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Central Bank Liquidity Management Techniques in crisis times

Bank of England (BOE)2007-2010

Yonca Kumsar

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Topics to cover :

1.Monetary Policy of BOE– Interest Rate– Quantitative Easing

2.Reserve Requirements 3.Operational Standing Facilities4.Balance Sheets of BOE

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1.Monetary Policy Operations• Monetary Policy Committee decides on Bank Rate • In March 2009 MPC announced it starts to inject money

directly into the economy by purchasing assets, known as Quantitative Easing

– Why ? In recession you cant lower interest rates below zero, then quantitative easing is used to support demand.

– BOE reduced Bank Rate by %0.5 to %0.5 and announced £75 Billion Asset Purchase Programme

(5 March 2009)

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Interest Rates

• Bank Rate: interest rate which bank lends to financial institutions

• SONIA: Sterling Overnight Interbank Average rate • The Bank seeks to meet the inflation target(%2)

by setting Bank rate.• In crisis: Bank rate is lowered to prevent

contraction in the economy.• BOE reduced bank rate by 0.5 to %0.5. (March

2009)

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Quantitative Easing

• In Jan2009, Asset Purchase Facility (APF) is authorised to buy high-quality assets

• Purchase of assets are financed by the Bank creating money

• In 5 March, MPC is authorised to use the APF for monetary policy purpose

• In crisis: BOE announced £75 Billion Asset Purchase Programe

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UK policy rates and o/n rate (SONIA)

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2.Reserve Requirements

• voluntary reserve ratio system, with no minimum reserve requirement

• reserves averaged over a monthly maintenance period during which they are remunerated at Bank Rate

• How can we explain these changes in average cash reserve ratio across the entire United Kingdom banking system ?

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Country 1968 1978 1988 1998 2010

United Kingdom

20.5 15.9 5.0 3.1 43.1

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• Answer: • In 2010 it was very high, with a 43.1% average

this reflects the impact of Quantitative Easing . • From 1968 to 1998 it has been declining for

many years

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3.Operational Standing Facilities

• Aim : to prevent money market rates moving away from Bank rate

• Corridor is symmetric with the deposit rate of 25bps below Bank Rate and the lending rate 25bps above Bank Rate.

• Banks are encouraged to transfer colleteral into the Bank

• They have weekly intermeetings.

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Symmetric Corridor Approach

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In crisis times:

• But , In March 2009 : deposit rate was set to zero and lending rate to 25bps above Bank rate.

• Also , they enlarged their colleteral demand to be more productive.

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4.Balance Sheets of BOE

Why do Balance sheet percentages of annual nominal GDP increase after crisis times ?

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Balance Sheet as % of GDP

It reflects an expansion of both the Bank’s liquidityinsurance operations, and more recently the addition of assetpurchases as an operating objective of the Monetary Policy Committee.

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Assets :

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Liabilities:

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In Crisis:

• Dollar reverse repo operations increased , because Federal Reserve Bank of New York provided $ after Lehman Bankruptcy and in return BOE lended sterling

• In case of long term need of liquidity long term reverse repos increased.

• Loan to asset purchase facility : Quantitative easing

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Leanness Indicator :

• When AF- BN is zero , when Balance Sheet only displays MPI , than BS is lean

• Indicator :1-(AF in assets+AF in liab –BN) /( 2* BS Length)

• In crisis: BN remained almost same but since AF as FX and assets increased, leanness decreased.

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BS pre and after crisis

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Thank you!