Appendix I. Overview of Systemic and Idiosyncratic Responses to the Global Financial Crisis in the Three Major Central Banks
When the GFC broke, three major CBs (the U.S. Federal Reserve, the ECB, and the BOE) responded by increasing the supply of reserve money to meet a liquidity need—and only later on by cutting their policy rates (in many cases close to the zero lower bound) in response to monetary policy needs. They adopted a series of unconventional monetary policy actions in response to systemic and idiosyncratic liquidity needs.
Appendix II. Designing a Framework
Appendix III. Collateral and Risk Control Measures
Appendix IV. Minimizing Stigma—The Case of Open Market Operations
Stigma concerns could potentially be reduced, where a number of banks are stressed, by providing liquidity via an OMO.130 This could involve expanding the collateral accepted in the monetary policy framework and satisfy the liquidity need through—in some instances longer term—OMOs, and using an interest rate higher than the policy target.131 This is somewhat related to the Goodfriend and King (1998) view mentioned earlier, but there is one importance difference, as in this instance the CB does not rely on the liquidity being distributed to ‘concerned’ banks, instead it is more likely that the required reserves provided will be bid for (only) by the institution(s) in need. In addition, it could be argued that its announcement could help with market confidence. Similar approaches (sometimes pre-emptive) were adopted during the GFC by the Reserve Bank of New Zealand, the Reserve Bank of Australia and, to a certain extent, the ECB.132 In many countries, even if counterparties have suitable monetary policy eligible collateral, there is at least an internal stigma associated with accessing standing facilities, as the performance of bank treasurers is sometimes measured on their usage of these facilities.133 The provision of (possibly longer term) OMOs against collateral that is normally reserved for standing facilities (if there is a separate collateral list) could mitigate this constraint.134
Careful consideration needs to be given to the design of any market-wide operation. Paul Tucker in BIS (2014) outlines that such solutions need constant innovation: if it is suspected that these facilities are being used to assist illiquid institutions, there is a risk that “sound” institutions may publically declare their intention not to use these facilities in the future. In the euro zone, a number of so-called “stronger” banks publically declared that they had repaid their three-year LTRO borrowings, implying that it was only ‘stressed’ institutions that remained in these operations. Any perceived stigma could potentially be managed through the use of moral suasion by the CB, as was used recently by the BOE.135
The use of OMOs to meet market-wide needs during the GFC helped to reduce stigma over accessing CB liquidity. Announcing clear eligibility criteria and intended goals of the systemic operations, disclosure of access only with an appropriate time lag, and the non-applicability of increased supervisory intrusion and conditionality, also provided the banking system with more comfort in terms of access. But by the same token, removing stigma from liquidity provided via OMO must increase the risk of stigma for bilateral LOLR.
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Bagehot, W., 1873, Lombard Street: A Description of the Money Market. E. Johnstone; Hartley Withers, eds. 1873. Library of Economics and Liberty. June 25, 2014, www.econlib.org/library/Bagehot/bagLom7.html.
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BCBS, 2013a, “Global Systemically Important Banks: Updated Assessment Methodology and the Higher Loss Absorbency Requirement”, Basel Committee on Banking Supervision.
BCBS, 2013b, “Liquidity Stress Testing: a Survey of Theory, Empirics and Current Industry and Supervisory Practices”, Basel Committee on Banking Supervision.
Begalle, B., A. Martin, J. McAndrews, and S. McLaughlin, 2013, “The Risk of Fire Sales in the Tri-Party Repo Market”, Federal Reserve Bank of New York, Staff Report No. 616.
Bindseil, U., and F. Papadia, 2009, “Risk Management and Market Impact of Central Bank Operations”, Risk Management for Central Banks and Other Public Investors, Cambridge University Press.
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Brealey, R., A. Clark, J. Healey, G. Hoggarth, D.T. Llewwllyn, C. Shu, P. Sinclair, and F. Soussa, 2001, “Financial Stability and Central Banks A Global Perspective”, Central Bank Governors’ Symposium Series, Bank of England.
