The management of bank reserves: The system in Norway
The objective of monetary policy in Norway is annual consumer price inflation of close to 2.5 per cent over time (see Regulation on Monetary Policy of 29 March 2001). Norges Bank's main instrument for achieving this objective is the key policy rate, the interest rate on banks' sight deposits overnight in Norges Bank. The objective of liquidity policy is to implement the Executive Board's interest rate decision by ensuring that the short-term money market rate remains close to the key policy rate. Implementation requires a system for managing bank reserves, i.e. bank deposits in the central bank. It is by managing bank reserves that the central bank influences the shortest money market rates and can through that channel achieve the objective of liquidity policy.
Central bank reserves, or just reserves, refer to bank (freely useable) deposits with the central bank. Banks need central bank reserves for interbank settlement purposes There are different systems for managing bank reserves. A feature common to all the systems is that the central bank manages bank reserves with a view to keeping the shortest money market rates close to the key rate. This is carried out through different forms of market operations, which means that the central bank can either supply or withdraw reserves to/from the banking system. Moreover, all system have standing facilities, which means that banks can borrow reserves overnight or deposit surplus liquidity overnight in the central bank. There are also guidelines relating to collateral, which set out the collateral requirements for borrowing reserves in the central bank. In addition, most central banks offer an intraday facility, i.e. banks can borrow reserves free of interest against collateral through the day in the central bank. Some central banks also require that banks hold reserves, i.e. reserve requirements, which forces banks to hold a certain volume of deposits in the central bank.
On 15 December 2010, Norges Bank's Executive Board adopted an amendment to the "Regulation on the access of banks to lending and deposit facilities in Norges Bank etc." in order to change the system for managing banks reserves. The new system was implemented on 3 October 2011. The details of this quota system are described below.
Variations in bank reserves
Reserves in the banking system are determined by two factors – autonomous factors and central bank market operations. Autonomous factors refer to factors beyond the control of the central bank. In Norway, this primarily refers to transactions over the government's account in Norges Bank. When private agents pay taxes and excise duties to the government, or when the government issues government securities, reserves are transferred from the banks' account in the central bank to the government's account in the central bank. This reduces the quantity of reserves in the banking system. When the government transfers funds to private agents (wages, benefits and different transfers), and when government securities mature, reserves are transferred from the government's account in the central bank to the banks' account in the central bank.
Other autonomous factors are notes and coins in circulation. When banks buy notes and coins from the central bank, they pay by drawing on their deposits in the central bank. Hence the reserves in the banking system are reduced.
Structural liquidity refers to the level of reserves that would have existed if Norges Bank had neither supplied reserves to the banking system nor withdrawn reserves from the banking system. Structural liquidity is determined by the autonomous factors. Given the level of structural liquidity, Norges Bank must provide reserves or withdraw reserves from the banking system in order to maintain the desired level of reserves.
Projections of structural liquidity
In order to manage the total quantity of reserves in the banking system, Norges Bank makes projections of structural liquidity, which are published every Monday and Thursday.
Market operations for managing bank reserves
F-loans and F-deposits
Norges Bank uses market operation to steer bank reserves towards a desired level, primarily using fixed-rate loans (F-loans) and fixed-rate deposits (F-deposits), see also Regulation on the access of banks to lending and deposit facilities in Norges Bank etc.
Norges Bank supplies reserves to the banking system by providing F-loans to banks. An F-loan is a loan extended against collateral in the form of securities. The interest rates on F-loans are normally determined by multi-price auctions. In a multi-price auction, also referred to as an American auction or an ordinary auction, banks submit bids for a desired amount and interest rate. Norges Bank decides the aggregate amount of the allotment. The banks' interest rate bids are ranked in descending order. Banks that place bids within the aggregate amount will be awarded an amount at the interest rate submitted. The maturity on F-loans is determined by Norges Bank and varies depending on the projection of structural liquidity. The interest rate on F-loans is normally fixed during the duration of the loan. Norges Bank can in special situations provide F-loans at a floating rate, i.e. the interest rate on the F-loans depends on the benchmark rate in the money market. . F-loans at floating rates were last issued in the wake of the financial crisis in 2008
Norges Bank reduces the quantity of reserves in the banking system by providing banks with F-deposits. As in the case of F-loans, the interest rate is normally determined by multi-price auction. Banks submit bids for a desired amount and interest rate. Norges Bank decides the aggregate amount of the allotment. The banks' interest rate bids are ranked in ascending order. Banks that place bids within the aggregate amount will be awarded an amount at the interest rate submitted. The maturity on F-deposits is determined by Norges Bank and varies depending on the projection of structural liquidity. The interest rate on F-deposits is normally fixed during the duration of the deposit period Norges Bank can provide F-deposits at a floating rate, i.e. the interest rate on the F-deposits depends on the benchmark rate in the money market.
Only banks with access to Norges Bank's standing facilities (see below) have access to participating in F-loan and F-deposit auctions.
Foreign exchange swaps
Norges Bank can use foreign exchange swaps to supply krone liquidity to Norwegian and foreign banks. Foreign exchange swaps can be used to supply liquidity in addition to fixed-rate loans (F-loans). Foreign exchange swaps can also be used to supply liquidity in foreign currency to Norwegian banks. Extraordinary liquidity supplied in foreign currency is applicable only in special situations. Maturities for foreign exchange swaps vary and depend on the liquidity situation in the banking system.
