Bank of Canada’s Framework for

Market Operations and Liquidity

Provision

Updated April 2020

This document describes the Bank of Canada’s framework for its market operations

and liquidity provision. The most up-to-date version of the Framework can be found at

http://www.bankofcanada.ca/markets/market-operations-liquidity-provision/framework-

market-operations-liquidity-provision/.

The legal terms and conditions for the market operations and liquidity provision can be

found at http://www.bankofcanada.ca/markets/market-operations-liquidity-

provision/terms-and-conditions/. Related policy documents, including the Statement of

Policy Governing the Acquisition and Management of Financial Assets for the Bank of

Canada’s Balance Sheet, the Bank of Canada Policy for Buying and Selling

Securities, and Rules Governing Advances to Financial Institutions and Financial

Market Infrastructures can be found at http://www.bankofcanada.ca/markets/market-

operations- liquidity-provision/.

I. Contents

I. Overview 4

II. Reinforcing the Target for the Overnight Rate 5

1. Operating Band Supported by Standing Deposit and Lending Facilities 5

LVTS Settlement Balance 6

Standing Liquidity Facility 6

Overnight Standing Repo Facility 7

2. Adjustments to the Level of Settlement Balances 7

3. Overnight Repo and Overnight Reverse Repo Operations 9

III. Supporting the Efficient Functioning of Canadian Financial Markets 11

1. Government of Canada Securities Portfolio 12

2. Term Repo Operations 13

3. Standing Term Liquidity Facility (STLF) 14

4. Securities-Lending Program 15

IV. Providing Liquidity Under Extraordinary Circumstances 16

1. Providing Market-Wide Liquidity 16

Contingent Term Repo Facility 17

2. Advances 18

Emergency Lending Assistance 18

4

Overview

Bank of Canada’s Framework for

Market Operations and Liquidity

Provision

I. Overview

In the course of executing its monetary policy and financial system responsibilities, the

Bank undertakes a range of financial market operations as part of its regular monetary

policy operating framework and provides liquidity to the Canadian financial system as

required. The Bank also plays the role of lender of last resort, which has been a

fundamental role of central banks since at least the nineteenth century. The Bank

provides routine liquidity to reinforce the target for the overnight rate and to facilitate

settlement in the payments system and has various tools at its disposal to respond to

situations where exceptional or emergency liquidity may be required, either on a

bilateral basis to specific entities through the provision of Emergency Lending

Assistance (ELA) or on a market-wide basis through the use of extraordinary liquidity

facilities.

The Bank has in place a clear framework to:

• guide its financial market operations;

• support the provision of routine liquidity to facilitate settlement in the payments

system; and

• respond to exceptional or emergency liquidity needs, either on a bilateral basis

through ELA or on a market-wide basis through extraordinary liquidity facilities.

Each of the tools in the Bank’s framework for financial market operations and liquidity

provision is designed to achieve one or more specific objectives:

• reinforce the target for the overnight rate

• support the efficient functioning of Canadian financial markets

• provide backstop liquidity under extraordinary circumstances.

These tools are facilitated by — and in turn influence — the size, structure, and

management of the Bank’s balance sheet.

5

Reinforcing the Target for the Overnight Rate

II. Reinforcing the Target for the Overnight Rate

The Bank of Canada conducts monetary policy by setting the target for the overnight

interest rate (often referred to as the policy rate). This directly influences the interest

rates at which banks and other financial system participants borrow and lend funds for

a term of one business day. The level of the overnight interest rate and expectations

about its future path also influence other longer-term interest rates, as well as a

broader range of asset prices.

The Bank’s implementation of monetary policy is closely linked to Canada’s main

payments system – the Large Value Transfer System (LVTS).1 Almost all payments

(measured by value) flow through the LVTS; therefore, this system is the focus of the

Bank’s framework for the implementation of monetary policy. The Bank’s framework to

support trading at the target rate includes the operating band, or interest rate corridor,

which is in turn supported by standing deposit and lending facilities.2 The midpoint of

the operating band is the Bank’s target for the overnight rate, and the presence of the

standing deposit and lending facilities provide strong incentives for transactions

between major participants in the overnight market to take place near the target rate.

The Bank can adjust the level of the settlement balances available in the system to

address some frictions in the payments system and to further support trading at the

target for the overnight rate. However, unexpected payment frictions in the market can

sometimes cause the overnight rate to move away from the Bank’s target rate during

the day. In cases where the Bank judges that the deviation is a result of generalized

pressure on liquidity, it can offset this pressure by adding or withdrawing liquidity with

Overnight Repo and Overnight Reverse Repo operations.

1. Operating Band Supported by Standing Deposit and Lending

Facilities

The Bank’s operating band is a 50-basis-point interest rate corridor around the Bank’s

target for the overnight rate (Figure 1). Because LVTS participants must have a zero

balance in their settlement account at the Bank of Canada at the end of each day, any

positive balances in participants’ settlement accounts must be left on deposit with the

Bank and are remunerated at the “deposit rate” (the target rate minus 25 basis points),

which is the bottom of the operating band.

Conversely, LVTS participants in a deficit position must take an overnight

collateralized advance from the Bank through the Standing Liquidity Facility (SLF) at

the “Bank Rate” (the target rate plus 25 basis points), which is the top of the operating

1 See http://www.bankofcanada.ca/core-functions/financial-system/canadas-major-payments- systems/#lvts to learn more about the LVTS 2 There are two standing lending facilities: the Standing Liquidity Facility, available to LVTS participants, and the Overnight Standing Repo Facility (formerly the Overnight Standing Purchase and Resale Agreement Facility), which is available to Primary Dealers.

6

Reinforcing the Target for the Overnight Rate

band. This helps provide incentives for LVTS participants to settle surplus and deficit

positions with each other over the course of the day near the Bank’s target for the

overnight rate, which is the midpoint of the operating band.

