Bank of Canada:
Operational Challenges During the
Crisis
National Asset Liability
Management Conference
Donna Howard, Bank of Canada
London, UK – March 24, 2011
Monetary Policy in Canada
One Objective
 Total CPI inflation at 2 per cent
(midpoint of a 1 to 3 per cent control range)
One Instrument
 The target overnight interest rate
(based on collateralized transactions)
2
Crisis spill-overs to Canada: Confidence
and Liquidity Channels
 Short term corporate debt market: ABCP market freeze,
drying up of liquidity in CP, BA, repo markets
August 2007
Montreal Accord
3
Crisis spill-overs to Canada: Confidence
and Liquidity Channels
Canadian Short-Term Interest Rates
4
Crisis spill-overs to Canada: Confidence
and Liquidity Channels
Reduced short-term bank funding market liquidity
Autumn 2007
market turmoil
Autumn 2008
Lehman
failure
5
Standard Framework for Monetary
Policy Implementation
The Bank implements monetary policy in the
Large Value Transfer System (LVTS)
environment
•Target for the Overnight Rate: The rate on
collateralized, market-based overnight
transactions
Overnight
Rate
Bank Rate
+25
bps
Operating
Band
•Operating Band: 50 basis points band around
the target overnight rate
Price incentives to keep overnight rate close
to target:
Target
-25
bps
Deposit Rate
–The Bank of Canada targets a daily final LVTS
balance of $25MM.
–Participants with excess LVTS balances at the
end of the day are paid interest at the Deposit
Rate, while participants with deficits must take
an overdraft loan at the Bank Rate.
66
Standard Framework for Monetary
Policy Implementation
The Bank of Canada is also able to intervene in
the overnight(O/N) market to reinforce the
Target Rate:
–If O/N is trading too far above the target, the Bank
will provide (intraday) liquidity at the target rate via
Special Purchase and Resale Agreements (SPRAs)
(repo vs GoC)
–If O/N is trading too far below the target, the Bank
will withdraw (intraday) liquidity at the target rate
via Sale and repurchase agreement (SRAs)
(reverse repo vs GoC)
Overnight
Rate
Bank Rate
SPRA
Operating
Band
Target
SRA
Deposit Rate
77
Operational Challenges During Onset of Market
Turmoil: Overnight Rate Deviations from Target
Jun-2007
Aug-2007
Oct-2007
Dec-2007
8
Unconventional Response to Ongoing
Liquidity Stress in Funding Markets
Term Purchase and Resale Agreements (PRA) liquidity operations
introduced in December 2007:
•
Main term liquidity facility used during crisis
•
Expanded Eligible Securities
•
Competitive auctions (multiple price, no constraints)
•
1-month terms: first time operations in support of funding liquidity were
extended beyond 1 day
•
No Term PRAs in January or February 2008, resumed March-June with
failure of Bear Stearns.
2008 Spring: BoC also expanded set of assets acceptable as collateral in
the LVTS (allowing more liquid collateral to be used in market-based
funding)
9
Principles for Intervention
1.
2.
3.
4.
5.
Targeted
Graduated
Well-designed
Minimize distortions
Mitigate moral hazard
10
Operational Challenges During Peak Stress
Periods
Autumn 2008: Failure of Lehman Brothers
- Severe liquidity shortages in term funding markets,
impaired market function as FIs became more
conservative in liquidity management
- Credit spreads spiked, trading volumes declined
- Conditions in Canada more moderate than in other
jurisdictions
11
Addressing Operational Challenges During
Crisis Peak – Unconventional Policy Measures
Expansion of liquidity provision
 Term PRAs:
 Expanded acceptable collateral, counterparty list, terms, size of
operations
 Increased frequency of operations
 USD swap agreement (not drawn upon)
 New Facilities introduced:
 Term PRA for Private Sector Instruments
 Term Loan Facility
12
Unconventional Policy Measures –
Expanded Liquidity Provision
13
Operational Challenge: Changing Structure of
Asset Composition
14
Addressing Operational Challenges During
Crisis Peak – Unconventional Policy Measures
• As the global downturn intensified, the Bank’s
economic outlook was downgraded further through
2009H1.
• By mid-April 2009, core and headline inflation were both forecast
to
remain below the 2% target for the next two years.
Bank of Canada April 2009 MPR Forecast:
15
Monetary Policy in Canada
One Objective
 Total CPI inflation at 2 per cent
(midpoint of a 1 to 3 per cent control range)
One Instrument
 The target overnight interest rate
?
16
Addressing Operational Challenges During
Crisis Peak – Unconventional Policy Measures
Reduction in Overnight Rate Target to the Effective
Lower Bound (25 bps)
17
Addressing Operational Challenges During
Crisis Peak – Unconventional Policy Measures
• Explicit conditional policy statement tied to the inflation
outlook was used as a monetary easing tool:
“Conditional on the outlook for inflation, the target overnight
rate can be expected to remain at its current level until the
end of the second quarter of 2010 in order to achieve the
inflation target.”
