De Nederlandsche Bank Eurosysteem The Monetary Policy Framework of the Eurosystem, liquidity and...

De Nederlandsche Bank Eurosysteem

The Monetary Policy Framework

of the Eurosystem, liquidity and Collateral Management

Richard Derksen Conference Financial Sector of Macedonia on Payments and Securities Settlement Systems

Ohrid 24 June 2008

De Nederlandsche Bank


• The ESCB (Euro System of Central Banks) monetary policy framework

•Collateral management framework

•Trends in collateral: European and NL

•Mobilising collateral

TopicsContents


Monetary policy strategy:Monetary policy strategy:

Why central banks?Why central banks? What targets have central banks?What targets have central banks? Why to fight inflation?Why to fight inflation?

Monetary policy implementation:Monetary policy implementation: How to implement these strategies?How to implement these strategies? Role and functions of official interest rates?Role and functions of official interest rates? How can a central bank generate stable interest How can a central bank generate stable interest rate movements?rate movements?

Monetary policy strategy:Monetary policy strategy:

Why central banks?Why central banks? What targets have central banks?What targets have central banks? Why to fight inflation?Why to fight inflation?

Monetary policy implementation:Monetary policy implementation: How to implement these strategies?How to implement these strategies? Role and functions of official interest rates?Role and functions of official interest rates? How can a central bank generate stable interest How can a central bank generate stable interest rate movements?rate movements?


Monetary policy strategy:Monetary policy strategy:The monetary strategy determines which money

market interest rate level is required to maintain

price stability.

Monetary policy implementation:Monetary policy implementation:The operational framework determines how to

achieve this interest rate level using the available

monetary instruments.


Functions of the operational framework

Eurosystem sets and stabilises interest rates inthe short term money market in two ways:

Signalling its monetary policy stance to the money market

Managing the liquidity situation in the money market


How to set (money market) interest rates?How to set (money market) interest rates?

Step 1: determine official interest ratesStep 1: determine official interest rates

Step 2: make banks dependent on credit by the ECBStep 2: make banks dependent on credit by the ECB

Step 3: extend credit to banks with the appropriateStep 3: extend credit to banks with the appropriate interest rateinterest rate

Step 4: design framework to stabilise very Step 4: design framework to stabilise very short-term interest ratesshort-term interest rates

How to set (money market) interest rates?How to set (money market) interest rates?

Step 1: determine official interest ratesStep 1: determine official interest rates

Step 2: make banks dependent on credit by the ECBStep 2: make banks dependent on credit by the ECB

Step 3: extend credit to banks with the appropriateStep 3: extend credit to banks with the appropriate interest rateinterest rate

Step 4: design framework to stabilise very Step 4: design framework to stabilise very short-term interest ratesshort-term interest rates


Monetary policy instruments:Monetary policy instruments:

• Minimum reserve requirementsMinimum reserve requirements Credit extension to banks viaCredit extension to banks via• Open Market OperationsOpen Market Operations

Main refinancing operationsMain refinancing operations Long-term refinancing operationsLong-term refinancing operations Fine-tuning operations Fine-tuning operations Structural operations Structural operations

• Standing facilitiesStanding facilities Marginal lending facilityMarginal lending facility Deposit facilityDeposit facility

Monetary policy instruments:Monetary policy instruments:

• Minimum reserve requirementsMinimum reserve requirements Credit extension to banks viaCredit extension to banks via• Open Market OperationsOpen Market Operations

Main refinancing operationsMain refinancing operations Long-term refinancing operationsLong-term refinancing operations Fine-tuning operations Fine-tuning operations Structural operations Structural operations

• Standing facilitiesStanding facilities Marginal lending facilityMarginal lending facility Deposit facilityDeposit facility


Basic requirements for successful Basic requirements for successful monetary policy implementation:monetary policy implementation:

Confidence market playersConfidence market players

Demand and supply Demand and supply

Regulatory framework Regulatory framework

…………

Basic requirements for successful Basic requirements for successful monetary policy implementation:monetary policy implementation:

