burnt” reserves.
In the United Kingdom the band was widened to +/-37.5 percent for the reserve maintenance period (RMP) ending in September 2007, to +/-60 percent for the RMP ending in October, and subsequently reduced to +/-30 percent for the RMPs ending in November, December, and January 2008.
Independently from emergency liquidity support operations, a money market network in which only few nodes are directly connected to the central bank might expose banks relying on intermediation through counterparties to funding risks.
The use of pre-pledging of collateral allows some of the administrative work to be undertaken well in advance of OMO.
Participation was typically 60-90 banks, three to five times the number of Primary Dealers.
Interestingly, the SNB auctions are open to all Swiss and nonresident banks which are eligible to participate in its main financing and fine-tuning operations.
For detailed analysis of the impact of the TAF, see “A Black Swan in the Money Market,” Taylor and Williams (2008); and “The Effect of the Term Auction Facility on the London Interbank Offered Rate,” McAndrews, Sarkar and Wang (2008).
Mostly using regular OMO in the form of repos, mature market central banks typically aim to provide the market with a certain amount of short-term funding at or close to the target policy rate. Longer-term OMO are conducted at market/bid rates. For the Fed, these are mostly in the form of outright purchases of long-term securities. The ECB provides 3 month repos; the BoE provides 3, 6, 9, and 12 month repos as well as outright purchases of longer-term securities. All three also make available a credit standing facility: overnight funds (normally) at 100bp above the policy rate. Pricing is set to make the facility expensive but usable. However, in some countries there is a reluctance to use the standing facility because of a perceived stigma attached, despite central bank statements that this should not be the case (in theory, the market should not know who has used a standing facility, but in practice it can become known).
The breadth and nature of the collateral pool has been strongly influenced by lessons from the episodes of financial fragility in the 1990s.
The BoE accepted in its September and October 2007 facilities to Northern Rock collateral which fell outside its usual definition. This in itself is not uncommon (though a few central banks pre-define what collateral is acceptable in lender-of-last-resort (LOLR) operations). Under the Tripartite MoU with HM Treasury and the Financial Services Authority, Treasury authorization was required before this lending could be undertaken.
The 6, 9, and 12 month auctions on the same date, against the normal collateral pool, settled at rates below the prevailing Bank Rate.
The BBA Libor quotes are for rates prime banks would expect to pay for borrowing in reasonable size; for other banks or very large amounts, rates will of course vary.
Jacome, Ishi, and Stella, “Legal Constraints to Making Central Bank Operational Frameworks More Flexible,” IMF Working Paper forthcoming presents a worldwide survey of this issue.
In its statement on December 6, 2007, the RBA stated “Over the past decade, the Reserve Bank has gradually widened the range of securities which it is prepared to accept under repurchase agreements, to take account of the changing structure of financial markets. … As a continuation of this trend, and after reviewing the range of international practice by other central banks, the Reserve Bank has decided to further widen the range of securities eligible for its repo operations.”
There has been a long-term trend in some markets towards secured transactions; the current turmoil may have accelerated that trend. It is not clear whether this acceleration is likely to be reversed.
The Fed’s TSLF and the BoE’s SLS.
An increase in unremunerated reserves might be expected to alter banks’ behavior. But if reserves are remunerated at or close to market rates, the opportunity cost to banks is small, and any negative impact on their behavior should also be small.
The U.K. government is considering, via consultation, whether to remove the requirement for the BoE to release weekly data returns detailing its summary balance sheet, to facilitate the provision of appropriate liquidity assistance.
Some swaps business continues, of course. In some cases, banks may have borrowed term funds from central banks (instead of the interbank market) and swapped into the target currency to obtain a pricing arbitrage. Uncollateralized interbank funding may be more efficient, but collateralized central bank funding is a useful second-best. See BIS Quarterly (2008), Baba, Packer, and Nagano.
As discussed elsewhere, in some countries it was necessary to increase the number of direct links (counterparties) to accomplish this.
An increase in cover at the Eurosystem’s TAF auctions in July-August 2008 may indicate a growing demand for USD from this source; but may also reflect the fixed-interest nature of the auction. If a bank wants a higher share of the amount on offer, it cannot bid a higher price (as it can in other ECB OMO), but may over-bid in the expectation that all bids will be pro-rated.
The SLS stipulates that any securities used must have been on a bank’s balance sheet before end-2007 or eligible securities formed from loans held on balance sheet as at December 31, 2007.
Both the FRBNY and the BoE should make a small profit from “selling liquidity” to the market.
On July 30, 2008 the Fed announced an extension to end January 2009, or as long as conditions in the market remain “unusual and exigent.”
Not all the new assets provided are securitized.
In fact, the U.S. Discount Window Rate is fixed by reference to the Fed funds target rate, but not by reference to the Fed’s OMO transactions; the latter can vary, at times substantially, from the target rate.
And even observing market prices accurately might become difficult in times of market stress.
In normal market conditions, even market counterparties pay relatively little attention to the philosophy of the monetary operations framework.
This is indeed observed among Asian central banks, e.g., the Chiang Mai initiatives; and more recently in regard to Iceland.