Figure 1: Bank of Canada’s Operating Band

Target

0

LVTS Settlement Balance

Deficit Surplus

These arrangements encourage transactions for overnight funds in the marketplace at

rates within the operating band, since participants are aware that they will earn at

least the deposit rate on positive balances and need not pay more than the Bank Rate

to cover shortfalls in their settlement account. Given that the opportunity costs of

borrowing from and depositing funds with the Bank at the end of each day are

generally the same when using the midpoint of the operating band as a reference (i.e.,

+/- 25 basis points), participants have an incentive to trade among each other at the

Bank’s target for the overnight rate.

Standing Liquidity Facility

Through its SLF, the Bank of Canada provides overnight credit (advances) on a

routine basis to participants in the Large Value Transfer System (LVTS) that are

experiencing temporary liquidity shortages due to unexpected payment frictions.3

Advances extended by the Bank to LVTS participants under the SLF are made on a

secured basis against a wide range of high-quality collateral. In facilitating overnight

settlement in the LVTS payments system, the SLF reinforces monetary policy and

3 See http://www.bankofcanada.ca/core-functions/financial-system/canadas-major-payments-systems/ to learn more about Canada’s major payments systems.

Bank rate

+25 bps

-25 bps

Deposit rate

50-basis-point operating band

7

Reinforcing the Target for the Overnight Rate

facilitates the smooth functioning of the financial system.

The SLF helps the Bank reinforce monetary policy, since LVTS participants accessing

the SLF pay the Bank rate (target plus 25 basis points). The higher cost of using the

SLF provides an incentive for LVTS participants to cover their net deficit positions by

undertaking interbank transactions prior to settlement at rates within the operating

band. While only LVTS participants have access to the SLF (and a deposit facility),

this incentive supports the Bank’s monetary policy objectives more broadly by

influencing the behaviour of a broader group of market participants through their

interactions with LVTS participants.

The SLF also helps facilitate the smooth functioning of the financial system by

providing overnight liquidity to institutions that are unable to borrow from their LVTS

counterparts. In the majority of cases, LVTS participants are able to borrow from each

other to settle any end-of-day net negative position in the payments system. However,

there may be occasions where a participant finds itself unable to find a lending LVTS

counterpart on short notice or for technical reasons, such as reaching constraints on

their counterparty credit limit. The SLF ensures that LVTS participants are able to

cover temporary shortfalls in funds that can arise from the daily flow of LVTS

settlement of payments.

The SLF is not intended for use by an institution experiencing persistent liquidity

shortages. In such extraordinary circumstances, the institution should consider

requesting Emergency Lending Assistance (ELA) from the Bank.

Overnight Standing Repo Facility

In 2009, the Bank introduced a new standing facility, the Overnight Standing Repo

Facility (formerly the Overnight Standing Purchase and Resale Agreement Facility), to

provide another source of funding for Primary Dealers in Government of Canada

securities who may not have access to the SLF. The facility provides a funding

backstop to Primary Dealers on an overnight secured basis at the Bank Rate,

reinforcing the top of the operating band.

2. Adjustments to the Level of Settlement Balances

At the end of each day, the Bank sets a target for LVTS settlement balances that is

effective for the following day. This helps set trading conditions for the overnight

market. As well, changes in the targeted level of settlement balances can act as a

powerful signal of the Bank’s resolve to reinforce its target for the overnight rate.

The LVTS is a closed system, which means that the net overall cash position of the

entire system should generally be zero. Hence, any LVTS participant with a deficit

position knows that there is at least one participant in the system with an offsetting

surplus position, and is therefore a potential counterparty for transactions at market

rates. However, since the introduction of the LVTS in 1999, the Bank’s target level for

8

Reinforcing the Target for the Overnight Rate

settlement balances has typically been set above zero, which puts the other

participants in the system in a slight surplus cash position. This added liquidity helps

reduce transaction costs and other frictions during the end-of-day process and, as a

result, lessens the need for participants in deficit positions to take frequent small

advances from the Bank.

Changing the level of settlement balances is an effective policy tool to reinforce the

Bank’s target for the overnight rate, and the Bank retains the right to adjust the

targeted level of settlement balances higher or lower, depending on conditions in the

overnight market. For example, in the early years of LVTS, the targeted level of

settlement balances was often adjusted in anticipation of seasonal or temporary

upward pressure on the overnight rate, such as around quarter-ends and the fiscal

year-end of commercial banks.

Increasing the level of settlement balances provides a strong incentive for LVTS

participants to lend their cash, thus putting downward pressure on the overnight rate,

because higher settlement balances will inevitably result in some participants being in

a surplus cash position at the end of the day. These surplus funds must be deposited

overnight through the Bank’s deposit facility at a below-market rate (the target for the

overnight interest rate minus 25 basis points).

To achieve the target level of settlement balances, the Bank, as fiscal agent for the

Government of Canada, transfers net public sector payments and receipts within the

system, including its own and those of its other clients, to and from the government

deposit on its balance sheet. The Bank manages these transfers through the

afternoon Receiver General Auction. The Bank publishes on its website the target

level of settlement balances the day before the target’s effective date and the actual

amount each day, after completion of the afternoon Receiver General Auction. In the

majority of cases, the targeted level of settlement balances is achieved; however, in

less-common situations, such as forecast errors where the Bank is unable to make the

necessary adjustment to the afternoon Receiver General Auction to offset the error,

the actual level can differ from the targeted level.

During times of severe financial system stress, such as the 2008-2009 global financial

crisis and the 2020 COVID pandemic, the Bank may adjust its operating framework to

reinforce its target rate, accommodate increased market-wide demand for liquidity,

and reduce the operational burden on the Bank and LVTS participants. To do so, the

Bank may allow settlement balances to reach a higher level than usual (or cease

targeting a specific level of settlement balances).

By providing an ample amount of settlement balances during these periods of stress,

the overnight rate is less sensitive to the overall level of settlement balances. Because

of this, there is less need for intraday liquidity operations or afternoon Receiver

General auctions that the Bank typically uses to achieve its target level of settlement

balances.