Confidence market playersConfidence market players

Demand and supply Demand and supply

Regulatory framework Regulatory framework

…………


Liquidity management Eurosystem:Liquidity management Eurosystem:Liquidity management Eurosystem:Liquidity management Eurosystem:

Demand- Reserve

requirements - Excess reserves- Autonomous factors factors (net)

- deposit facility

Supply– Open market operations

- MROs (policy rate)- LTROs- Fine tuning- Structural operations

– marginal lending facility


Demand- Reserve

requirements - Excess reserves- Autonomous factors factors (net)

- deposit facility

Supply– Open market operations

- MROs (policy rate)- LTROs- Fine tuning- Structural operations

– marginal lending facility

=

(over

a

reserve

mainte-

nance

period)

Liquidity management Eurosystem:Liquidity management Eurosystem:Liquidity management Eurosystem:Liquidity management Eurosystem:


July2007

March2008

July2007

March2008

factors affecting the liquidity of the banking system 432.6 478.0

factors affecting the liquidity of the banking system 692.0 737.9

net foreign assets (including gold) 316.7 350.5 banknotes in circulation 639.6 660.8

other assets (net) 115.9 127.5government deposits with the Eurosystem 52.3 77.1

monetary policy operations of the Eurosystem 451.8 486.0

monetary policy operations of the Eurosystem 192.4 226.1

main refinancing operations 301.7 216.0 current accounts - minimum reserves 192.0 225.1

longer-term refinancing operations 150.0 270.0 deposit facility 0.4 1.0

marginal lending facility 0.1 0.0 other operations 0.0 0.0

other operations 0.0 0.0

total 884.4 964.0 total 884.4 964.0

Consolidated Balance Sheet of the Eurosystem (July 2007 and March 2008) (EUR bn)


Future challengesFuture challenges::

a)a) the management of the volatility of short term the management of the volatility of short term interest ratesinterest rates

b)b) determining the optimal size and composition of determining the optimal size and composition of central bank balance sheetcentral bank balance sheet

c)c) the appropriate level of communication with the the appropriate level of communication with the financial marketsfinancial markets

d)d) contribute to further integration of financial contribute to further integration of financial markets by harmonising and expanding collateral markets by harmonising and expanding collateral instrumentsinstruments

Future challengesFuture challenges::

a)a) the management of the volatility of short term the management of the volatility of short term interest ratesinterest rates

b)b) determining the optimal size and composition of determining the optimal size and composition of central bank balance sheetcentral bank balance sheet

c)c) the appropriate level of communication with the the appropriate level of communication with the financial marketsfinancial markets

d)d) contribute to further integration of financial contribute to further integration of financial markets by harmonising and expanding collateral markets by harmonising and expanding collateral instrumentsinstruments






TopicsContents


• Article 18.1 of the Statute requires all credit operations by the Eurosystem to be “based on adequate collateral”. The concept of adequacy has 2 notions:1. Collateral must be able to protect the Eurosystem from incurring

losses in its credit operations 2. There must be sufficient collateral potentially available to ensure that

the Eurosystem can carry out its tasks

• To reconcile both notions of “adequate collateral” may not be easy:1. The range of assets must be broad to ensure the sufficiency of collateral

2. This may be in conflict with the desire for operational efficiency and transparency

To what extent compromises on the principle of operational efficiency need to be made depends on the structure of financial markets

Guiding Principles of the Collateral Framework


Single list of collateral

Operational on January 1st, 2007 Drawbacks 2-tiers list (1999-2006): heterogeneity

and no transparency 2 asset classes:

marketable assets and non-marketable assets (no quality difference)

Marketable assets: high credit standards (single A↑), located in the euro area, denomination euro


Single list of collateral

Marketable assets: listed on regulated markets or certain accepted non-regulated markets

Non-marketable assets: credit claims and Irish non-marketable retail mortgage backed debt instruments, no market criterion

For both asset classes -> Eurosystem credit assessment framework


Eurosystem Credit Assessment Framework

ECAF sources: ECAI – External Credit Assessment Institutions ICAS – NCBs in-house credit assessment systems IRB – counterparties internal ratings-based systems RT – third-party providers rating tools.

