This paper was prepared by the FSAP mission team as part of the background work for the U.K. FSAP in the summer-fall of 2002. The primary contributors to this paper were Eric Parrado and Mark Zelmer of the IMF’s Monetary and Financial Systems Department.
Indeed, in August 2002 netting was introduced for gilt transactions in LCH Repo Clear.
As will be described later, eligible institutions are free to choose whether they wish to borrow money for a roughly two week tenor at a rate equal to the Bank’s two-week repo rate, or on an overnight basis at a rate equal to the two-week repo rate plus one percent. This choice is often highly dependent on expectations regarding future changes in the Bank’s monetary policy stance. For example, eligible institutions will often borrow on an overnight basis when they are anticipating a near-term reduction in the Bank’s two-week repo rate.
There have been around 15–20 counterparties in recent years. The list of counterparties is not made public because the Bank wants to avoid creating the perception in the market that the obligations of these institutions would receive special treatment in the event of financial distress. Nonetheless, some market participants believe they have a fair understanding of which institutions are on the list. Four ‘functional criteria’ are used by the Bank to select its counterparties and to monitor their performance: (i) counterparties must maintain an active presence in the markets for at least one of the instruments eligible in the Bank’s operations; (ii) they must have the technical capability to respond quickly and efficiently to the Bank’s daily rounds of operations; (iii) they are expected to participate regularly in the Bank’s daily rounds of open market operations; and (iv) they are expected to provide useful information to the Bank on a regular basis on market conditions and developments in the sterling money markets.
The length of the repo period is sometimes adjusted by a couple of days to provide for a smoother flow of daily shortages. A list of eligible assets is maintained on the Bank’s web site. It includes: gilts (including gilt strips); sterling treasury bills; Bank of England euro bills and notes; eligible bank and local authority bills; U.K. government non-sterling marketable debt; sterling securities issued by European Economic Area (EEA) central governments and central banks and major international institutions; and euro-denominated securities (including strips) issued by EEA central governments and central banks and major international institutions where they are eligible for use in the European System of Central Banks’ monetary policy operations.0
The Debt Management Office (DMO) assumed full responsibility for managing the government’s daily cash position in April 2000. Since then, the level of the outstanding ‘Ways and Means advance’ to the government on the Bank’s balance sheet has been stable, and the DMO, rather than the Bank, offsets the government cash position with the money market each day. It aims for a small, constant, precautionary deposit with the Bank each day, and does not carry out operations, which by their nature or timing could be perceived to clash with the Bank’s open market operations. As a result, the Bank’s balance sheet has become more stable and predictable, and the money market’s funding need from the Bank is no longer influenced by the government’s net cash position. The two key factors that now influence the money market’s need for refinancing from the Bank are changes in the note issue and the maturity of the existing stock of refinancing operations.
As noted above, settlement banks are required to maintain positive credit balances in their accounts at the Bank at the end of each business day. However, they are required to hold non-interest bearing “cash ratio deposits” (CRDs) at the Bank, set at a rate of 0.15 percent of their domestic deposit base. These deposits are meant to provide the Bank with seignorage revenues to finance the unrecovered costs associated with its monetary policy and financial stability activities. The CRD scheme is scheduled to be reviewed in 2003. These reviews are expected to be conducted every five years.
By the same token, if the Bank was faced with a daily surplus at some point in the future, it could ask the DMO to issue additional Treasury bills on its behalf, or it could begin issuing its own securities to mop up liquidity.
These data need to be interpreted with care, since the interbank deposit component is materially inflated by intragroup business, e.g., lending from the treasury area of a bank to the rest of the group.
Another relatively new market segment, for which data were not available, is the sterling overnight index average (SONIA) swap market.
There is, however, an active offshore interbank market in unsecured deposits denominated in U.S. dollars and other currencies, of which London is an important trading center.
However, as these concerns abated, the government began issuing floating-rate gilts in the mid-1990s, and over the past year has begun issuing Treasury bills in larger volumes as these gilts matured. The government plans to dematerialize T-bills and other money market instruments, which would help to promote the future growth of this market.
This point is discussed at length in: H. Bernard and J. Bisignano, 2000, “Information, Liquidity and Risk in the International Interbank Market: Implicit Guarantees and Private Credit Market Failure,” BIS Working Papers No. 86 (March).
Another crisis was the secondary banking crisis in the 1970s when the Bank launched the ‘lifeboat’ operation to prevent a loss of confidence in the U.K. banking system—see Bank of England, 1978, “The secondary banking crisis and the Bank of England’s support operations,” Bank of England Quarterly Bulletin (June).
It is important to bear in mind that the usefulness of these data will be limited by the inability of the Bank to monitor exposures that arise offshore, since many important players in the U.K. interbank market are branches of foreign banking groups—thus, the offshore exposures of the parent institution of these branches are also relevant in order to gain a precise indication of the vulnerability of the U.K. banking system. Nevertheless, a partial picture is more informative than no picture.
An increasing amount of trading is being conducted over the internet, but the extent of this is reportedly small in both percentage and volume terms.
Market participants were also advised that a smaller £/US$ swap facility was also available throughout this period from the U.K. government’s own foreign exchange reserves. However, no bank chose to access this facility.