9

Reinforcing the Target for the Overnight Rate

In such circumstances, the Bank may also narrow its operating band for implementing

monetary policy, setting the deposit rate equal to the target for the overnight rate,

while maintaining the Bank rate at 25 basis points above the target rate. Along with

higher settlement balances, this helps motivate trading in the general collateral

overnight market at or close to the deposit rate during the day and supports the

Bank’s ability to achieve its overnight rate target.

3. Overnight Repo and Overnight Reverse Repo Operations

The Bank conducts Overnight Repo and Overnight Reverse Repo operations to

further support the effective implementation of monetary policy by injecting or

withdrawing intraday liquidity, thereby reinforcing the Bank’s target for the overnight

rate.

When the conditions in the Canadian general collateral overnight repo market so

warrant, the Bank may intervene and inject intraday liquidity through repurchase

agreements (repos), called Overnight Repo operations, or to withdraw intraday

liquidity through reverse repurchase agreements (reverse repos) called Overnight

Reverse Repo operations. These operations are conducted through a competitive

auction to channel funds to the counterparties that need them most.

If transactions in the general collateral overnight market are generally taking place at

rates above the Bank’s target, the Bank may inject liquidity using Overnight Repo

operations by purchasing Government of Canada securities from Primary Dealers,

with an agreement to resell those securities to the same counterparty the next

business day, with the difference in price equal to the interest for one business day.

Conversely, if transactions in the general collateral overnight market are generally

taking place at rates below the Bank’s target, the Bank may withdraw liquidity using

Overnight Reverse Repo operations by selling some of its holdings of Government of

Canada securities (typically treasury bills) to Primary Dealers, with an agreement to

repurchase them at a value that includes interest for one business day. Those

transactions are conducted at rates equal to or below the Bank’s target for the

overnight rate, depending on market conditions and bidding behaviour at the auction.

The Bank typically conducts these operations at 11:45 a.m. (ET) but, if necessary, the

Bank is prepared to enter into multiple rounds of operations and to conduct those

operations outside of the regular time. While these overnight repo operations typically

involve the purchase of Government of Canada securities, in times of market-wide

stress, the Bank has discretion to expand the list of eligible securities.

Typically, the Bank neutralizes the cash impact on the system from any Overnight

Repo or Reverse Repo operations by adjusting the amount of the afternoon Receiver

General Auction to enable it to achieve the targeted level of settlement balances at the

end of the day. However, depending on the size of the operation, the Bank may not

always be able to fully offset this amount. As an additional tool to offset pressure on

10

Reinforcing the Target for the Overnight Rate

the overnight rate, the Bank also has at its discretion the option of not fully neutralizing

the impact of those operations. If some or all of these operations are not fully

neutralized, the system could be left in a larger surplus or deficit position at the end of

the day, requiring at least one LVTS participant to leave funds on deposit at the

Bank’s deposit rate or to take an overnight advance at the Bank Rate.

11

Supporting the Efficient Functioning of Canadian Financial Markets

III. Supporting the Efficient Functioning of Canadian

Financial Markets

The Bank’s holdings of financial assets are generally driven by its role in issuing bank

notes. The issuance of bank notes creates a liability for the Bank, the largest on its

balance sheet. Government of Canada deposits, including those supporting the

government’s prudential liquidity plan, typically represent the second-largest liability

for the Bank. To offset these liabilities, the Bank needs to hold financial assets. These

assets are mainly denominated in Canadian dollars, given that the Bank’s liabilities

are mainly denominated in Canadian dollars and composed mostly of investments in

Government of Canada securities and term repos.

The Bank also undertakes financial market transactions with eligible counterparties in

support of monetary policy and the efficient functioning of Canadian financial markets.

The Bank’s transactions are typically repurchase agreements, where the Bank injects

or withdraws liquidity and acquires or sells financial assets.

The Bank’s holdings of financial assets help to promote its operational independence

and support the execution of its responsibilities. This is accomplished in two ways:

• the financial assets provide a means for the Bank to carry out its responsibilities

without being dependent on government appropriations, and

• the Bank avoids investments that might impair the process by which the federal

government allocates funds or credit to the private sector or other levels of

government.

The Bank’s Statement of Policy Governing the Acquisition and Management of

Financial Assets for the Bank of Canada’s Balance Sheet (“Statement of Policy”)

establishes the policy governing the Bank’s acquisition and management of domestic

financial assets for its balance sheet. As set out in the Statement of Policy, decisions

about the acquisition and disposition of financial assets and the management of the

Bank’s balance sheet are based on the following guidelines:

• Neutrality: The Bank limits potential market distortions from its investment

activities by acting in as broad and neutral a fashion as possible. The composition

of the Bank’s balance sheet should be structured such that the impact on the

market prices of those assets from routine purchases of specific securities should

be minimal.

• Prudence: The Bank mitigates financial risks to its balance sheet that could arise

from valuation losses or credit losses through a risk-management framework. The

framework includes collateralization, with appropriate haircuts, of any lending or

advances, and minimum credit-quality requirements for securities eligible for

collateral, repurchase transactions or outright purchases.

12

Supporting the Efficient Functioning of Canadian Financial Markets

• Transparency: Any purchase or sale of assets by the Bank should be transparent

to the public.4

While the Bank of Canada Act allows for the acquisition of a broad range of eligible

assets, the objectives and guidelines outlined above effectively limit the types of

financial assets that the Bank should acquire for its portfolio of financial assets in the

normal course of business.5 The Bank primarily acquires Government of Canada

nominal bonds and treasury bills for its balance sheet outright through non-competitive

bids at government securities auctions, and it may also acquire these securities in the

secondary market. While the Bank’s investments in Government of Canada nominal

bonds are held to maturity, the Bank may sell treasury bills in the secondary market to

fulfill its monetary policy and financial stability responsibilities.

The Bank also conducts a program of term repos that make up a portion of the assets

on the Bank’s balance sheet. These term repos are short-term transactions with

Primary Dealers against high-quality securities.