Buiter, W., A.C. Sibert, 2007, “The Central Bank as the Market Maker of last Resort: From lender of last resort to market maker of last resort”, www.voxeu.org.
Bulir, A., M. Cihak, and D-J. Jansen, 2014, “Does the Clarity of Inflation Reports Affect Volatility in Financial Markets?”, IMF Working Paper No. WP/14/175.
Calomiris, C., and U. Khan, 2015 “An Assessment of TARP Assistance to Financial Institutions, Journal of Economic Perspectives, Volume 29, Number 2.
Campbell, A., and R. Lastra, 2009, “Revisiting the Lender of Last Resort”, Banking & Finance Law Review 2008-2009, Thomson Reuters Canada.
CGFS, 2013, “Asset Encumbrance, Financial Reform and the Demand for Collateral Assets”, Bank for International Settlements, Paper No. 49.
CPSS-IOSCO, 2012, “Principles for Financial Market Infrastructures”, Bank for International Settlements and International Organization of Securities Commissions, April.
Dudley, B., 2013, “Fixing Wholesale Funding to Build a More Stable Financial System”, Remarks at the New York Bankers Association’s 2013 Annual Meeting & Economic Forum, The Waldorf Astoria, New York City.
Del Mar Cacha, M., and R. A. Morales, 2003, “The Role of Supervisory Tools in Addressing Bank Borrowers’ Currency Mismatches”, IMF Working Paper No. WP/03/219.
Financial Stability Board, 2011, “The Key Attributes of Effective Resolution Regimes for Financial Institutions”, updated October 2014, Financial Stability Board.
Financial Stability Board, 2012, “OTC Derivatives Market Reforms: Third Progress Report on Implementation”, Financial Stability Board.
Financial Stability Board, 2014, “Guidance on Supervisory Interaction with Financial Institutions on Risk Culture - A Framework for Assessing Risk Culture”, April 7, 2014.
Freixas, X., C. Giannini, G. Hoggarth, and F. Soussa, 2000, “Lender of Last Resort: What Have We Learned Since Bagehot?”, Journal of Financial Services Research.
Fontaine, J.S., J. Selody, and C. Wilkins, 2009, “Improving the Resilience of Core Funding Markets”, Financial System Review, Bank of Canada, December.
Goodfriend, M., and R.G. King, 1988, “Financial Deregulation, Monetary Policy, and Central Banking”, Federal Reserve Bank of Richmond, Working Paper No. 88–1.
Goodhart, C.A.E., 1999, “Myths about the Lender of Last Resort”, Financial Markets Group, London School of Economics, Special Paper 120.
Hoggarth, G., J. Reidhill, P. Sinclair, 2004, “On the Resolution of Banking Crises: Theory and Evidence”, Bank of England, Working Paper no. 229.
Humphrey, T.M., 1975, “The Classical Concept of the Lender of Last Resort”, FRB Richmond Economic Review, Vol. 61, January/February 1975, pp. 2–9.
Humphrey, T.M., 1989, “Lender of Last Resort: The Concept in History”, FRB Richmond Economic Review, March/April 1989, pp. 8–16.
IMF, 2011, “Sweden: Financial Sector Assessment Program Update—Technical Note on Contingency Planning, Crisis Management and Bank Resolution”, IMF Country Report No. 11/287.
IMF, 2013, “European Union: Publication of Financial Sector Assessment Program Documentation—Technical Note on Deposit Insurance”, IMF Country Report No. 13/66.
IMF, 2014, “Austria: Publication of Financial Sector Assessment Program Documentation—Technical Note on Crisis Preparedness and Management Framework”, IMF Country Report No. 14/15.
IMF, 2015, “Assessing Reserve Adequacy—Specific Proposals”, April, http://www.imf.org/external/np/pp/eng/2014/121914.pdf.
