Download Bank`s financial market operations and liquidity

Bank of Canada’s Framework
for Market Operations and
Liquidity Provision
Updated October 2016
This document describes the Bank of Canada’s framework for its market operations and
liquidity provision. The most up-to-date version of the Framework can be found at
http://www.bankofcanada.ca/markets/market-operations-liquidity-provision/frameworkmarket-operations-liquidity-provision/.
The legal terms and conditions for the market operations and liquidity provision can be
found at http://www.bankofcanada.ca/markets/market-operations-liquidityprovision/terms-and-conditions/. Related policy documents, including the Statement of
Policy Governing the Acquisition and Management of Financial Assets for the Bank of
Canada’s Balance Sheet, the Bank of Canada Policy for Buying and Selling Securities,
and Rules Governing Advances to Financial Institutions and Financial Market
Infrastructures can be found at http://www.bankofcanada.ca/markets/market-operationsliquidity-provision/.
Contents
I. Overview ..................................................................................................................... 1
II. Reinforcing the Target for the Overnight Rate ....................................................... 2
1. Operating Band Supported by Standing Deposit and Lending Facilities .................. 2
Standing Liquidity Facility.................................................................................................... 3
Overnight Standing Repo Facility ........................................................................................ 4
2. Adjustments to the Level of Settlement Balances .................................................... 4
3. Overnight Repo and Overnight Reverse Repo Operations ...................................... 6
III. Supporting the Efficient Functioning of Canadian Financial Markets ................. 7
1. Government of Canada Securities Portfolio ............................................................. 8
2. Term Repo Operations ............................................................................................ 9
3. Securities-Lending Program................................................................................... 10
IV. Providing Liquidity Under Extraordinary Circumstances .................................. 11
1. Providing Market-Wide Liquidity............................................................................. 11
Contingent Term Repo Facility ...........................................................................................12
2. Advances ............................................................................................................... 13
Emergency Lending Assistance .........................................................................................13
I. Overview
Bank of Canada’s Framework for
Market Operations and Liquidity
Provision
I. Overview
In the course of executing its monetary policy and financial system responsibilities, the
Bank undertakes a range of financial market operations as part of its regular monetary
policy operating framework and provides liquidity to the Canadian financial system as
required. The Bank also plays the role of lender of last resort, which has been a
fundamental role of central banks since at least the nineteenth century. The Bank
provides routine liquidity to reinforce the target for the overnight rate and to facilitate
settlement in the payments system and has various tools at its disposal to respond to
situations where exceptional or emergency liquidity may be required, either on a
bilateral basis to specific entities through the provision of Emergency Lending
Assistance (ELA) or on a market-wide basis through the use of extraordinary liquidity
facilities.
The Bank has in place a clear framework to:
•
•
•
guide its financial market operations;
support the provision of routine liquidity to facilitate settlement in the payments
system; and
respond to exceptional or emergency liquidity needs, either on a bilateral basis
through ELA or on a market-wide basis through extraordinary liquidity facilities.
Each of the tools in the Bank’s framework for financial market operations and liquidity
provision is designed to achieve one or more specific objectives:
•
•
•
reinforce the target for the overnight rate
support the efficient functioning of Canadian financial markets
provide backstop liquidity under extraordinary circumstances.
These tools are facilitated by — and in turn influence — the size, structure, and
management of the Bank’s balance sheet.
1
II. Reinforcing the Target for the Overnight Rate
II. Reinforcing the Target for the Overnight Rate
The Bank of Canada conducts monetary policy by setting the target for the overnight
interest rate (often referred to as the policy rate). This directly influences the interest
rates at which banks and other financial system participants borrow and lend funds for a
term of one business day. The level of the overnight interest rate and expectations
about its future path also influence other longer-term interest rates, as well as a broader
range of asset prices.
The Bank’s implementation of monetary policy is closely linked to Canada’s main
payments system – the Large Value Transfer System (LVTS). 1 Almost all payments
(measured by value) flow through the LVTS; therefore, this system is the focus of the
Bank’s framework for the implementation of monetary policy. The Bank’s framework to
support trading at the target rate includes the operating band, or interest rate corridor,
which is in turn supported by standing deposit and lending facilities. 2 The midpoint of
the operating band is the Bank’s target for the overnight rate, and the presence of the
standing deposit and lending facilities provide strong incentives for transactions
between major participants in the overnight market to take place near the target rate.
The Bank can adjust the level of the settlement balances available in the system to
address some frictions in the payments system and to further support trading at the
target for the overnight rate. However, unexpected payment frictions in the market can
sometimes cause the overnight rate to move away from the Bank’s target rate during
the day. In cases where the Bank judges that the deviation is a result of generalized
pressure on liquidity, it can offset this pressure by adding or withdrawing liquidity with
Overnight Repo and Overnight Reverse Repo operations.