The liability-driven process of managing the Bank’s balance sheet, as described

above, could change into an asset-driven one under exceptional circumstances, if the

Bank chose for monetary policy or financial stability purposes, to conduct large-scale

asset purchases, credit easing and/or provide extraordinary liquidity. In this instance,

the Bank would actively change the size and composition of assets on its balance

sheet in a targeted fashion to meet its policy objectives. In turn, Government deposits

and/or settlement balances on the liability side of the balance sheet would grow to

passively offset assets.

1. Government of Canada Securities Portfolio

The Bank’s outright holdings of Government of Canada nominal bonds and treasury

bills are structured to broadly reflect the composition of the federal government’s stock

of nominal domestic marketable debt. The Bank does not purchase or hold

Government of Canada Real Return Bonds, given the low level of issuance of such

bonds and to avoid any perceived conflict with monetary policy.

Typically, a fixed percentage of Government of Canada bonds is acquired on a non-

competitive basis at each bond auction to achieve the target structure for asset

allocations. The Bank’s minimum purchase amount is disclosed in the Call for Tenders

of the relevant bond auction, and the actual amount purchased is disclosed in the

bond auction results. The public would also be notified of any change to this fixed

percentage of purchases.

4 This requirement for transparency may be waived under exceptional circumstances. 5 When market conditions warrant, the Bank can implement unconventional monetary policy, which may involve targeted purchases to affect certain segments of the yield curve or purchases of other assets. See the Annex included in the April 2009 Monetary Policy Report at http://www.bankofcanada.ca/wp- content/uploads/2010/03/mpr230409.pdf to learn more about the Bank’s framework for conducting monetary policy at low interest rates.

13

Supporting the Efficient Functioning of Canadian Financial Markets

Government of Canada treasury bills and cash-management bills are also acquired on

a non-competitive basis but for a variable amount, depending on the Bank’s specific

balance-sheet needs at the time of each auction. These amounts are based on Bank

staff projections of expected future demand for bank notes and other liabilities and the

amount of treasury bills and bonds that will mature in the following weeks. The actual

amount purchased is disclosed in the results of each treasury bill auction, which is

consistent with the Bank’s principle of transparency. The typical practice is to split the

total amount of treasury bills purchased by the Bank across the various maturities

offered so that the Bank’s purchases broadly reflect the same proportions of issuance

by the government across the three maturity tranches.

2. Term Repo Operations

These operations, where high-quality assets are acquired temporarily through the

repo market, are conducted to manage the Bank’s balance sheet, to promote the

orderly functioning of Canadian financial markets and to provide the Bank with

information on conditions in short-term funding markets.

As explained above, the Bank’s implementation of monetary policy is based on

influencing the overnight interest rate. However, the Bank also conducts money

market operations at longer maturities, provided such operations do not reduce the

Bank’s influence on the overnight interest rate.

Term repos transacted by the Bank typically have approximately 1- and 3-month

terms. In these transactions, the Bank purchases from Primary Dealers Canadian

dollar- denominated marketable securities that are directly issued or explicitly

guaranteed by the Government of Canada or by a Canadian provincial government. At

the end of the term, the Bank sells these same securities back to the original

counterparty at a pre- determined price, with the difference between the Bank’s initial

purchase and subsequent sale prices equaling the interest for the term of the

transaction. The Bank may also conduct term repos for different terms—for example,

to offset seasonal fluctuations in the demand for bank notes—and can modify the

range of securities eligible if deemed appropriate.

Term repo operations allow the Bank to acquire assets on a temporary basis for its

balance sheet. This provides the Bank with flexibility in the management of its assets,

and it also helps reduce the need for the Bank to acquire Government of Canada

securities outright for its balance sheet, which may help support the liquidity of the

Government of Canada securities market. These term repo operations also support

the Bank’s monitoring of liquidity conditions in term funding markets and may

encourage the further development of, and liquidity in, the longer-term repo market in

Canada.

14

Supporting the Efficient Functioning of Canadian Financial Markets

3. Standing Term Liquidity Facility (STLF)

The STLF is intended to provide greater confidence that an eligible financial institution

facing liquidity stress will have access to central bank liquidity on terms that are known

in advance. This liquidity stress can stem from various sources, including system-wide

liquidity conditions as well as operational incidents such as cyber attacks, system

failures and natural disasters. An institution is eligible to draw on the facility if the Bank

of Canada has no concerns about its financial soundness.

The STLF provides access to a broader set of eligible counterparties against a

broader set of collateral at a higher price relative to routine term repo operations and

the Standing Liquidity Facility (SLF). This facility provides the Bank with a larger menu

of complementary tools that support graduated and well-designed interventions,

consistent with the Bank’s previously established principles for liquidity intervention.

As with other Bank liquidity tools, provision of liquidity under the STLF will be at the

sole discretion of the Bank of Canada.

Figure 2: Graduated nature of the Bank of Canada's liquidity provision tool kit

15

Supporting the Efficient Functioning of Canadian Financial Markets

4. Securities-Lending Program

The Bank established its Securities-Lending Program in 2002 to help support the

liquidity of Government of Canada securities by providing a secondary and temporary

source of these securities to the market. Under this program, the Bank can lend a

portion of its holdings of Government of Canada securities to Primary Dealers when

the Bank judges that a specific bond or treasury bill is trading below a certain

threshold, or is unavailable, in the repo market. Securities are lent through a tender

process for a term of one business day.

This program helps support the liquidity of the Government of Canada securities

market and is designed to support efficient clearing and price discovery. A liquid and

efficient market for Government of Canada securities is important to the efficient

functioning of Canadian financial markets. It helps the Government and other

borrowers in their financing activities and supports the Bank’s objectives in the

transmission of monetary policy.

The Securities-Lending Program is structured such that when the program

intervention threshold is triggered, the Bank can make up to 50 per cent of its portfolio

of Government of Canada bonds and bills available on any given day. The securities

are offered through a tender process, once a day (typically at 11:15 a.m. ET) and for a

term of one business day.

