Bank of Canada’s Response
to the Financial Market Turmoil
Conference on Business, Banking, and Finance
28-29 May 2009
Ron Allenby, Assistant Director
Financial Markets Department
Bank of Canada
* The views expressed here are my own, and do not necessarily reflect the views of the Bank's Governing Council.
Overview
The Crisis: causes and impacts
Central Bank Actions: the Bank of
Canada’s evolving liquidity framework
Results
Lessons Learned
2
The Crisis: Causes
 Low US interest rates for extended period
 US banking system deregulation
 Search for higher yield: growth in
securitization; increased leverage;
increased risk taking
 Real estate boom: ease of lending
standards
3
The Crisis: Causes
 US real estate prices stop increasing
Poor performance of subprime
mortgages: concerns with assetbacked securities
ABCP market freeze in Canada
Reduced confidence in structured
products: increased awareness of risk
4
The Crisis: Impacts
 Uncertainty in banking sector re: future funding needs
and distribution of losses related to mortgages and
structured products
 More cautious liquidity and credit management: tensions
in money markets; bank funding costs rise
 Spill-over of credit market turmoil into asset prices:
decline in equities; impact on financial institutions
 Several waves over 2007-2008
5
The Crisis: Impacts
Cumulative Losses, Writedowns and
Capital Raised at Banks and Brokers
Globally, banks are affected
Spreads between 3-Month LIBOR and Overnight Index Swaps*
1200
Basis points
400
350
300
250
US$ billions
Canada
United States
Euro Zone
200
Total private capital raised
1000
Total public and private capital raised
Losses
800 and writedowns
600
150
400
100
50
0
Jan-07 Apr-07 Jul-07 Oct-07 Jan-08 Apr-08 Jul-08 Oct-08 Jan-09 Apr-09
* U.S. LIBOR, EU EURIBOR and Canada CDOR
Source: Bloomberg; last observation made end of day 24th April 2009
200
0
Q307 Q407 Q108 Q208 Q308 Q408 Q109 Q209
6
Bank of Canada’s Actions
Strategy:

Continued focus on monetary policy objective –
reinforcing target rate during periods of stress;
aggressive reductions in overnight interest rate.

Provision of extraordinary liquidity to core
market participants.

Support of global initiatives – central bank
cooperation and communication; leadership in
creating a sounder financial system
7
Bank of Canada’s Actions
Importance of Liquidity:

Liquidity required for efficient pricing – banking
and market-making are key functions, but endogenous
liquidity generation had broken down

Financial system stability more dependent on
efficient pricing – in large part because of
securitization and mark-to-market accounting