Kohn, D.L., 2009, “Policy Challenges for the Federal Reserve”, Speech at the Kellogg Distinguished Lecture Series, Kellogg School of Management, Illinois.
Laidler, D., 2002, “Two Views of the Lender of Last Resort: Thornton and Bagehot”, University of Western Ontario, Research Report No 36.
Lavoie, S., A. Sebastian, and V. Traclet, 2011, “Lessons from the Use of Extraordinary Central Bank Liquidity Facilities”, Bank of Canada Spring Review.
Moe, T.G., 2012, “Shadow Banking and the Limits of Central Bank Liquidity Support: How to Achieve a Better Balance between Global and Official Liquidity”, Levy Economics Institute, Working Paper No 712.
Nakaso, H., 2013, “Financial Crises and Central Banks’ ‘Lender of Last Resort’ function”, Remarks at Executive Forum, World Bank, Washington DC, and April 22, 2013.
Nyberg L., 2010, “The Infrastructure of Emergency Liquidity Assistance - What is Required in Today’s Financial System?” Speech at the CGFS regional meeting in Tokyo, Bank of Japan, www.bis.org.
Plenderleith, I., 2012, “Review of the Bank of England’s Provision of Emergency Liquidity Assistance in 2008-09”, Presented to the Court of the Bank of England, www.bankofengland.co.uk.
Psaroudakis, G., 2012, “State Aids, Central Banks and the Financial Crisis”, European Company and Financial Law Review, Volume 9, Issue 2 (Jul 2012).
Reinhart, C., and K. Rogoff, 2013, “Financial and Sovereign Debt Crises: Some Lessons Learned and Those Forgotten”, IMF Working Paper No. WP/13/266.
Thornton, H., 1802, An Enquiry into the Nature and Effects of the Paper Credit of Great Britain, Edited with an Introduction by F. A. v. Hayek. New York: Rinehart & Company, Inc., 1939.
Webel, B., 2013, “Troubled Asset Relief Program (TARP): Implementation and Status, Congressional Research Service”, www.crs.gov.
Winters, B., 2012, “Review of the Bank of England’s Framework for Providing Liquidity to the Banking System”, Presented to the Court of the Bank of England, www.bankofengland.co.uk.
The authors wish to thank Dong He, Alvaro Piris Chavarri, Kristine Drevina, Kelly Eckhold, Darryl King, Peter Lohmus, Erlend Nier, Miguel Savastano, and Froukelien Wendt, for their useful comments. A special thanks also to a number of central bank colleagues who offered advice and comments on an earlier draft of this working paper. Remaining errors are the authors’ responsibility.
OMOs are undertaken at the initiative of the CB, while SFs are automatic and provided at the initiative of individual banks. See Gray and Talbot (2006) for a longer discussion of this point.
Some of the ‘non-traditional’ approaches mirrored schemes used by some emerging market countries in previous years.
While a system-wide need for liquidity support may indicate the need for heightened supervisory attention, this will be of a different nature to heightened scrutiny in response to idiosyncratic needs.
For example, when Northern Rock in the United Kingdom (U.K.) was unable to roll over market funding in September 2007, the provision of LOLR funding had to be offset by a reduction in normal OMO lending, to avoid leaving the market with an overall excess of reserve money balances.
Liquid assets may comprise (i) reserve money, possibly provided at a longer term maturity than normally available; (ii) FX; or (iii) liquid securities.
A run may be more likely on wholesale rather than retail funding where credible deposit insurance is in place.
Some CBs offer a hybrid between a standing credit facility and LOLR in these circumstances, but this is not sound practice.
Asset swaps (government bonds provided in exchange for illiquid assets) may be available, taking advantage of the government’s ability to issue debt securities quickly. In some countries, parliamentary approval may be needed, for example if issuance of additional debt securities or the provision of a government guarantee has to be accommodated in that year’s budget.
See Bindseil (2014) for a longer discussion on the topic of CB liquidity provision and moral hazard.