16

Providing Liquidity Under Extraordinary Circumstances

IV. Providing Liquidity Under Extraordinary

Circumstances

Under exceptional circumstances, the Bank has the authority to provide extraordinary

liquidity to support financial system stability.

To respond to severe system-wide liquidity stress, the Bank can provide market-wide

liquidity in a number of ways, including by:

• increasing the level of settlement balances;

• conducting exceptional buyback transactions, to a maximum term of 380 days,

using an expanded range of securities provided that certain criteria are met;

• lending to a broader range of financial institutions than participants in the LVTS and

for terms longer than overnight;

• engaging in outright purchases of an expanded range of securities provided that

certain criteria are met and subject to amending the Bank of Canada Policy for

Buying and Selling Securities under subsection 18.1(1) of the Bank of Canada Act;

and

• typically lending on a market wide-basis, but could also lend on a bilateral basis.

To address funding shortages at specific financial entities, the Bank can also provide

secured advances through Emergency Lending Assistance (ELA) subject to the Rules

Governing Advances to Financial Institutions.

1. Providing Market-Wide Liquidity

To support the efficient functioning of Canadian financial markets in response to a

severe system-wide liquidity shortage, the Bank could expand existing operations

(e.g., Overnight Repo/Overnight Reverse Repo operations, Term Repos) along

different dimensions or introduce additional facilities to provide extraordinary market-

wide liquidity. If the liquidity shortage is system-wide rather than due to an

idiosyncratic liquidity shock at an individual institution, ELA would not necessarily be

needed.

In determining the form and quantity of extraordinary market-wide liquidity to provide,

the Bank would consider the following five guiding principles for central bank

intervention:

1. Targeted: Intervention should target market failures (liquidity distortions) that are of

system-wide importance and that can be rectified by a central bank.

2. Graduated: Intervention should be commensurate with the severity of the problem.

3. Well designed: Use the right tools for the right job. Market-based transactions, in

most cases provided through auction mechanisms, should be used to alleviate

17

Providing Liquidity Under Extraordinary Circumstances

market-wide liquidity problems, while loans should be used to address liquidity

shortages affecting specific institutions.

4. Efficient and non-distortionary: Central bank transactions should be at market-

determined prices to minimize distortions.

5. Mitigation of moral hazard: The risk of creating adverse incentives that could

impair the functioning of the financial system over time should be considered

carefully, and measures should be taken to mitigate such risks. For example, such

measures can include limited, selective intervention and penalty pricing, where

appropriate.

In terms of expanding existing operations, which are auction-based and subject to

minimum bid rates, the Bank could increase the size or overall amount of liquidity

provided (possibly alongside an increase in the level of settlement balances), the term

of the operations and/or their frequency. Additional enhancements to existing

operations could include broadening the set of eligible collateral and/or expanding the

list of eligible counterparties, subject to any criteria deemed appropriate by the Bank.

Amid the 2007–09 global financial crisis, the Bank expanded its provision of liquidity

and activated a number of temporary market-wide liquidity facilities. In accordance

with the five guiding principles outlined above, these facilities varied along different

parameters, including eligible counterparties, eligible securities and terms.6 As of April

2010, all of these temporary facilities had been deactivated; however, the Bank retains

the ability to reactivate any of these facilities or to introduce new operations to deal

with severe market-wide liquidity stress.

An additional area where the Bank could expand flexibility in response to severe

market-wide liquidity stress is to activate its standing, or non-auction based, bilateral

facility, the Contingent Term Repo Facility.

Contingent Term Repo Facility

The Bank’s standing facility to respond to severe market-wide liquidity stress is the

Contingent Term Repo Facility (CTRF). Upon activation, the CTRF would offer eligible

counterparties liquidity on a standing, bilateral basis. This facility would provide

flexibility to the Bank to offer liquidity beyond Primary Dealers and their affiliates, at

the Bank’s discretion, should the Bank deem it necessary to support the stability of the

Canadian financial system. Counterparties beyond Primary Dealers and their affiliates

would need to demonstrate significant activity in the Canadian money and/or bond

markets, be subject to federal or provincial regulation, and meet any other conditions

the Bank requires.

Activation and deactivation of the CTRF would be at the Bank’s sole discretion, as

6 These temporary market-wide liquidity facilities included the Term Purchase and Resale Agreement (PRA); the Term PRA for Private Sector Money Market Instruments, which was replaced by the Term PRA for Private Sector Instruments; and the Term Loan Facility.

18

Providing Liquidity Under Extraordinary Circumstances

conditions warrant. This facility would not be used to address idiosyncratic liquidity

shocks at individual institutions. Terms and conditions for the CTRF would be

published upon activation.

2. Advances

Emergency Lending Assistance

Emergency Lending Assistance, or ELA, is a loan or advance to eligible financial

institutions (FIs) and financial market infrastructures (FMIs) at the Bank of Canada’s

discretion.7 The provision of ELA is extraordinary and designed to provide last-resort

liquidity to individual FIs or FMIs that are facing serious liquidity problems.

These entities — FIs and FMIs — are critical players in the financial system

susceptible to large and sudden liquidity shocks. Deposit-taking FIs make loans to

individuals and businesses, partially financing them through redeemable retail

deposits and short-term wholesale funds. If an otherwise sound FI experiences a large

and sudden withdrawal of deposits and wholesale funds, it can become illiquid

because of a mismatch in the timing of cash inflows and outflows. Payment clearing

and settlement systems, or FMIs, can also experience liquidity shortages under

extreme scenarios such as multiple member defaults.8 While an FMI must have

adequate financial resources and arrangements to manage extreme but plausible

scenarios, these may not be sufficient under every scenario.

