De Nederlandsche Bank Eurosyst eem 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
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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
De Nederlandsche Bank Eurosysteem
• The ESCB (Euro System of Central Banks) monetary policy framework
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?
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?
De Nederlandsche Bank Eurosysteem
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.
De Nederlandsche Bank Eurosysteem
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
De Nederlandsche Bank Eurosysteem
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
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)
De Nederlandsche Bank Eurosysteem
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
De Nederlandsche Bank Eurosysteem
• The ESCB (Euro System of Central Banks) monetary policy framework
•Collateral management framework
•Trends in collateral: European and NL
•Mobilising collateral
TopicsContents
De Nederlandsche Bank Eurosysteem
• 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
De Nederlandsche Bank Eurosysteem
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
De Nederlandsche Bank Eurosysteem
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
(ECAF principles: consistency, accuracy and comparability)
De Nederlandsche Bank Eurosysteem
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)
De Nederlandsche Bank Eurosysteem
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
De Nederlandsche Bank Eurosysteem
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)
De Nederlandsche Bank Eurosysteem
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
De Nederlandsche Bank Eurosysteem
• The ESCB (Euro System of Central Banks) monetary policy framework
•Collateral management framework
•Trends in collateral: European and NL
•Mobilising collateral
TopicsContents
De Nederlandsche Bank Eurosysteem
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)
De Nederlandsche Bank Eurosysteem
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
De Nederlandsche Bank Eurosysteem
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
De Nederlandsche Bank Eurosysteem
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
De Nederlandsche Bank Eurosysteem
EuroclearNetherlands Bank A
DNB
12
1
Structure of domestic safekeeping
3 (= €)
Domestic
De Nederlandsche Bank Eurosysteem
EuroclearNetherlands
(I)CSD(Monte Titoli)
DNB1
21
Bank A3 (= €)
Structure of eligible links
Eligible links
De Nederlandsche Bank Eurosysteem
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
De Nederlandsche Bank Eurosysteem
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
De Nederlandsche Bank Eurosysteem
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
De Nederlandsche Bank Eurosysteem
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
De Nederlandsche Bank Eurosysteem
Sub -Cash
accounts
Cash accounts
Securities accounts
Single Eurosyste
m Interface
TARGET2-Securities
TARGET2
Synergies with other Eurosystem initiatives
CCBM2
Custody accounts
De Nederlandsche Bank Eurosysteem
Summing up
Basics on monetary and collateral framework Single list and ECAF NL situation Collateral mobilisation
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)
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)
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)
De Nederlandsche Bank Eurosysteem
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
De Nederlandsche Bank Eurosysteem
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
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
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
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
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
De Nederlandsche Bank Eurosysteem
Standing facilitiesStanding facilities : :
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
Standing facilitiesStanding facilities : :
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
De Nederlandsche Bank Eurosysteem
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)
De Nederlandsche Bank Eurosysteem
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)
De Nederlandsche Bank Eurosysteem
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)