Further information on key policy rate

The overnight lending rate for banks (the D-loan rate) was Norges Bank's key policy rate from March 1986 to May 1993. Since June 1993, the sight deposit rate has been used as the key policy rate

The interest rate on banks' deposits with Norges Bank (up to a certain quota), also known as the sight deposit rate, is the key policy rate in Norway today. Norges Bank uses the key policy rate to give policy signals to money market participants.

In the 1980s, however, the rate used as the key policy rate was the interest rate on banks' overnight loans from Norges Bank, the D-loan rate. The D-loan rate was used as the key policy rate as from 1 March 1986 throughout the period until the liquidity situation in the banking system changed in 1993 and banks' needs shifted from borrowing to depositing funds with the central bank. To be exact, the last change in the D-loan rate as Norges Bank's key policy rate was made with effect as from 25 May 1993.

As from 14 June 1993, the rate that was used to give policy signals to money market participants was the sight deposit rate, the interest rate on banks' overnight deposits with Norges Bank. The sight deposit rate can therefore reasonably be regarded as Norges Bank's key policy rate as from 14 June 1993.

From D-loan rate to sight deposit rate

As from 1 March 1986, Norge Bank's overnight lending facility for private banks was considerably simplified. A graduated system was replaced by a system whereby banks could borrow a limited amount at a given interest rate, the D-loan rate. Changes in the D-loan rate were understood as an important policy signal from Norges Bank to money market participants. The D-loan rate can reasonably be regarded as Norges Bank's key policy rate as from March 1986 and as long as banks were in a net borrowing position.

Admittedly, temporary restrictions were introduced in the new lending facility in connection with the exchange rate turbulence at the beginning of May 1986. A restriction on the D-loan facility was introduced combined with the option of additional loans at an interest rate that would be set daily. In the period 5-12 May, this rate was used as the key policy rate. As these loans were also overnight loans, this constituted a tiered interest rate system with a low rate for ordinary D-loans and a high rate (penalty interest) for marginal D-loans, first 30 percent, then 50 percent. These marginal D-loan rates are the rates reported in Norges Bank's interest rate database for the relevant dates in May 1986.

Following the devaluation on 11 May 1986, the marginal rate was reset at the same level as the ordinary D-loan rate, and on 25 June the system was again changed to encompass only one lending facility.

During the exchange rate turbulence in November 1992, the D-loan rate was increased to 25 percent. In connection with the exchange rate turbulence in November and December 1992, restrictions on the D-loan facility and a penalty rate of 40 percentage points above the D-loan rate were also introduced. The restrictions were revoked when intervention obligations were suspended on 10 December at 11 a.m. For the relevant dates in November and December 1992, we note that in contrast to the dates in May 1986 the rate now reported in Norges Bank's interest rate base is the ordinary D-loan rate. However, we see that short-term money market rates in this period were as high as 100-200 percent, and it is therefore possible that the interest rate on Norges Bank's D-loans (for borrowing in excess of the restrictions on the D-loan facility applicable at any time) should have been set 40 percentage points higher based on the assumption that D-loans were provided at a marginal rate that included a penalty rate.

The sight deposit rate and the D-loan rate form an interest rate corridor within which short-term money market rates normally move. When banks shifted to a net deposit position in summer 1993, it is reasonable to regard the sight deposit rate as Norges Bank's key policy rate.

It is possible to pinpoint fairly accurately when this occurred. The last change with the D-loan rate as key policy rate was made with effect as from 25 May 1993, when the interest rate corridor was changed from (6.75-7.75) to (6.75-7.50) through a reduction in the D-loan rate of 25 basis points (without similarly reducing the sight deposit rate). The interest rate corridor at this time was at the narrowest ever recorded, only 75 basis points. The next change in the key policy rate occurred on 14 June 1993 when the interest rate corridor was changed from (6.75-7.50) to (6.50-7.50) through a reduction in the sight deposit rate of 25 basis points (without similarly reducing the D-loan rate). This was the first time a policy signal was given by changing the sight deposit rate, which was subsequently regarded as Norges Bank's key policy rate. After this change, the interest rate corridor widened to 100 basis points. At the next key policy rate changes, the sight deposit rate was reduced further, first by 25 basis points on 21 June, then by a further 25 basis points on 28 June and finally by 50 basis points on 3 August. When these three changes were made in 1993, the D-loan rate was kept unchanged throughout, so that with the changes in Norges Bank's key policy rate (now defined as the sight deposit rate) the interest rate corridor widened to 200 basis points. When the key policy rate was subsequently changed, this width was maintained as the D-loan rate was changed to correspond to the changes in the sight deposit rate. In March 2007, the width of the interest rate corridor was reduced by half to 100 basis points when the D-loan rate was reduced by 100 basis points without a corresponding reduction in the key policy rate.

In October 2011, quotas were introduced defining the size of deposits banks could hold with Norges Bank on sight deposit rate terms. Banks' reserves with Norges Bank in excess of the quota were remunerated at a rate equal to the sight deposit rate minus 100 basis points. The change provided banks with a strong incentive to manage liquidity so as to avoid holding surplus reserves at the low reserve rate. After the most recent change, the key policy rate forms the midpoint in an interest rate corridor with a width of 200 basis points and a lower limit equal to the reserve rate (on deposits in excess of the quota, which is remunerated at the sight deposit rate) and an upper limit equal to the D-loan rate.

Published 16 March 2006 16:09
Edited 16 March 2015 13:13