Examples would include attracting short-term deposits or wholesale funding rather than paying up for longer term funding, assuming that the CB will meet any non-rollover of this short-term funding; or lending (even unsecured) to risky entities, knowing that if the funds are not returned, the CB will step in to meet the liquidity shortfall. This may be equivalent to parking illegally, on the assumption that over time it is cheaper and easier to pay an occasional fine, than to pay regularly for legal parking.
The U.S. Dodd-Frank Act (2010) deliberately restricts the ability of the Fed to provide idiosyncratic support to financial institutions, weakening any perception of an automatic bail-out.
Given this supervisory intrusion and conditionality, LOLR should not be used in order to comply with regulatory ratios.
A systemic action would be a short-term response to a market shock; in contrast a change in monetary policy stance is normally the outcome of a pre-established calendar of meetings of the CB because OMOs would be aimed at longer-term price stability.
The transmission mechanism is the process through which monetary policy decisions are transmitted through financial intermediaries to affect the economy in general. As has been amply documented, during the recent global financial crisis this mechanism became impaired in a number of countries.
The LCR requires banks to hold a minimum amount of high quality liquid assets to overcome liquidity pressures under certain stress assumptions over a 30 day period.
In the case of the South African Reserve Bank, banks using the facility will be charged a scaled commitment fee (between 10 and 45 bps) based upon each bank’s usage of the facility, while the Reserve Bank of Australia applies a commitment fee of 15 bps applied to both drawn and undrawn amounts.
Laeven and Valencia (2012) estimate the average loss in output resulting from 147 banking crises between 1970 and 2011, as 23 percentage points of GDP.
Prior to the amendment of the Federal Reserve Act by the Dodd-Frank Act, Section 13(3) permitted the U.S. Federal Reserve to provide idiosyncratic liquidity support to individuals, partnerships and corporations. Restrictions on the Fed’s ability to give idiosyncratic support provide a recent example of constraints imposed in legislation.
While paying for deposit protection is clearly a cost, banks also receive a benefit—depositors are more willing to entrust their funds to them—so that strong regulation and supervision necessarily accompanies deposit protection.
Best practice suggests that CCPs should be able to withstand the default of their two largest counterparties. For a wider discussion on managing the systemic risks relating to CCPs, please see Singh (2014) and Wendt (2015).
The internationally accepted presumption is that in principle all CCPs are systemically important at least in their own jurisdiction. See CPSS-IOSCO (2012).
In some countries, a few large SDs are OMO counterparties (typically called “Primary Dealers”); in some markets they may be designated market-makers, supporting secondary market trading.
The authorities should consider, ideally preemptively, whether the activity itself displays inherent weaknesses (involving for instance ‘privatization of profits, and socialization of losses’) that need to be addressed.
Since asset managers act, legally, as agents, they do not need to bear the regulatory costs of capital, liquidity buffers, contributions to deposit protection funds etc; but investors may nevertheless expect the state to provide a backstop. This expectation could be changed, in part by addressing marketing of such products. Regulators should insist that clear “health warnings” are displayed, and that non-professional investors are proactively advised of the liquidity risks.
Circuit breakers can in principle impact “redemptions” in funds now: a prospectus will typically say that redemptions may be suspended or payment dates postponed when the stock exchange is closed (other than weekends or holidays), or when trading is restricted, or as permitted by the regulator.
This may operationally be difficult. If the suspension of “redemption rights” were to be preemptive, it would need to be extended to MFs that were not experiencing a run. Given the wide variety of assets in which MFs may invest, regulators would be unlikely to want to suspend redemptions in all funds; while defining a group of sufficiently homogenous funds would be difficult.
This does not mean institutional investors could not use them, but that the treatment should be differentiated from cash.
This may explain why in 2008 the U.S. Treasury provided a guarantee to MMMF investors—to stop them exiting—rather than lending to the MMMFs.
Ibid p.48. The safeguard states that CCPs must hold adequate liquid assets or have adequate lines of credit in all of the currencies of the products cleared by the CCP.
