It is balance sheets gaore. All central bankers are busy explaining how they used their balance sheets in this crisis. See Bank of England, Fed, Comparison between Fed, Bank of England and Bank of Japan and other posts on the topic here.
Now, Svante Öberg, Riksbank’s First Deputy Governor explains how Riksbank used its balance sheet to ease crisis situation. Broadly the picture is same, but there are diferences in operations and frameworks.
In normal circumstances the Riksbank can steer the short market rates without any tangible effect on its balance sheet. This is because the banks usually turn to one another directly to smooth deficits and surpluses in liquidity instead of turning to the Riksbank. They then pay an interest rate that is the same as the repo rate. The repo rate thus has a direct impact on the interbank rate and through this on short-term interest rates paid by companies and households.
However, this mechanism has not functioned during the financial crisis. Banks that have had surplus liquidity have wished to keep it available for their own use instead of lending it to banks with a deficit.
So Riksbank had to do something extra
Firstly, the Riksbank issues Riksbank Certificates every week with a one week maturity and at an interest rate that is the same as the repo rate decided on, that is, at present 0.25 per cent. This assumes that the bank system – as is now the case – has a surplus and needs to invest money. If the bank system instead has a deficit, as was the case just over a year ago, then the Riksbank will implement what are known as repos every week with a week’s maturity. This means that the Riksbank buys securities from the banks with a simultaneous agreement that a repurchase will be made one week later and where the interest rate is the repo rate that has been decided
Secondly, the Riksbank carries out what are known as fine-tuning transactions every day to smooth the daily fluctuations in the bank system’s regular payments. The banks can invest money in the Riksbank overnight at an interest rate of 10 basis points below the repo rate, that is, at present 0.15 per cent …. The fine-tuning is normally very small, but during the crisis it has grown to entail very large amounts.
Thirdly, there are so-called standing facilities. The banks have the right to borrow from the Riksbank overnight at a lending rate that is 50 basis points higher than the repo rate, and the right to invest surplus in the Riksbank at a deposit rate that is 50 basis points lower than the repo rate. But these possibilities are very little used, as there are other alternatives that are more advantageous for the banks.
There was a big discussion when Riksbank had lowered the depoits rate to a negative 25 bps. Oberg clarifies the facility was hardly used
Something that has attracted relatively great attention internationally is the fact that the low repo rate and the application of an interest rate corridor of plus/minus 50 basis points for the Riksbank’s standing facility means that the Riksbank in principle applies a negative interest rate for deposits in the Riksbank. In practice, this is of little significance, as only a very small part of the banks’ liquidity surplus is invested in the standing deposit facility. Instead, the banks invest most of their liquidity surplus at a positive interest rate in the daily fine-tuning transactions or the weekly Riksbank Certificates.
Initially, the banks invested the majority of their large surpluses in autumn 2008 in the Riksbank as “fine-tuning”. As a result of the crisis the banks had a substantial need of immediate access to liquidity. More recently they have invested most of their surplus in the weekly Riksbank Certificates, which is a sign that market conditions have improved.
When Riksbank lowered the rate to negative there was a big celebration by people who said interest rates could go negative. It was seen as a strong signal for banks to stop putting reserves at central bank but lend. However, the facility was hardly used and was of little significance. The banks continued to deploy reserves into other central bank facilities. The credit continued to dip as Oberg also shows in the speech.
Hence, the negative interest rate would perhaps only work if there is one central bank facility. With multiple facilities, all should have negative interest rates on the deposit side which looks difficult.
The lesson is: What matters is not just interest rate signal but also the usage of the facility on which interest rate is negative. Details matter.