The Monetary Policy Framework of the Eurosystem, liquidity and

1. De Nederlandsche Bank The Monetary Policy Framework of the Eurosystem, liquidity and Collateral Management Richard DerksenConference Financial Sector of Macedonia on Payments and Securities Settlement Systems Ohrid 24 June 2008

2. Contents Topics • The ESCB (Euro System of Central Banks) monetary policy framework • Collateral management framework • Trends in collateral: European and NL • Mobilising collateral

3. Monetary policy strategy: • Why central banks? • What targets have central banks? • Why to fight inflation? • Monetary policy implementation: • How to implement these strategies? • Role and functions of official interest rates? • How can a central bank generate stable interest rate movements?

4. Monetary policy strategy: The monetary strategy determines which money market interest rate level is required to maintain price stability. Monetary policy implementation: The operational framework determines how to achieve this interest rate level using the available monetary instruments.

5. Functions of the operational framework • Eurosystem sets and stabilises interest rates in • the short term money market in two ways: • Signalling its monetary policy stance to the money market • Managing the liquidity situation in the money market

6. How to set (money market) interest rates? Step 1: determine official interest rates Step 2: make banks dependent on credit by the ECB Step 3: extend credit to banks with the appropriate interest rate Step 4: design framework to stabilise very short-term interest rates

7. Monetary policy instruments: • Minimum reserve requirements • Credit extension to banks via • Open Market Operations • Main refinancing operations • Long-term refinancing operations • Fine-tuning operations • Structural operations • Standing facilities • Marginal lending facility • Deposit facility

8. Basic requirements for successful monetary policy implementation: • Confidence market players • Demand and supply • Regulatory framework • ……

9. 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

10. 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 = (over a reserve mainte- nance period)

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

12. Future challenges: • the management of the volatility of short term interest rates • determining the optimal size and composition of central bank balance sheet • the appropriate level of communication with the financial markets • contribute to further integration of financial markets by harmonising and expanding collateral instruments

13. Contents Topics • The ESCB (Euro System of Central Banks) monetary policy framework • Collateral management framework • Trends in collateral: European and NL • Mobilising collateral

14. Guiding Principles of the Collateral Framework • 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: • Collateral must be able to protect the Eurosystem from incurring losses in its credit operations • 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

15. 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

16. 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

17. 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)

18. 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)

19. Valuation principles • 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

20. Present collateral framework (NL) • 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]

21. 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

22. Contents Topics • The ESCB (Euro System of Central Banks) monetary policy framework • Collateral management framework • Trends in collateral: European and NL • Mobilising collateral

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

24. Trend towards use of more illiquid collateral

25. Situation NL: Statistics on collateral in the pool (end December 2006 versus end March 2008) Total (Marketvalue, before haircuts) € 74 bn € 138 bn Credit claims ± € 2,3 bn ± € 2,9 bn vault Via link: ± € 2,7 bn € 2,8 bn Domestic ± € 17 bn ± € 78,3 bn ENL Eurobonds ± € 19,6 bn € 31 bn EB DE ± 8/ IT ± 11 ± € 32,4 bn € 23 bn CCBM

26. Infrastructure • Collateral management • domestic • DNB vault • Euroclear Netherlands (CSD) • Foreign (cross border) • Direct links • Euroclear Bank • CCBM CCB CCB

27. Domestic Structure of domestic safekeeping DNB 2 1 3 (= €) 1 Euroclear Netherlands Bank A

28. Eligible links Structure of eligible links 1 Bank A DNB 3 (= €) 1 2 EuroclearNetherlands (I)CSD (Monte Titoli)

29. 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

30. CCBM Structure of CCBM 4 CCB HCB 3 1 CSD 5 (= €) 2 1 Custodian/ Agent BankA CCBM - Correspondent Central Bank Model CCB - Correspondent Central Bank HCB - Home Central Bank CSD - Central Securities Depository

31. The current framework for the use of collateral Step1: Request for credit Step2: Matching National domestic procedures SSS A CPY A NCB A Step 3: Confirmation/receipt Step4: Release credit Step2: transfer instruction Step3: Matching Step1: Request for credit Step2: CCBM message A common procedure with minimum harmonisation for cross-border use (level of automation, communication protocols) CPY A NCB A NCB B SSS B Step 4: Confirmation Step6: Release credit Step5: Receipt Step3: transfer instruction

32. CCBM2 – A single procedure for domestic and cross-border use of collateral CPY A NCB A SSS A CPY B NCB B NCB A SSS A CCBM2 platform Single procedure for domestic and cross-border Harmonised procedures for counterparties PSSC/SWG/2007/414

33. Synergies with other Eurosystem initiatives TARGET2-Securities Single Eurosystem Interface Securities accounts Sub -Cash accounts Custody accounts CCBM2 TARGET2 Cash accounts

34. Summing up • Basics on monetary and collateral framework • Single list and ECAF • NL situation • Collateral mobilisation

35. Thank you very much ! Qu€stions?

36. Some detailed slides

37. Minimum reserve requirements: • During a reserve maintenance period banks have on average to maintain a certain percentage of certain banks’ balance sheet items (2%) on an account at the central banks • Create / increase money market shortage (counterparties vis à vis Eurosystem) • Averaging feature helps stabilising overnight and intraday money market rates

38. Minimum reserve requirements: • Interest paid over required reserves • Excess reserves not remunerated, giving incentive to go to the market • Penalty in case of non-compliance • Banks with large payment flows prefer large reserve requirements

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

40. Open markt operations: • Main refinancing operations (MROs) about 70% of total credit extension • Long term refinancing transactions (LTROs) about 30% of total credit extension • Fine-tuning operations (FTOs) nowadays last day of the reserve maintenance period • Structural operations

41. Main refinancing operations (MROs): • Open for all banks with a minimum reserve requirement (cf US system of primary dealers) • Interest rate on MROs is main ECB interest rate • Main source credit extension Eurosystem • Variable rate tender (opposite to fixed rate tender) • Marginal rate few base points above min. bidrate

42. Main refinancing operations (MROs):

43. Long term refinancing transactions (LTROs): • Liquidity providing • Monthly auction via variable rate tender • Three month maturity

44. Long term refinancing transactions (LTROs): • Reverse transactions • Pre-announced 50 billion euro size each • Particularly designed for smaller banks • Amount allotted is sufficient to balance supply and demand

45. Fine-tuning operations (FTOs): • Smooth out effects on interest rates of unexpected liquidity fluctuations • Liquidity providing or liquidity absorbing • Ad hoc basis and regular basis i.e. last day of a reserve maintenance period

46. Fine-tuning operations (FTOs): • Short-term basis • Tender or bilateral operation • Selected group of fine-tuning counterparties

47. Structural operations: • Liquidity-providing or liquidity-absorbing • Conducted on an ad hoc basis (never used yet) • Maturity not standardised • Tender or bilateral operations

48. Types of open market operations: • Reverse transactions • Outright transactions • Foreign exchange swaps • Collection of fixed-term deposits • Issuance of ECB debt certificates

49. Stabilizing money market interest rates: • Fine-tuning instruments • Averaging facility on the reserve requirements • Standing facilities

50. Standing facilities : • Deposit facility • overnight liquidity absorption • at relatively low (official) interest rate • floor for market rates • normally no restrictions • Marginal lending facility • overnight liquidity provision • at relatively high (official) interest rate • ceiling for market rates • normally no restrictions except collateral