It is generally the case that minimum regulatory levels of capital form the basis for the assessment of solvency. An institution may have positive net assets—and so technically is not insolvent—but still be undercapitalized.
Recapitalization via government bonds may not convince market counterparties, e.g., if it is difficult to demonstrate the real value of unfunded non-marketable securities.
Moreover, in many financial systems, banks share exposures to certain debtors and sectors, and if the solvency of one institution is in doubt in crisis times, it will be expected that the solvency of other institutions will also be uncertain, even if difficulties have not yet fully materialized.
Such a forward-looking approach is something the ECB caters for by forming an “… assessment, over the short and medium term, of the liquidity position and solvency of the institution receiving the ELA, including the criteria used to come to a positive conclusion with respect to solvency”. See ECB (2013).
In the case of the Riksbank, “Solvency assessment is aimed at assessing long term survival capacity of an institution, including its balance-sheet solvency, business model, profit generation capacity, and capacity to resolve capital problems without further public interventions, even if the bank momentarily does not meet the capital adequacy requirements.” See IMF (2011).
Hoggarth et al. (2004) describe a bridge bank as an entity controlled by the liquidator, taken into temporary state-ownership in order to permit its restructuring and ultimate private sale.
It may not be possible to clearly establish at the outset an exact maturity date for the operations, however, adequate incentives should be put in place so that the restructuring concludes within an agreed timeline.
Careful consideration needs to be given the form of liquidity support provided as such actions could create significant stigma for sound banks. As Paul Tucker outlines “if it is believed that the central bank will not turn away insolvent banks, then it becomes toxic for a solvent but illiquid bank if there is any chance of that becoming known.” (p. 20). See Bank for International Settlements (BIS) (2014).
The liquidity support should be time bound and in no way be seen as a substitute for the development of crisis management plans and appropriate resolution measures.
Some may consider that if a government undertakes an obligation to recapitalize an institution, there is little preventing the institution being recapitalized immediately. However, the inability to access debt markets quickly or due process requirements may preclude the government from affecting this immediately.
This of course assumes that the recapitalization is a binding and irrevocable commitment of the government and a change of government would not void this obligation.
See, for example, BCBS (2013a) for a discussion on the assessment methodology for globally systemic important banks.
In such instances an element of judgment is unavoidable. For example, while it is not always true, it is highly probable that the removal of a bank branch network from a market will have a significant impact—be it for a limited time—on the local economy.
This misperception is not entirely surprising, as (open ended) mutual funds typically have an obligation to “redeem” shares with seven days’ notice (and in practice do so sooner). Since no entity has any obligation to buy the shares which are ‘redeemed’, the mutual fund will reserve the right to deliver assets (securities) rather than cash, or to suspend redemptions. In practice, delivering assets does not happen, and suspending redemptions would likely lead to closure of the fund.
Arguably, if an institution cannot legally own an asset, it should not lend on repo against that asset.
If a borrower did not need to provide collateral, the CB would need an alternative mechanism to limit its borrowing. There is no obvious reason why a firm should need to borrow more than 100 percent of its assets i.e., LOLR should not be provided to support new lending by a bank, or to support more leveraged activity.
The U.S. Federal Reserve Bank used a number of instruments with non-recourse lending during the GFC.
With a non-recourse loan, if the price falls below the amount of cash provided, the investor-borrower can walk away from the loan contract, with no recourse by the lender.
For example, see Article 16 (1) of the “Law on the Bank of Albania” No. 8269, dated 23.12.1997, www.bankofalbania.org ; Section 36 (1) of the Basic Constitutional Act of the Central Bank of Chile www.bcentral.cl ; and, Article (59) of the Central Reserve Bank of Peru Organic Law www.bcrp.gob.pe, The HKMA is permitted to respond to idiosyncratic liquidity needs for an initial term of 30 days, which can be rolled for a further 30 days on maturity.