Traditional central bank liquidity framework
insufficient – altering liquidity through monetary
policy, or in the core payments systems, or through a
reallocation of liquidity to banks insufficient when
markets centre of storm
8
Traditional Liquidity Framework
Monetary Policy:
Intervene at one-day, with a limited set of highly regulated
counterparties, against only the most liquid of collateral
Standing Liquidity Facility: at target +/- 25 basis points
Buyback operations (at target rate)
Financial Stability:
Emergency Lending Assistance (restricted to core
financial institutions, broad collateral)
 Stigma - perceived to be precursor to supervisory intervention
9
BoC Revised Liquidity Framework
Margins of Change to Liquidity Framework:
 Term: lending beyond one day
 Collateral: wider range of eligible securities
 Counterparties: wider range of financial institutions
 Size: value of operations evolve with Bank’s
assessment of requirements
 New Facilities: Term PRA, Term PRA for Private
Sector Instruments, Term Loan Facility; temporary
increase to USD swap agreement
10
Bank of Canada’s Actions
Evolution of the Liquidity Framework
2007
2008
Summer 2008:
 US Treasury securities and ABCP
accepted as collateral under SLF
December 2007:
 1-Month term PRAs
introduced
 Expansion of securities
eligible as collateral
under SLF
Autumn 2008:
 1 and 3-month term
PRAs introduced.
Frequency & size of
operations increased and
list of eligible
counterparties expanded
 Term PRA for private
sector money market
instruments introduced
Term loan facility
introduced
 US dollar swap facility
announced
2009
February 2009:
 Term PRA for
private sector
instruments
amended
April 2009:
 6 and 12-month
term PRAs
introduced
 QE/ CE
framework for
monetary policy
11
Liquidity Provision: Results
 Liquidity extensions, as a percentage of banking
system assets and GDP, is relatively low in Canada
 Changes in the Bank of Canada balance sheet:
assets have grown; holding a broader range of assets
 Bank funding costs have declined
 But, some markets have not recovered: significant
decline in outstanding ABCP
12
Results
Liquidity extension is relatively low in Canada
Total Public Sector Liquidity Extension
Ratio to Banking System Assets
Ratio to GDP
25%
20%
15%
10%
5%
0%
US
EU
UK
Canada
13
Results
Bank funding costs have declined
%
Canadian Bank Funding Costs
6
5
4
3
2
3 month OIS
3 month CDOR
Senior 5yr swapped to 3m floating rate debt
3 month Treasury Yield
1
0
A
S O
2007
N
D
J
F
M
A
M
J J
2008
A
S
O
N
D
J
F
M A
2009
14
Results
Bank of Canada’s balance sheet has changed
Bank of Canada Assets
C$ bln
90
Private Sector Term PRA
TLF
Term PRA
Treasury Bills
Bonds
80
70
60
50
40
30
20
10
-0
9
-M
ar
30
n09
-J
a
29
30
-N
ov
-
08
ct
-0
8
1O
ug
-0
8
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3Ju
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8
4A
b08
4Fe
-0
7
ec
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-0
7
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-0
7
0
15
Lessons Learned
 Central banks have a role in liquidity provision, from both
a monetary policy and financial system stability
perspective
 Monetary policy transmission is affected by asset-market
liquidity; support of the inter-bank market may be
required to maintain control over overnight rates
 Intervention may be required when liquidity problems
have a system-wide significance; but, must be
reasonable assurance that action can mitigate the
problem and contribute to stability.
16
Lessons Learned
Principles of Intervention:
 Target intervention to problems with system-wide
importance
 Intervention should be graduated and commensurate
with the severity of the problem
 Tailor the response/tools to the problem
 Capability to transact with extensive set of counterparties and
collateral
 Capability of aiding cross-border liquidity distribution
17
Lessons Learned
Principles of Intervention, continued:
 Intervention should not be distortionary
 Reduce potential stigma problems through design of liquidity
facility
 Encourage usage of central bank programs, but as a backstop
 Mitigate moral hazard by clarifying objectives and principles
 Exit strategy should be considered along with design of
facility
18
Appendix
19
Liquidity Facilities
Term PRA Facility
Announced
December 12, 2007
Term PRA for Private
Sector Money Market
Instruments
October 14, 2008
Term PRA for Private
Sector Instruments
Term Loan Facility
February 23, 2009
November 12, 2008
 Provide liquidity
& support financial
markets
 Reinforce the
BoC’s conditional
statement regarding
the overnight rate
 Support liquidity in
private-sector money
markets (replaced by
Term PRA for Private
Sector Instruments)
 Support liquidity
in markets for
private-sector
instruments
 Give LVTS
participants greater
flexibility in balance
sheet management
 Improve
conditions in money
and credit markets
Eligible
Participants
 Primary dealers
 Participants in
LVTS
 PDs (direct basis)
 Firms active in the
CAD private sector
money markets &
subject to regulation
(indirect basis)
 Institutions active
in the CAD private
sector money
and/or bond
markets and subject
to regulation
 Direct Participants
in the LVTS on an
indirect basis
through a PD
Frequency
of Offering
Weekly
Weekly
Weekly
Weekly
Loan Terms
1, 3, 6 and 12
months
2 weeks
1 and 3 months
1 month
Objective
20
Liquidity Provision
Outstanding Value at BoC Liquidity Facilities
Outstanding Term PRA*
Outstanding Private Sector PRA*
Outstanding TLF**
50
30
20
Apr-09
Mar-09
Feb-09
Jan-09
Dec-08
Nov-08
Oct-08
Sep-08
Jul-08
Jun-08
May-08
Apr-08
Mar-08
Feb-08
Jan-08
0
Aug-08
10
Dec-07
$CAD (Billions)
40
*Cash value
**Par Value
Source: Bank of Canada
21
Monetary Policy Response
 Since December 2007, the BoC has lowered the policy
rate from 4.50% to 0.25%.
 The Bank is committed to hold the target overnight rate
at the effective lower bound of 0.25% until the second
quarter of 2010 conditional on the inflation outlook.
22
Macro-prudential Regulation & Global Initiatives
Macro-prudential Regulation:
• In cooperation with domestic partners, focus on systemwide issues and appropriate regulatory responses
– Examine how to best coordinate management of both risks to
individuals (depositors, investors) and risks to the system
Global Objectives:
• Coordinate on international regulatory frameworks
– Standards of transparency, infrastructure
• Examine role for central banks not only as providers of
liquidity to institutions, but to markets
23