ELA is not intended to address broader, more severe system-wide liquidity shortage

and is distinct from other extraordinary liquidity facilities that may be activated during

times of funding market stress and made available to a broad set of participants.9

ELA can play a role in both the recovery and resolution of an individual FI or FMI:

• Recovery: An FI or FMI under extreme stress can trigger a process known as

recovery, whereby the entity takes actions to restore the market’s confidence in

its financial soundness. ELA can provide liquidity in support of recovery actions

undertaken by an FI.10

• Resolution: Should recovery actions be insufficient to mitigate stress faced by

an FI or FMI, the firm’s resolution authority could place the FI or FMI into

7 The power to provide ELA to FIs comes from the Bank of Canada Act, s. 18(h). The power to provide ELA to FMIs comes from the Payment Clearing and Settlement Act (PCSA), s. 7(a) and 7(b) and from the Canadian Payments Association Bylaw No. 7 Respecting the Large Value Transfer System. 8 A member participant is usually a type of financial institution but can include other types of entities. 9 During the 2007–09 financial crisis, the Term Purchase and Resale Agreement (PRA) Facility, Term PRA Facility for Private Sector Instruments and Term Loan Facility were activated as part of the Bank’s extraordinary liquidity facilities. 10 Examples of recovery actions that a financial institution could take are restructuring business lines and raising capital or funding.

19

Providing Liquidity Under Extraordinary Circumstances

resolution. At the point of entering resolution, the FI or FMI would be deemed

“non-viable.” Through the resolution process, the resolution authority would seek

to maintain functions that are critical to the economy and return the firm to

viability, or liquidate the firm in an orderly fashion.11 ELA could serve as a

source of temporary public sector liquidity to support the broader efforts of

authorities to conduct an orderly resolution of the firm.

In both recovery and resolution, the Bank retains its discretion to provide ELA.

Figure 3 illustrates how ELA may support an FI or FMI’s return to long-term viability.

This serves to highlight important differences between the role of ELA in recovery and

resolution.

The provision of ELA can create the risk of moral hazard, where FIs and FMIs

mismanage their liquidity risk because they assume central bank support will be

available. Supervisory scrutiny and liquidity regulations can help to mitigate moral

hazard.12 Nevertheless, the Bank imposes eligibility requirements and terms and

conditions for ELA to encourage FIs and FMIs to manage their liquidity safely and to

rely on private funding sources.

Terms and Conditions

The terms and conditions of ELA loans are framed by the Bank of Canada Act, the

Payment Clearing and Settlement Act (PCSA), the Bank’s lending policies, and its

loan and security agreements.13 The terms and conditions are designed to provide the

appropriate safeguards to protect the Bank from financial and legal risk and to mitigate

moral hazard.

Interest rate: The minimum rate that the Bank charges on ELA loans is the Bank

Rate, which is the rate of interest that the Bank charges on one-day loans to major

financial institutions. While the Bank has the discretion to charge an interest rate

higher than the Bank Rate, historically, the Bank has charged the Bank Rate for ELA.

Term: Under the Bank of Canada Act, the Bank can provide ELA for a maximum term

of six months. The loans can be renewed for a period of up to six months, at the

Bank’s discretion, as many times as the Bank deems necessary. In practice, ELA

loans would typically be structured as one-day loans, to be rolled over daily.

11 Examples of resolution actions with respect to an FI or FMI include recapitalization and restructuring. The resolution authority could also choose to wind down the firm in an orderly fashion. 12 For example, new Basel III regulations such as the Liquidity Coverage Ratio and the Net Stable Funding Ratio help to mitigate moral hazard and reduce the probability that institutions will require ELA. 13 View the Bank of Canada Rules Governing Advances to Financial Institutions for further information on ELA provision to financial institutions.

20

Providing Liquidity Under Extraordinary Circumstances

Figure 3: Emergency Lending Assistance in recovery or resolution

The following assumptions apply:

1. Eligibility conditions for ELA are satisfied: Eligibility conditions depend on the type

of entity making the ELA request (see Table 1).

2. The Bank decides to offer ELA: The provision of ELA complements either the

recovery actions of the FI/FMI or the resolution actions of the resolution authority.

21

Providing Liquidity Under Extraordinary Circumstances

Collateral: The Bank of Canada Act requires that all Bank lending be secured.14 As

with lending under the Bank’s Standing Liquidity Facility (SLF), the Bank must be able

to obtain a valid first-priority security interest in any collateral pledged or assigned to

support ELA.15 If the counterparty fails to repay the ELA loan, the Bank can then sell

or retain the collateral to address any losses it may face. The Bank is willing to take a

broader range of collateral for ELA than it accepts for credit under the SLF. This can

include but is not limited to

• the Canadian-dollar non-mortgage loan portfolio (NMLP);

• less liquid securities, including collateralized own-name securities; and

• Canadian-dollar mortgages, both residential and non-residential.

Because there are additional challenges inherent in accepting mortgages, the Bank

expects FIs to consider preparing alternative forms of collateral to ensure that ELA

can be readily accessed if needed. The Bank therefore generally expects to take

mortgages as a last resort to maintain financial stability. To protect the Bank from loss,

the Bank retains the right of refusal for any asset, accepting only that collateral for

which it can manage the associated legal, financial and operational risks.

Haircuts will be applied to collateral accepted so that the Bank lends an amount less

than the current value of the collateral it takes. This protects the Bank against

valuation risk and potential future declines in collateral value. For consistency, the

haircuts applied to SLF-eligible collateral pledged for ELA would generally be set

according to the Bank’s SLF collateral policy, although the Bank reserves the right to

impose different haircuts for collateral accepted under ELA.16,17 For loan collateral and

for securities for which market prices are unavailable or judged to be unreliable, the

Bank will value the collateral and set haircuts on a case-by-case basis to reflect their

risk characteristics.18

Currency: FIs and FMIs are responsible for ensuring that they have reliable

arrangements for liquidity support in foreign currencies important to their businesses,

either through private sector support or foreign central bank facilities. For FIs qualified

for ELA, the Bank could lend Canadian dollars on a collateralized basis to the illiquid

14 See the Bank of Canada Act, s. 23(d). 15 An institution would need to provide the Bank with acceptable legal documentation to support the Bank’s security interest in pledged or assigned collateral. See Rules Governing Advances to Financial Institutions for further details on the documentation required. 16 Collateral that is acceptable under the Standing Liquidity Facility (SLF) will also be accepted for ELA. For more information on the Bank’s SLF collateral policy, see http://www.bankofcanada.ca/2015/06/assets-eligible-collateral-under-bank-canadas-standing-liquidity-15- june-2015/. 17 For example, haircuts applied to the non-mortgage loan portfolio may be different under ELA than under SLF. 18 Because the Bank has the flexibility to accept any collateral for which it can manage the associated risks, it does not publish a complete list or haircut schedule for collateral accepted under ELA.