Some central banks in emerging markets have provided LOLR support for three-five years, without regular reviews or strong supervisory intervention or control, reducing the incentives for weak institutions to tackle underlying problems.
Some estimate this spread to be between 100 bps and 150 bps over the ECB’s marginal lending facility. See https://mninews.marketnews.com, October 18, 2013.
The rate could be higher for those entities with poorer risk management and more illiquid collateral. See Plenderleith (2012).
Some CBs have limits on the amount of monetary policy lending that can be accessed by an individual institution, or have concentration limits in terms of collateral presented. When these limits are breached, and while the bank may continue to hold monetary policy eligible collateral, it may be asked to apply for idiosyncratic liquidity support.
For instance, the authors are aware of one case where a central bank, after a prolonged court case lasting several years, lost title to a commercial property asset taken as collateral.
In some jurisdictions, debtor notification and/or approval may be required before the loan assets can be used as collateral with the CB; in others, local custom may make it practically impossible to take possession of residential property collateral.
Prepositioning of collateral—as done for instance for the U.S. Federal Reserve’s “Discount Window” access (though this is not a LOLR facility)—allows the CB time to examine documentation and conduct any necessary valuations before the collateral is used.
Should the CB request additional support by way of a government indemnity, the provision of LOLR then becomes a joint responsibility with the fiscal authority.
It is worth noting that flexibility on the retention of profits is not possible for all CBs; in many cases precise profit distribution conditions are stipulated in legislation.
For example, the U.S. support for state-sponsored enterprises was not seen to impact the U.S.’ AAA rating (see Cebotari (2008), p. 3); on the other hand, the Wall Street Journal quotes Moody’s explanation of their five notch downgrade of Ireland (in 2010) as being due to “the repeated crystallization of bank-related contingent liabilities on the government’s balance sheet”. See: www.wsj.com.
It would be expected that the recipient institution would not engage in activities beyond its core functions without prior CB approval.
Such flows could include the potential loss of CB repo eligible collateral, cash triggers in securitized products and derivative related margin calls, resulting from, for example, rating downgrades.
Indeed, controls may be needed even before LOLR is provided. For example, the authors are aware of cases where a bank that was put into administration had expanded its balance sheet substantially despite regulatory concerns.
There is also the risk that centralized collateral management within the group may make it difficult to identify, from a legal perspective, which entity within the group has title to that collateral. This risk should be removed before the CB extends liquidity.
Some 14 CBs borrowed USD via currency swaps with the Fed, and some European CBs engaged in swaps and repos with the ECB.
In many countries, only domestic-currency deposits benefit from deposit insurance; and even when foreign currency deposits are covered, payouts are typically in domestic currency.
The same considerations could hold when meeting a systemic need for FX liquidity is being considered. However systemic FX liquidity needs may reflect macro economic imbalances within the economy which may need to be addressed through a wider policy response.
However, FX swap lines may not prove a sufficient or efficient substitute for the accumulation of FX reserves, as they are conditional and time-bound, and many CBs do not have access to them.
To ensure that swap lines are available when called upon, it is preferable for CBs to enter into swap arrangements with international authorities or central banks, rather than with private institutions.
For some CBs this could also involve seeking access to government FX holdings normally reserved for FX intervention, rather than for financial stability/liquidity provision purposes.
In its evolving practice during the crisis, the EU Commission sought to avoid opening formal proceedings and instead take a quick decision by requiring suitably severe commitments (including divestment of assets) from the recipients which allowed it to conclude that the aid did not raise serious competition issues.
Indirectly, through the primary dealers, Asset-Backed Commercial Paper Money Market Mutual Fund Liquidity Facility (AMLF) made liquidity available to investment banks, broker-dealers and mutual funds.
See the BOE’s “Red Book” available at http://www.bankofengland.co.uk. Some non-banks have had access to the BOE’s OMO for some years, but not to credit facilities.