• Term PRA facility modified to reinforce the conditional
commitment
• QE / CE framework introduced.
18
Addressing Operational Challenges During
Crisis Peak – Unconventional Policy Measures
 Quantitative easing (not
implemented)
– Outright purchases of financial
assets (T-bills and government
bonds) through creation of
excess settlement balances
 Credit easing (not
implemented)
– Purchases of private sector
assets in credit markets that
are important to the financial
system but temporarily
impaired
19
Implementing Monetary Policy at the
Effective Lower Bound
The operating band narrowed
to 25 basis points vs. standard
50 basis points
Overnight
Rate
0.50%
–Target overnight rate not in the
middle of the bands (it is the same
as the deposit rate)
–Settlement balances (deposits by
CPA members) raised to $3 billion
to encourage rates at the lower
end of the band
Bank Rate
SPRA
0.25%
Deposit Rate = Target
SRA
–SPRA and SRA transactions still
available if required
20
Impact of the Conditional Commitment
21
Overall Impact of Measures
22
Lessons Learned
1. Markets are an important component of the financial system
and of the monetary policy transmission mechanism with
limits to the real economy
2. Strong inter linkages exist between the resilience of financial
institutions and the resilience of funding markets
3. Central banks are the ultimate providers of liquidity to
markets
4. In times of crisis, central banks must be flexible in approach
to provide liquidity with the ultimate objective of restoring the
endogenous liquidity creation process in markets
5. Mitigation of moral hazard is an important consideration
23
23
Winding Down Extraordinary Operations
- Phase-out of extraordinary liquidity operations as market
conditions improved
• Initiated term repo operations for balance sheet purposes
- Removed conditional commitment in April 2010; raised
overnight rate target in June, July, and September 2010
(target now standing at 1 per cent)
• Returned to standard operating framework for the implementation of
monetary policy
• Phase-out of excess settlement balances
24
Monetary Policy Operations in the “New
Standard”
- Markets generally functioning without central bank
intermediation
- Overnight funding conditions: returned to stability
- Term funding conditions: not as liquid as before the
crisis; however, most markets are able to function
without public sector support
- Ongoing policy and industry initiatives to reinforce the
resilience of core funding markets
25
Background Slides
Adjustments to Liquidity Operations Summary
Pre-Crisis
Peak of the crisis
Currently
Term
Overnight
1, 3, 6 and 12-month
Overnight
Counterparties
SRA/SPRA:
Primary
Dealers (PDs)
SLF: direct
participants in
LVTS
PDs, direct participants
in LVTS, private sector
market participants
SRA/SPRA: PDs
SLF/Overnight SPRA
facility for PDs: Direct
Participants in LVTS and
PDs
Collateral
Government
of Canada
securities,
corporate
paper,
provincial
securities.
Government of Canada
securities, corporate
paper, ABCP,
provincial securities,
non-mortgage loan
portfolio, U.S. Treasury
securities
Government of Canada
securities, corporate
paper, ABCP, provincial
securities, non-mortgage
loan portfolio (limited),
U.S. Treasury securities.
27
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 conditional
commitment for the
overnight rate
 Support liquidity in
private-sector money
markets
 Support liquidity in
markets for privatesector instruments
 Give LVTS participants
flexibility in managing
collateral
 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
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 (reduced to biweekly, monthly)
Weekly
Weekly
Weekly
Loan Terms
1, 3, 6, 9 and 12 months
2 weeks
1 and 3 months
1 month
April 12, 2010
March 9, 2009
October 27, 2009
October 28, 2009
Objective
Final
Operation
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Evolution of the Bank of Canada’s Liquidity
Framework
2007
Summer/Fall 2007
•Traditional tools
(overnight SPRAs
and excess
settlement balances)
used to address
liquidity pressures
December 2007:
•1-month term PRAs
introduced
2008
2009
Fall 2008:
• 3-month term PRAs introduced. Frequency
and size of operations increased; list of
eligible counterparties and assets expanded.
• Term PRA for private sector money market
instruments introduced
• Term loan facility introduced
• US-dollar swap facility announced.
• Non-mortgage loan portfolio accepted as
collateral under the Standing Liquidity Facility
Spring/Summer 2008:
• ABCP and US Treasury
securities as collateral under the
Standing Liquidity Facility
•Amendments to BoC Act come
into force
February 2009:
•Term PRA for private sector
instruments introduced
Spring 2009:
•Framework for monetary policy at the effective
lower bound introduced
•6, 9, and 12-month term PRAs introduced
•Prospective sunset dates for extraordinary
liquidity measures announced
2010
Fall 2009:
•Term loan facility expires
•Term PRA for private sector
instruments expires
•Bank announces pledging
limits on non-mortgage loans
in LVTS
December 2009:
•Term PRA frequencies
reduced, ABCP and BBB
bonds no-longer eligible as
collateral
January 2010:
•Term PRA tenor and frequency
reduced, ABCP and BBB bonds
no longer eligible as collateral.
April 2010:
•Final Term PRA operation
29