22

Providing Liquidity Under Extraordinary Circumstances

institution, which could in turn exchange those Canadian dollars for the needed

foreign currency. Where foreign exchange markets are also constrained, the Bank

may provide foreign currency liquidity to eligible FIs. For FMIs, where it is

operationally feasible, the Bank could provide foreign currency ELA, if needed, to

prevent a Canadian-domiciled designated FMI from failing to meet its obligations to a

foreign FMI.19

Eligibility Criteria

The Bank sets eligibility criteria for each type of financial entity. These criteria help

protect the Bank from loss and minimize moral hazard while ensuring that ELA can

fulfill its role in supporting the recovery or resolution of financial entities.

The Bank determines whether the preconditions for ELA are met prior to an ELA

request and updates its judgment at the time of an ELA request. The opinions of the

relevant supervisors and resolution authorities will be a key determining factor in this

judgment.

Table 1 lists the eligibility criteria for the three types of entities that are eligible for

ELA: federally regulated FIs, provincially regulated deposit-taking institutions (DTIs)

and FMIs.20

Entities that would not generally be eligible for ELA include the following:

• Insurance companies, mutual funds, and investment dealers. These entities do not

issue deposits and hold a significant share of their assets in illiquid, hard-to- value

claims.

• Foreign bank branches. Foreign bank branches should look to the central bank of

their home jurisdiction for emergency liquidity.

• Foreign FMIs. Lead central banks overseeing foreign-domiciled FMIs are

responsible for ensuring that emergency liquidity is available to those systems.

However, the Bank could facilitate the lead central bank’s provision of Canadian-

dollar liquidity should the lead central bank choose to do so.

19 A domestic FMI could require intraday access to a foreign currency to meet its obligations to a foreign FMI, and a foreign currency ELA could therefore prevent an unnecessary and costly default of the domestic FMI. 20 A deposit-taking institution is a type of financial institution that accepts deposits, which are fixed-value promises to pay, often redeemable at short notice.

23

Providing Liquidity Under Extraordinary Circumstances

Table 1: Eligibility criteria for access to Emergency Lending Assistance

Type of financial entity Eligibility criteria

Federally-regulated FI21 1. Member of the Canadian Payments Association (CPA)a 2. Credible recovery and resolution framework

Provincially-regulated DTIs

1. Member of the Canadian Payments Association (CPA)b 2. Provincial indemnity 3. Important to the stability of the broader financial system 4. Credible recovery and resolution framework

Financial market infrastructure

Canadian-domiciled FMI designated for Bank of Canada oversight

a For FIs, ELA funds would generally be disbursed through Canada’s Large Value Transfer System

(LVTS).22 Only CPA members can be LVTS participants. For federally regulated FIs that are not LVTS participants, ELA funds would be received through an LVTS participant clearing on their behalf. b For credit unions or caisse populaires that are not members of the CPA but meet all other eligibility

conditions, the Bank can lend to their provincial central with CPA membership. The central could then pass on the liquidity to the individual credit unions or caisse populaires that are not themselves CPA members.

Each of the eligibility conditions from Table 1 is described in further detail below.

Member of the Canadian Payments Association: The Bank of Canada Act provides

the Bank with the power to make secured loans or advances to members of the CPA.

Every bank is required to be a CPA member. Provincial centrals are entitled to be

members and can become a member upon application to and approval by the CPA.23

Credible recovery and resolution framework: A recovery and resolution framework

consists of the powers, governance arrangements, strategies and facilitating tools that

would be used by a firm to recover from stress, as well as the powers, governance

arrangements, strategies and facilitating tools that authorities would use to support

orderly resolution.24 A recovery and resolution framework is credible if it provides the

relevant authorities, including the Bank of Canada, with a high degree of confidence

that the long-term viability of a troubled institution can be maintained or restored, or

the institution can be liquidated in an orderly manner, without systemic disruption. This

is consistent with the Financial Stability Board’s Key Attributes of Effective Resolution

Regimes for Financial Institutions.

The Bank does not intend to develop any specific criteria or requirements for recovery

and resolution frameworks beyond those that have been or will be developed by the

21 In the case of trust companies, the “in-trust” nature of the assets held by such a firm means that ELA could be provided only through a loan secured by company assets, or through an outright purchase of assets, associated with provisions to sell the assets back to the trust company at predetermined prices. 22 The Large Value Transfer System is the large-value payments system operated by the Canadian Payments Association and forms the core of Canada’s national payments system. For further details, see http://www.bankofcanada.ca/core-functions/financial-system/canadas-major-payments-systems/#lvts. 23 For a list of CPA members, see https://www.payments.ca/our-directories/member-financial-institutions. 24 Facilitating tools can include but are not limited to contingency plans, default simulations and stress testing.

24

Providing Liquidity Under Extraordinary Circumstances

relevant supervisors and resolution authorities. Accordingly, institutions should

continue to respect the guidelines and expectations for recovery and resolution

planning established by their supervisors and resolution authorities. Before providing

an ELA loan to an institution, however, the Bank undertakes the necessary due

diligence to satisfy itself that all ELA preconditions are met.

While it will not develop specific criteria, the Bank generally considers a framework

credible if it

• seeks to maintain continuity of functions that are important to financial stability;

• identifies recovery and resolution strategies that can be readily implemented to

address extreme stress events;

• provides for effective coordination and information sharing with relevant authorities;

and

• has sufficient funding and liquidity arrangements in place to respond to extreme

stress events while ensuring that ELA, if needed for temporary funding, is used

only after private funding sources are no longer available.