This arrangement was conducted through the ECB; for further details on this along with an overview of all foreign currency liquidity providing swaps entered into by the ECB, see ECB (2014).
For a description of the responsibilities around the provision of bilateral LOLR support within the Eurosystem see ECB (2013).
This approach is used in countries such as Hong Kong (policy statement), Montenegro (Board decision) and Bank of Canada (guidance note).
Moreover, given the possible wider systemic risks at play, the decision not to support an institution over and above an “arbitrary” threshold may be difficult to defend in any ex post assessment conducted.
Constructive ambiguity—access to CB liquidity assistance is uncertain, something that is determined ad hoc in each situation (He, 2000). This approach is used in Eurosystem countries, Russia, New Zealand, and Norway, to name a few.
In the U.K., the information on liquidity support to Northern Rock precipitated a retail deposit run. This was stopped only after the announcement of a government guarantee.
CBs have many means of communicating with the market after the event, through its annual report or regular economic reviews, or public speeches. The annual report, because it is issued at a lag, more than the interim statements, provides an opportunity to clarify if emergency liquidity has been extended, through a note to the accounts, or in an explicit statement.
Some CBs have policies relating to the disclosure of their emergency operations. For example, see Plenderleith (2012) on the BoE’s delayed disclosure of LOLR to RBS and HBOS, for more than a year. The Dodd-Frank Act introduced a new mechanism of delayed disclosure where loans received under the U.S. Federal Reserve’s regular discount window or through OMOs would be disclosed approximately two years after the operation, while operations conducted under 13.3 of the Federal Reserve Act would be disclosed one year after authorization for the facility has terminated.
If the additional reserves are created in response to a systemic shock, the CB would generally not sterilize the operation since this would defeat its purposes.
In the case of such asset swaps, there is no creation of reserve money, and so there is no need to sterilize.
However, it may be possible for CB to explain to the market the rationale behind the idiosyncratic action in fact it could be explained as a regular action. For example, a CB could outline to the market that through its monetary policy framework it aims to maintain smooth market conditions and a fall in market rates below its policy target has necessitated the need for the sterilization operation.
Moreover, in some countries during the GFC the systemic need for extra reserves balances were not required as much as an additional source of term funding. In such cases, term lending operations balanced by short term sterilization instruments can be combined to keep market rates in line with the policy target.
Under Eurosystem accounting rules there is no specific requirement for the provision of idiosyncratic liquidity to be specifically ‘labeled’ in the CB’s accounts.
Stigma concerns can also exist for regular monetary policy operations (see Winters, 2012). Regulatory, disclosure, or other consequences can prevent sound counterparties from accessing standard monetary policy operations.
Plenderleith (2012) provides an interesting example “…in August 2007 Barclays used the Standing Lending Facility for purely operational reasons and journalists contacted U.K. banks the following day to find out which bank did not deny usage. The story of Barclays’ use of the facility ended up on the front page of the Financial Times and acted to stigmatize the facility” (p33).
Depending on the operational capabilities of the government and its familiarly with the deposit and repo markets, the government or other entities may request the CB—as honest broker—to carry out the operational aspects of these market solutions on their behalf.
Some countries, such as the U.K., Denmark, and Australia have established MOUs.
Tasks are in no particular order. (L) indicates lead role.
Depending on the institution at hand cross-border arrangements for cooperation, coordination, and exchange of supervisory information may also be required.
See MOU between the Bank, including the Prudential Regulation Authority, and the treasury regarding Financial Crisis Management available at www.bankofengland.co.uk.
The authorities in the U.K. have not yet made clear if, following the recommendations made in the Plenderleith report, the risk associated with LOLR lending resides with the BoE or with the U.K. Treasury.
Section 61 of the Financial Services Act 2012, allows the Chancellor to direct the Bank to “conduct special support operations for the financial system as whole, in operations going beyond the Bank’s published frameworks” where “the Chancellor directs the Bank to conduct a support operation, either to the financial system as a whole or to one or more individual firms, the Bank will act as the Treasury’s agent”. See: www.bankofengland.co.uk.
