A possible role for asymmetric standing facilities in liquidity management

The Eurosystem’s liquidity management policy was designed in such a way that money markets play a central role in distributing and reallocating the reserves injected by the central bank. Not surprisingly, therefore, the negative effects of the financial crisis, which commenced in August 2007, on the functioning of these markets led the monetary authority to modify its liquidity management policy, exploiting the opportunities provided by an operational framework designed to have a notable degree of fl. Given the origin of these changes, the need for them is naturally being reconsidered as normality returns to the money and financial markets. However, the experience gained in the meantime in the functioning of these modifications may be useful both for the design of the time-sequence of their withdrawal and for preparing responses in the event that some of the changes that have taken place as a consequence of the crisis prove to be more permanent in nature. In particular, the process of recovery of market confidence in the solvency of credit institutions is proving complicated, although the recent publication of the results of stress tests has had a notable accelerator effect. The normalisation of the money markets is thus taking place rather gradually. Moreover, it is unlikely that the assessment of risk, in general, and of liquidity risk in particular, that the banks eventually make at the end of the crisis will be at pre-crisis levels. Both considerations make it reasonable to assume that the Eurosystem will continue over the coming months – and perhaps a longer period – to face a higher demand for reserves than before the crisis. The ongoing provision of large volumes of reserves poses challenges not only in the area of the management of this liquidity (e.g. the maturities it is provided at), but also, for example, in the management of the risks associated with the collateral that the institutions provide for the Eurosystem liquidity loans and in terms of the financial market distortions that may arise if collateral requirements lead banks to demand some types of assets more than others, because the latter are not accepted by the central bank in its monetary policy operations. However, the extent of these challenges will depend crucially on the duration and scope of this greater demand. Against this background, this article analyses the role that the standing facilities provided for in the Eurosystem’s operational framework (the marginal lending facility and the deposit facility) could play in regulating institutions’ demand for reserves. The analysis is performed in three stages. First, the role of standing facilities within the context of the operational framework for the implementation of monetary policy and liquidity management is briefl y described. Then, the main changes made to this framework in response to the crisis are highlighted. Finally, a theoretical framework is constructed in which a change in the interest rates on the standing facilities to make an asymmetric corridor around the policy rate may reduce the demand for reserves.