1. Operating Band Supported by Standing Deposit and Lending
Facilities
The Bank’s operating band is a 50-basis-point interest rate corridor around the Bank’s
target for the overnight rate (Figure 1). Because LVTS participants must have a zero
balance in their settlement account at the Bank of Canada at the end of each day, any
positive balances in participants’ settlement accounts must be left on deposit with the
Bank and are remunerated at the “deposit rate” (the target rate minus 25 basis points),
which is the bottom of the operating band.
1
See http://www.bankofcanada.ca/core-functions/financial-system/canadas-major-paymentssystems/#lvts to learn more about the LVTS.
2
There are two standing lending facilities: the Standing Liquidity Facility, available to LVTS participants,
and the Overnight Standing Repo Facility (formerly the Overnight Standing Purchase and Resale
Agreement Facility), which is available to Primary Dealers.
2
II. Reinforcing the Target for the Overnight Rate
Conversely, LVTS participants in a deficit position must take an overnight collateralized
advance from the Bank through the Standing Liquidity Facility (SLF) at the “Bank Rate”
(the target rate plus 25 basis points), which is the top of the operating band. This helps
provide incentives for LVTS participants to settle surplus and deficit positions with each
other over the course of the day near the Bank’s target for the overnight rate, which is
the midpoint of the operating band.
Figure 1: Bank of Canada’s Operating Band
Bank rate
Target
+25 bps
50-basis-point operating band
-25 bps
Deposit rate
0
LVTS Settlement Balance
Deficit
Surplus
These arrangements encourage transactions for overnight funds in the marketplace at
rates within the operating band, since participants are aware that they will earn at least
the deposit rate on positive balances and need not pay more than the Bank Rate to
cover shortfalls in their settlement account. Given that the opportunity costs of
borrowing from and depositing funds with the Bank at the end of each day are generally
the same when using the midpoint of the operating band as a reference (i.e., +/- 25
basis points), participants have an incentive to trade among each other at the Bank’s
target for the overnight rate.
Standing Liquidity Facility
Through its SLF, the Bank of Canada provides overnight credit (advances) on a routine
basis to participants in the Large Value Transfer System (LVTS) that are experiencing
3
II. Reinforcing the Target for the Overnight Rate
temporary liquidity shortages due to unexpected payment frictions. 3 Advances extended
by the Bank to LVTS participants under the SLF are made on a secured basis against a
wide range of high-quality collateral. In facilitating overnight settlement in the LVTS
payments system, the SLF reinforces monetary policy and facilitates the smooth
functioning of the financial system.
The SLF helps the Bank reinforce monetary policy, since LVTS participants accessing
the SLF pay the Bank rate (target plus 25 basis points). The higher cost of using the
SLF provides an incentive for LVTS participants to cover their net deficit positions by
undertaking interbank transactions prior to settlement at rates within the operating band.
While only LVTS participants have access to the SLF (and a deposit facility), this
incentive supports the Bank’s monetary policy objectives more broadly by influencing
the behaviour of a broader group of market participants through their interactions with
LVTS participants.
The SLF also helps facilitate the smooth functioning of the financial system by providing
overnight liquidity to institutions that are unable to borrow from their LVTS counterparts.
In the majority of cases, LVTS participants are able to borrow from each other to settle
any end-of-day net negative position in the payments system. However, there may be
occasions where a participant finds itself unable to find a lending LVTS counterpart on
short notice or for technical reasons, such as reaching constraints on their counterparty
credit limit. The SLF ensures that LVTS participants are able to cover temporary
shortfalls in funds that can arise from the daily flow of LVTS settlement of payments.
The SLF is not intended for use by an institution experiencing persistent liquidity
shortages. In such extraordinary circumstances, the institution should consider
requesting Emergency Lending Assistance (ELA) from the Bank.
Overnight Standing Repo Facility
In 2009, the Bank introduced a new standing facility, the Overnight Standing Repo
Facility (formerly the Overnight Standing Purchase and Resale Agreement Facility), to
provide another source of funding for Primary Dealers in Government of Canada
securities who may not have access to the SLF. The facility provides a funding backstop
to Primary Dealers on an overnight secured basis at the Bank Rate, reinforcing the top
of the operating band.
2. Adjustments to the Level of Settlement Balances
At the end of each day, the Bank sets a target for LVTS settlement balances that is
effective for the following day. This helps set trading conditions for the overnight market.
3
See http://www.bankofcanada.ca/core-functions/financial-system/canadas-major-payments-systems/ to
learn more about Canada’s major payments systems.
4
II. Reinforcing the Target for the Overnight Rate
As well, changes in the targeted level of settlement balances can act as a powerful
signal of the Bank’s resolve to reinforce its target for the overnight rate.