Additionally: PSE-list and guarantees

(ECAF principles: consistency, accuracy and comparability)


ECAF benchmark/threshold

´Single A` (A-Fitch and S&P, A3 Moody´s)

Or Probability of default (PD) over a one-year

horizon of 0,10%

Default definition from EU Capital Requirements Directive (CRD)


Marketable assets

Define the most representative price source

Rules for non-availability of prices

Treatment of income flows

Non-marketable assets

Theoretical price or outstanding amount

Valuation principles


Legal technique: pledge Pool of collateral

- total market value minus haircut (+interest) = credit line

- integrated use of the collateral pool on request of credit institutions like supporting services, e.g. CCP margin and guarantees for special purposes

Legal setting credit claims: public pledge, physical delivery loan documentation, ex ante notification of debtor

[Situation before EMU/1999: extensive collateral list: equities, private loans, loans in other currencies]

Present collateral framework (NL)


Stabilising features of the Eurosystem’s collateral framework

Key features of the Eurosystem’s collateral framework: Acceptance of a broad range of debt instruments as collateral No collateral differentiation between tender operations and standing

facilities Single auction rate applicable to different types of collateral in

tender operations

Performance during the turmoil: Sufficiency of collateral ensured, facilitating broad access to central

bank money Low consumption of high opportunity cost collateral Mitigation of asset refinancing risk through large scale acceptance

of ABS in the main refinancing operations






TopicsContents


0

1000

2000

3000

4000

5000

6000

7000

8000

9000

10000

2004 2005 2006 2007

Non-marketableassets

Other marketableassets

ABS

Corporate bonds

Covered bank bonds

Uncovered bankbonds

Regional government

Central government

Evolution of eligible marketable and non-marketable collateral by asset type (€ billion)


0%

10%

20%

30%

40%

50%

60%

70%

80%

90%

100%

2004 2005 2006 2007

Non-marketableassets

Other marketableassets

ABS

Corporate bonds

Covered bank bonds

Uncovered bankbonds

Regional government

Central government

Trend towards use of more illiquid collateral


Situation NL: Statistics on collateral in the pool (end December 2006 versus end March 2008)

Total (Marketvalue, before haircuts)

€ 74 bn € 138 bn

CCBM

ENL

EB

Domestic± € 17 bn ± € 78,3 bn

Via link:± € 2,7 bn € 2,8 bn

Eurobonds± € 19,6 bn € 31 bn

DE ± 8/ IT ± 11

± € 32,4 bn € 23 bn

vaultCredit claims

± € 2,3 bn ± € 2,9 bn


Collateral management domestic

DNB vault Euroclear

Netherlands (CSD) Foreign (cross border)

Direct links Euroclear Bank CCBM

CSD foreign

CSD domestic

CSD foreign

DNB

ICSD (eurobonds)

CCB

CCB

Infrastructure


EuroclearNetherlands Bank A

DNB

12

1

Structure of domestic safekeeping

3 (= €)

Domestic


EuroclearNetherlands

(I)CSD(Monte Titoli)

DNB1

21

Bank A3 (= €)

Structure of eligible links

Eligible links


CCBM Dutch Eurosystem counterparty sends Swift

MT540 to DNB (and MT542 to its own custodian)

DNB sends MT540 to the respective CCB Upon receipt of the securities, the CCB

sends an MT544 to DNB DNB updates its collateral management

system and increases the credit facility for the Dutch Eurosystem counterparty


Structure of CCBM

CCBM - Correspondent Central Bank Model

CCB - Correspondent Central Bank

HCB - Home Central Bank

CSD - Central Securities Depository

CCB

CSD

Custodian/Agent Bank A

HCB

1

4

3

2

1

5 (= €)

CCBM


National domestic procedures

A common procedure with minimum harmonisation for cross-border use (level of automation, communication protocols)