In general, the tools and processes forming the recovery and resolution framework

should be commensurate with the size and complexity of the institutions within its

jurisdiction. Documents describing a firm’s crisis management or contingency planning

would help inform the judgment of the Bank and the relevant authorities regarding the

credibility of the recovery and resolution framework. Recovery and resolution plans

(“RRPs”) are not necessarily required of every financial institution in order to achieve a

credible framework, but as an institution increases in size and complexity such plans

provide greater assurance that a framework is credible.

Provincial indemnity: Provinces that have responsibility for the prudential oversight

of provincial institutions will need to indemnify the Bank from any losses if the

borrowing provincial institution were to default on its ELA loan. The requirement

reflects the fact that provincial authorities have the legislative powers to regulate local

co-operatives and therefore are responsible for the stability of the provincial financial

sector. The indemnity would only cover any residual amount should the value of the

collateral provided, as well as any guarantees by other institutions, prove insufficient.25

Provincial indemnification is not required for access to the Bank’s SLF or market-wide

liquidity facilities.

Important to the stability of the broader financial system: Bank of Canada ELA

would be available to a provincially regulated institution only if it is deemed, in the

judgment of the Bank, to be important for the stability of the broader financial system.

The Bank must be of the opinion that the distress or disorderly failure of the potential

25 Federal credit unions would be subject to the same eligibility criteria as other federally regulated deposit-taking institutions.

25

Providing Liquidity Under Extraordinary Circumstances

ELA recipient would have important adverse consequences for the broader financial

system and the Canadian economy. This requirement reflects the responsibility of

provincial authorities and the provincial centrals, to establish mechanisms to provide

liquidity to local co-operatives under most circumstances. ELA would only be supplied

in extreme scenarios.

In forming its judgment on the importance of the provincial institution to the broader

financial system, the Bank will consider, among other things, if

• stress from the co-operative system is materially contributing to and/or amplifying

adverse financial conditions;

• distress from a provincial or regional co-operative system is severely impairing

economic activity in that region; and

• distress in one or more co-operative system is actively spreading, or has an ability

to spread, through national co-operative frameworks and infrastructures.

Domestic FMIs designated for Bank of Canada oversight: The PCSA provides the

Bank with the power to lend to FMIs designated as subject to the Bank’s oversight

(designated FMIs). A financial market infrastructure is designated by the Bank if it has

the potential to pose systemic risk to Canada’s financial system or if it is a prominent

payments system that, while not systemically important, is critical for economic activity

in Canada.26

Managing ELA

Coordination with the relevant authorities

It is important to note that central bank lending cannot recapitalize an FI or FMI or

address the underlying problems that lead to liquidity shortfalls. Accordingly, the

deployment of the Bank’s liquidity facilities is just one component of a larger set of

coordinated actions that authorities can take to support the stability of the Canadian

financial system.

The Bank consults with the relevant authorities to determine whether the

preconditions for ELA have been met prior to and at the time of an ELA request. The

Bank also endeavours to keep the relevant authorities informed of prospective ELA

situations and to notify them immediately if ELA is provided to an institution.

For federally regulated FIs, the Financial Institutions Supervisory Committee (FISC) is

the primary forum for the exchange of information and for coordinating strategies,

such as those for contingency planning, among federal authorities when dealing with

troubled institutions that are still viable.27 Relatedly, federal authorities would primarily

26 For designated FMIs, see http://www.bankofcanada.ca/core-functions/financial-system/oversight- designated-clearing-settlement-systems/. 27 For the legislative basis underpinning FISC, see Section 18 of the Office of the Superintendent of Financial Institutions Act at http://laws-lois.justice.gc.ca/eng/acts/o-2.7/page-6.html#h-12.

26

Providing Liquidity Under Extraordinary Circumstances

coordinate resolution strategies for non-viable firms through the Board of Directors of

the Canadian Deposit Insurance Corporation’s. The borrowing institution may be

required to provide increased reporting (data and other information) to the Office of

the Superintendent of Financial Institutions or the Bank on the institution’s evolving

situation.

For provincially regulated deposit-taking institutions, the Bank endeavours to establish

formal arrangements for communication with the relevant provincial authorities.

For FMIs that are also overseen by other regulatory authorities, the Bank establishes

co-operative arrangements with those authorities to facilitate communication and

coordination.

Exiting ELA

The ELA loan agreements between the Bank and the borrowing entity would create a

one-day revolving facility in which the Bank would have discretion to decline to make

any further one-day loans. This would allow the Bank to readily cease ELA.

The Bank would cease ELA if this was judged by the Bank to be appropriate. This

could occur, for example, if the borrowing entity no longer met or is unlikely to

continue meeting all necessary ELA eligibility criteria or if the collateral to support ELA

was no longer sufficient.

ELA Disclosure

The Bank is legally prohibited from disclosing the identity of borrowing institutions. The

amounts of ELA advances are not included in the Bank’s Weekly Financial Statistics

until public disclosures have otherwise occurred. Any outstanding ELA advances are

included in the Bank’s monthly balance sheet and its annual and quarterly financial

statements at an aggregate level.

The Relationship Between the Standing Liquidity Facility and ELA

The Standing Liquidity Facility (SLF) is part of the Bank’s routine operations and helps

smooth the functioning of the payments system by providing overnight secured

advances to LVTS participants experiencing temporary liquidity shortages due to

unexpected payments system frictions. The Bank monitors SLF usage for any unusual

access that may be a sign of significant and persistent liquidity shortage, which the

SLF is not intended for. In such extraordinary circumstances, eligible financial

institutions may consider requesting ELA from the Bank. ELA is intended to address

persistent liquidity shortages and can provide more substantial and prolonged credit.

Since SLF advances are designed to help resolve day-to-day LVTS payment frictions,

there is no presumption of a protracted liquidity problem or solvency risk with its use.

In contrast, under ELA, there is clearly a significant liquidity problem affecting the

institution, so the risk to the Bank, as its lender, is greater. Consequently, more-

stringent eligibility conditions and different terms and conditions apply under ELA.