See Reuters (2014) in the case of Bulgaria. In addition, in Hong Kong lending to institutions not meeting the preconditions for idiosyncratic emergency support requires specific approval from the Financial Secretary.
See Presentation “Structural change in the corporate bond market in Korea after the currency crisis” by Sungmin Kim, The Bank of Korea, available at www.worldbank.org.
In certain jurisdictions, such as within Europe, the provision of sovereign guarantees may create issues from a state aid perspective.
See “Proposed securities repurchase transaction with Irish Bank Resolution Corporation” available at www.bankofireland.com.
This may be seen by some CBs as a reason to adopt a “constructive ambiguity” approach in relation to communication on its emergency idiosyncratic response framework, as this may make it easier for the CB to change, at a date in the future, the collateral it is willing to accept.
Common law frameworks allow for the mobilization of pools of loans under legal charge in favor of the assignee, which is legally complex under civil law.
For example, within asset backed securities or covered bonds, the CB may look to limit the role of related counterparties through haircut add-ons or by requesting that adequate contingency arrangements be incorporated into the underlying documentation.
In general examples of “close links” arise in situations where the counterparty submits assets issued or guaranteed by itself or by an entity from within its corporate structure.
At a minimum, the following eligibility criteria are important in the case of loans; consent of the borrower for the transfer of the loan, a defined level of arrears (which may well be zero), debtor income verification, a defined loan-to-value threshold, and the type of loan eligible (e.g., annuity loans only).
For example, it would not be prudent to accept loans as collateral in cases where legal title cannot be transferred to the CB.
Additional margin should be applied if other risks related to the underlying assets need to be considered in the valuation, such as legal and currency risks.
See General Documentation on the Instruments and Procedures of the Eurosystem Monetary Policy, September 2011, ECB.
The Law on the Bulgarian National Bank stipulates that emergency loans can be extended “up to the amount of the excess of the lev equivalent of the gross international FX reserves over the total amount of monetary liabilities of the Bulgarian National Bank” (Article 33 (3)). See He (2000) for other examples of limits prescribed in legislation.
The ECB publishes an Eligible Assets Database on a daily basis where the haircuts applicable to each potentially usable eligible asset are made public. One could argue that the application of valuation markdowns is easier to apply to self retained instruments as it simply means an adjustment to the theoretical valuation being applied to the asset at the time the asset is presented (the use of this valuation approach indicates a self retained issuance), rather than a technical update of the haircut where identification of those assets which are self retained is not clearly evident prior to their actual mobilization of the collateral.
A letter should be submitted by the counterparty with each pool, signed by the head of treasury of equivalent, confirming the eligibility of each of the loans in the pool, along with confirming that the pool is in the agreed format.
In the case of an urgent idiosyncratic request, these checks can be completed ex post, but within a short timeframe.
In some jurisdictions, given the nature of the regulatory regime such due diligence checks may not be necessary. For example New Zealand places greater emphasis on bank self-discipline and market discipline to provide incentives for prudent management, which it enforces through directors’ attestations on their banks’ risk management in public disclosures. See Reserve Bank of New Zealand: Bulletin, Vol. 67, No. 3.
It is important to note that CBs should have clear principles behind when they will provide such liquidity support and should not change these principles as individual liquidity needs arise.
Depending on the nature of demand, liquid securities instead of reserves could be provided.
As mentioned earlier, in the case of the ECB, collateral constraints continued to impact peripheral banks even after the ECB expanded its collateral base. Moreover, through their LTROs, the ECB relied to an extent on counterparties distributing LTRO reserves to concerned counterparties, which did not happen in practice.
Moreover, some monetary policy standing facilities are not automatic and may involve additional regulatory oversight, which is not recommended.
For example, in the U.S. Federal Reserve’s TAF operation, longer term liquidity was made available to a wider set of counterparties against a wider list of collateral normally reserved for the overnight discount window.