CPY A NCB A SSS A

SSS BNCB A NCB BCPY A

Step3: transfer instruction

Step1: Request

for credit

Step2: CCBM

message

Step3: Matching

Step 4:Confirmation

Step5: ReceiptStep6:Release credit

Step1: Requestfor credit

Step2: Matching

Step 3:Confirmation/

receipt

Step4:Release credit

Step2: transfer instruction

The current framework for the use of collateral


NCB A

NCB B NCB A SSS ACPY B

SSS ACPY A

CCBM2 platform

Single procedur

e for domestic

and cross-border

Harmonised procedures

for counterparti

es

CCBM2 – A single procedure for domestic and cross-border use of collateral

PSSC/SWG/2007/414


Sub -Cash

accounts

Cash accounts

Securities accounts

Single Eurosyste

m Interface

TARGET2-Securities

TARGET2

Synergies with other Eurosystem initiatives

CCBM2

Custody accounts


Summing up

Basics on monetary and collateral framework Single list and ECAF NL situation Collateral mobilisation


Thank you very much !

QuQu€€stions?stions?


Some detailed slides


Minimum reserve requirements:Minimum reserve requirements:

During a reserve maintenance period banks have During a reserve maintenance period banks have on average to maintain a certain percentage of on average to maintain a certain percentage of certain banks’ balance sheet items (2%) on an certain banks’ balance sheet items (2%) on an account at the central banksaccount at the central banks

Create / increase money market shortage Create / increase money market shortage (counterparties vis à vis Eurosystem)(counterparties vis à vis Eurosystem)

Averaging feature helps stabilising overnight andAveraging feature helps stabilising overnight and intraday money market ratesintraday money market rates


During a reserve maintenance period banks have During a reserve maintenance period banks have on average to maintain a certain percentage of on average to maintain a certain percentage of certain banks’ balance sheet items (2%) on an certain banks’ balance sheet items (2%) on an account at the central banksaccount at the central banks

Create / increase money market shortage Create / increase money market shortage (counterparties vis à vis Eurosystem)(counterparties vis à vis Eurosystem)

Averaging feature helps stabilising overnight andAveraging feature helps stabilising overnight and intraday money market ratesintraday money market rates



Interest paid over required reservesInterest paid over required reserves

Excess reserves not remunerated, Excess reserves not remunerated, giving incentive to go to the market giving incentive to go to the market

Penalty in case of non-compliancePenalty in case of non-compliance

Banks with large payment flows prefer large Banks with large payment flows prefer large reserve requirementsreserve requirements


Interest paid over required reservesInterest paid over required reserves

Excess reserves not remunerated, Excess reserves not remunerated, giving incentive to go to the market giving incentive to go to the market

Penalty in case of non-compliancePenalty in case of non-compliance

Banks with large payment flows prefer large Banks with large payment flows prefer large reserve requirementsreserve requirements



Current amount reserve requirements for the Current amount reserve requirements for the Eurosystem ± EUR 202 billion Eurosystem ± EUR 202 billion (The Netherlands ± EUR 20 billion, (The Netherlands ± EUR 20 billion, largest 5 counterparties account for ± 90% in NL) largest 5 counterparties account for ± 90% in NL)


Current amount reserve requirements for the Current amount reserve requirements for the Eurosystem ± EUR 202 billion Eurosystem ± EUR 202 billion (The Netherlands ± EUR 20 billion, (The Netherlands ± EUR 20 billion, largest 5 counterparties account for ± 90% in NL) largest 5 counterparties account for ± 90% in NL)


Open markt operationsOpen markt operations::

Main refinancing operations (MROs)Main refinancing operations (MROs)about 70% of total credit extensionabout 70% of total credit extension

Long term refinancing transactions (LTROs)Long term refinancing transactions (LTROs)about 30% of total credit extensionabout 30% of total credit extension

Fine-tuning operations (FTOs) Fine-tuning operations (FTOs) nowadays last day of the reserve maintenance nowadays last day of the reserve maintenance

periodperiod

Structural operations Structural operations

Open markt operationsOpen markt operations::

Main refinancing operations (MROs)Main refinancing operations (MROs)about 70% of total credit extensionabout 70% of total credit extension

Long term refinancing transactions (LTROs)Long term refinancing transactions (LTROs)about 30% of total credit extensionabout 30% of total credit extension

Fine-tuning operations (FTOs) Fine-tuning operations (FTOs) nowadays last day of the reserve maintenance nowadays last day of the reserve maintenance

periodperiod

Structural operations Structural operations


Main refinancing operations (MROs):Main refinancing operations (MROs):