Prices for foreign exchange swaps are normally determined by means of multiple-rate auctions. Banks submit bids for the desired amount and the price they are willing to pay. Norges Bank determines the total amount of liquidity to be allotted. The banks' bids are ranked and allotments are made until the total amount is reached. Amounts are allotted to banks at the price submitted in their bid. The price is expressed in swap points (PIPS), which is the interest rate differential between the currency pair during the swap period.
Unlike for F-loans and F-deposits, banks that do not have access to Norges Bank's standing facilities (see below), including foreign banks, can participate in foreign exchange swap agreements.
Norges Bank's standing facilities
Norges Bank offers standing facilities to banks. The interest rate terms for Norges Bank's standing facilities are set by the Executive Board of Norges Bank.
Norges Bank offers banks an intraday facility, referred to as intraday D-loans. Through the day banks can borrow reserves free of interest against collateral. The purpose of intraday loans is to ensure satisfactory settlement of interbank payments.
The standing lending facility provide banks with access to borrowing reserves overnight from Norges Bank, normally at a higher interest rate than the key policy rate. The loan is referred to as an overnight loan (D-loan).
Banks can deposit unlimited reserves in Norges Bank via the standing deposit facility. The interest rate on deposits up to the bank's quota is equal to the key policy rate. The interest rate on deposits in excess of the quota is lower, i.e. the reserve rate.
Guidelines for pledging collateral
Norges Bank requires collateral for loans to banks and has drawn up guidelines for pledging collateral. The guidelines apply to all types of loans, i.e. intraday loans, F-loans and D-loans
Norges Bank does not apply reserve requirement in liquidity management.
The system in Norway: A quota-based system
The system for managing bank reserves in Norway is a quota-based system which comprises two elements. First, Norges Bank seeks to maintain the total quantity of reserves in the banking system at a specific level. This level may vary over time. Second, the banks that have access to Norges Bank's standing facilities receive interest only on a certain portion of reserves – a quota – at the key rate. Deposits in excess of the quota bear lower interest – at the reserve rate. The quotas are calculated as follows:
- The new system for management of bank reserves apply to all banks in Norges Bank's settlement system (NBO).
- The banks in NBO are divided into three groups, A1, A2 and B. In principle, the same groups will apply when quotas are set:
- Group 1. Banks in NBO group A1.
- Group 2. Banks in NBO group A2.
- Group 3. Banks in NBO group B.
- A bank that quotes money market rates (i.e. a bank on the NIBOR panel) and that in principle belongs to group A2 in NBO will be moved to group 1 when the bank's quota is to be set.
- Norges Bank determines the sum of all the quotas in all the groups (the total quota).
- The share of the total quota for each group will equal the group's share of the aggregate total assets of the NBO banks.
- All the banks in a group will be assigned the same quota.
- Settlement banks will be assigned an additional quota determined by the size of the settlement bank in relation to the size of the second-tier banks (or equivalent banks) for which it performs settlements (as measured by total assets). If the initial quota calculated for a settlement bank is NOK Q billion, the settlement bank has total assets of NOK X billion, and the second-tier banks have combined total assets of NOK Y billion, the settlement bank will be awarded an additional quota of Q*(Y/X). The settlement bank's total quota will therefore be Q + Q*(Y/X). This additional quota is subject to an upper limit of the sum of the quotas for the second-tier banks for which the bank performs settlements.
- Norges Bank will normally review the total quota and the distribution among banks twice annually:
- On 1 March, Norges Bank will announce the quotas that apply from 1 April. Total assets as at the end of the fourth quarter will be applied.
- On 1 September, Norges Bank will announce the quotas that apply from 1 October. Total assets at the end of the second quarter will be applied.
- Norges Bank may also change the quotas at other times if deemed necessary.
- If a bank moves from group 2 to group 1, thereby becoming a NIBOR panel bank, Norges Bank will consider (i) expanding the total quota to enable each NIBOR bank to maintain the same quota as previously, or (ii) keeping the total quota unchanged, reducing the quota of each NIBOR bank, or (iii) an intermediate solution.
See circular for the distribution of the total quota across banks.
An interval for reserves in the banking system
Norges Bank seeks to maintain reserves at a specific average level, but operates using a symmetrical interval around this level (see circular). If projections indicate that reserves will exceed the upper limit of the interval, Norges Bank will normally withdraw reserves from the banking system. If projections indicated that reserves will be lower than the lower limit of the interval, Norges Bank will normally supply reserves to the banking system. The interval will not necessarily be followed mechanically. Norges Bank permits deviations from the interval if deemed appropriate. Norges Bank also engages in market operations even if reserves are expected to remain within the interval if deemed appropriate. An element of discretion is thus involved when Norges Bank assesses the scale of market operations and their frequency.
Fine-tuning operations late in the day
Norges Bank can, if deemed appropriate, undertake market operations late in the day after the last settlements enter Norges Bank settlement system (NBO). Such operations are referred to as fine-tuning operations. The structure is as follows:
- The last settlement in NBO will normally be made around 3.50 pm. The level of bank reserves will normally be known before 4.00 pm.
- If Norges Bank finds it desirable, an F-deposit or F-loan auction is launched as quickly as possible with same-day settlement and normally with an overnight maturity.
- The auction is closed 10 minutes after the announcement.
- The auction results are announced as quickly as possible to the banks.
- The opening hours for NBO are increased automatically to 5.00 pm (normally 4.35pm).
- When necessary, banks redistribute reserves among themselves.
- Liquidity management system: Floor or corridor? (Staff Memo 4/2010)
- Banks' assessment of Norges Bank's liquidity management system (Norges Bank Papers 4/2014)
- Structural liquidity (Economic Commentaries 9/2013)