Open for all banks with a minimum reserve Open for all banks with a minimum reserve requirement (cf US system of primary dealers)requirement (cf US system of primary dealers)

Interest rate on MROs is main ECB interest rateInterest rate on MROs is main ECB interest rate

Main source credit extension EurosystemMain source credit extension Eurosystem

Variable rate tender (opposite to fixed rate tender)Variable rate tender (opposite to fixed rate tender)

Marginal rate few base points above min. bidrateMarginal rate few base points above min. bidrate

Main refinancing operations (MROs):Main refinancing operations (MROs):

Open for all banks with a minimum reserve Open for all banks with a minimum reserve requirement (cf US system of primary dealers)requirement (cf US system of primary dealers)

Interest rate on MROs is main ECB interest rateInterest rate on MROs is main ECB interest rate

Main source credit extension EurosystemMain source credit extension Eurosystem

Variable rate tender (opposite to fixed rate tender)Variable rate tender (opposite to fixed rate tender)

Marginal rate few base points above min. bidrateMarginal rate few base points above min. bidrate


Main refinancing operations (MROs):Main refinancing operations (MROs):Main refinancing operations (MROs):Main refinancing operations (MROs):

BE; 94

GR; 29ES; 132

IT; 74

LU; 154

NE; 79AT; 32

FR; 127

IE; 39

DE; 849

FI; 13SI; 20PT; 33

BE DE GR ES FR IE IT LU NE AT PT SI FI

Graph Counterparties eligible for OMO by countryNumber and percentages respectively end of March 2007.

Source: ECB.


Long term refinancing transactions Long term refinancing transactions (LTROs):(LTROs):

Liquidity providingLiquidity providing

Monthly auction via variable rate tenderMonthly auction via variable rate tender

Three month maturity Three month maturity


Liquidity providingLiquidity providing

Monthly auction via variable rate tenderMonthly auction via variable rate tender

Three month maturity Three month maturity



Reverse transactionsReverse transactions

Pre-announced 50 billion euro size eachPre-announced 50 billion euro size each

Particularly designed for smaller banksParticularly designed for smaller banks

Amount allotted is sufficient to balance supplyAmount allotted is sufficient to balance supply and demandand demand


Reverse transactionsReverse transactions

Pre-announced 50 billion euro size eachPre-announced 50 billion euro size each

Particularly designed for smaller banksParticularly designed for smaller banks

Amount allotted is sufficient to balance supplyAmount allotted is sufficient to balance supply and demandand demand


Fine-tuning operations (FTOs):Fine-tuning operations (FTOs):

Smooth out effects on interest rates of unexpectedSmooth out effects on interest rates of unexpected liquidity fluctuationsliquidity fluctuations

Liquidity providing or liquidity absorbingLiquidity providing or liquidity absorbing

Ad hoc basis and regular basis i.e. last day of aAd hoc basis and regular basis i.e. last day of a reserve maintenance period reserve maintenance period


Smooth out effects on interest rates of unexpectedSmooth out effects on interest rates of unexpected liquidity fluctuationsliquidity fluctuations

Liquidity providing or liquidity absorbingLiquidity providing or liquidity absorbing

Ad hoc basis and regular basis i.e. last day of aAd hoc basis and regular basis i.e. last day of a reserve maintenance period reserve maintenance period



Short-term basisShort-term basis

Tender or bilateral operationTender or bilateral operation

Selected group of fine-tuning counterpartiesSelected group of fine-tuning counterparties


Short-term basisShort-term basis

Tender or bilateral operationTender or bilateral operation

Selected group of fine-tuning counterpartiesSelected group of fine-tuning counterparties


Structural operations:Structural operations:

Liquidity-providing or liquidity-absorbing

Conducted on an ad hoc basis (never used yet)

Maturity not standardised

Tender or bilateral operations

Structural operations:Structural operations:

Liquidity-providing or liquidity-absorbing

Conducted on an ad hoc basis (never used yet)

Maturity not standardised

Tender or bilateral operations


Types of open market operations:Types of open market operations:

Reverse transactions

Outright transactions

Foreign exchange swaps

Collection of fixed-term deposits

Issuance of ECB debt certificates

Types of open market operations:Types of open market operations:

Reverse transactions

Outright transactions

Foreign exchange swaps

Collection of fixed-term deposits

Issuance of ECB debt certificates


Stabilizing money market interest Stabilizing money market interest rates:rates:

Fine-tuning instrumentsFine-tuning instruments

Averaging facility on the reserve requirementsAveraging facility on the reserve requirements

Standing facilitiesStanding facilities

Stabilizing money market interest Stabilizing money market interest rates:rates:

Fine-tuning instrumentsFine-tuning instruments

Averaging facility on the reserve requirementsAveraging facility on the reserve requirements

Standing facilitiesStanding facilities


Standing facilitiesStanding facilities : :

Deposit facilityDeposit facility overnight liquidity absorptionovernight liquidity absorption at relatively low (official) interest at relatively low (official) interest raterate floor for market ratesfloor for market rates normally no restrictionsnormally no restrictions

Marginal lending facilityMarginal lending facilityovernight liquidity provisionovernight liquidity provision

at relatively high (official) interest at relatively high (official) interest raterate ceiling for market ratesceiling for market rates normally no restrictions except normally no restrictions except collateralcollateral


Deposit facilityDeposit facility overnight liquidity absorptionovernight liquidity absorption at relatively low (official) interest at relatively low (official) interest raterate floor for market ratesfloor for market rates normally no restrictionsnormally no restrictions

Marginal lending facilityMarginal lending facilityovernight liquidity provisionovernight liquidity provision

at relatively high (official) interest at relatively high (official) interest raterate ceiling for market ratesceiling for market rates normally no restrictions except normally no restrictions except collateralcollateral



General:General:

Providing / absorbing liquidity at the discretion ofProviding / absorbing liquidity at the discretion of banks/at the initiative of counterpartiesbanks/at the initiative of counterparties

Limiting maximum interest volatilityLimiting maximum interest volatility

Signal general stance of monetary policySignal general stance of monetary policy


General:General:

Providing / absorbing liquidity at the discretion ofProviding / absorbing liquidity at the discretion of banks/at the initiative of counterpartiesbanks/at the initiative of counterparties

Limiting maximum interest volatilityLimiting maximum interest volatility

Signal general stance of monetary policySignal general stance of monetary policy


MARKETABLE ASSETS

Type of assets ECB debt certificates; other marketable debt instruments

Credit standards Asset of high credit standard; using ECAF rules

Place of issue EEA

Settlement/handling procedures

Settled in euro area; centrally deposited in book-entry form with central banks or SSS fulfilling ECB’s minimum standards

Type of issuer/debtor/guarantor

Central banks; public sector; private sector; international and supranational institutions

Place of establishment of

Issuer/debtor/guarantor

Issuer: EEA or non-EEA G10 countries; Guarantor EEA

Acceptable markets Regulated markets; non-regulated market accepted by ECB

Currency Euro

Cross-border use Yes

(No minimum size; no governing law)


NON-MARKETABLE ASSETS: CREDIT CLAIMS

Type of assets Credit claims

Credit standards High credit standard for debtor/guarantor; using ECAF rules

Settlement/handling procedures

Eurosystem procedures

Type of issuer/debtor/guarantor

Public sector; non-financial corporations; international and supranational institutions

Place of establishment of

Issuer/debtor/guarantor

Euro area

Currency Euro

Minimum size Until Dec 2011: NCB choice for domestic use; 500,000 for cross-border use. After 1 Jan 2012: 500,000

Governing law Law of a euro area Member State;

Cross-border use Yes

(Additional legal requirement: verification of existence, notification of debtor or registration, no restrictions from banking secrecy, no restrictions on

mobilisation or realisation). (Not applicable: place of issue; acceptable markets)


Marketable assets Credit claims

Valuation haircut

Liquidity category Coupon type Residual maturity

Residual maturity Type of interest rate paymentValuation methodology (NCBs)

Variation margin

Trigger point (0.5%) Assets or cash (depends on NCBs)

Trigger point (0.5%)

Risk control

measures

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