The LVTS is a closed system, which means that the net overall cash position of the
entire system should generally be zero. Hence, any LVTS participant with a deficit
position knows that there is at least one participant in the system with an offsetting
surplus position, and is therefore a potential counterparty for transactions at market
rates. However, since the introduction of the LVTS in 1999, the Bank’s target level for
settlement balances has typically been set above zero, which puts the other participants
in the system in a slight surplus cash position. This added liquidity helps reduce
transaction costs and other frictions during the end-of-day process and, as a result,
lessens the need for participants in deficit positions to take frequent small advances
from the Bank.
Changing the level of settlement balances is an effective policy tool to reinforce the
Bank’s target for the overnight rate. In the first few years after the LVTS was
implemented, settlement balances were actively used to influence the overnight rate. In
subsequent years, the targeted level of settlement balances was often adjusted in
anticipation of seasonal or temporary upward pressure on the overnight rate, such as
around quarter-ends and the fiscal year-end of commercial banks. In the spring of
2009, amid the ongoing global financial crisis, the Bank temporarily adjusted its
operating framework when the target for the overnight rate was set at 0.25 per cent. To
push the overnight rate to this value, the Bank set the target level for settlement
balances at $3 billion, its highest levels since the inception of the LVTS. The Bank
retains the right to adjust the targeted level of settlement balances higher or lower,
depending on conditions in the overnight market.
Increasing the level of settlement balances provides a strong incentive for LVTS
participants to lend their cash, thus putting downward pressure on the overnight rate,
because higher settlement balances will inevitably result in some participants being in a
surplus cash position at the end of the day. These surplus funds must be deposited
overnight through the Bank’s deposit facility at a below-market rate (the target for the
overnight interest rate minus 25 basis points).
To achieve the target level of settlement balances, the Bank, as fiscal agent for the
Government of Canada, transfers net public sector payments and receipts within the
system, including its own and those of its other clients, to and from the government
deposit on its balance sheet. The Bank manages these transfers through the afternoon
Receiver General Auction. The Bank publishes on its website the target level of
settlement balances the day before the target’s effective date and the actual amount
each day, after completion of the afternoon Receiver General Auction. In the majority of
cases, the targeted level of settlement balances is achieved; however, in less-common
situations, such as forecast errors where the Bank is unable to make the necessary
5
II. Reinforcing the Target for the Overnight Rate
adjustment to the afternoon Receiver General Auction to offset the error, the actual level
can differ from the targeted level.
3. Overnight Repo and Overnight Reverse Repo Operations
The Bank conducts Overnight Repo and Overnight Reverse Repo operations to further
support the effective implementation of monetary policy by injecting or withdrawing
intraday liquidity, thereby reinforcing the Bank’s target for the overnight rate.
When the conditions in the Canadian general collateral overnight repo market so
warrant, the Bank may intervene and inject intraday liquidity through repurchase
agreements (repos), called Overnight Repo operations, or to withdraw intraday liquidity
through reverse repurchase agreements (reverse repos) called Overnight Reverse
Repo operations. These operations are conducted through a competitive auction to
channel funds to the counterparties that need them most.
If transactions in the general collateral overnight market are generally taking place at
rates above the Bank’s target, the Bank may inject liquidity using Overnight Repo
operations by purchasing Government of Canada securities from Primary Dealers, with
an agreement to resell those securities to the same counterparty the next business day,
with the difference in price equal to the interest for one business day.
Conversely, if transactions in the general collateral overnight market are generally
taking place at rates below the Bank’s target, the Bank may withdraw liquidity using
Overnight Reverse Repo operations by selling some of its holdings of Government of
Canada securities (typically treasury bills) to Primary Dealers, with an agreement to
repurchase them at a value that includes interest for one business day. Those
transactions are conducted at rates equal to or below the Bank’s target for the overnight
rate, depending on market conditions and bidding behaviour at the auction.
The Bank typically conducts these operations at 11:45 a.m. (ET) but, if necessary, the
Bank is prepared to enter into multiple rounds of operations and to conduct those
operations outside of the regular time. While these overnight repo operations typically
involve the purchase of Government of Canada securities, in times of market-wide
stress, the Bank has discretion to expand the list of eligible securities.
Typically, the Bank neutralizes the cash impact on the system from any Overnight Repo
or Reverse Repo operations by adjusting the amount of the afternoon Receiver General
Auction to enable it to achieve the targeted level of settlement balances at the end of
the day. However, depending on the size of the operation, the Bank may not always be
able to fully offset this amount. As an additional tool to offset pressure on the overnight
rate, the Bank also has at its discretion the option of not fully neutralizing the impact of
those operations. If some or all of these operations are not fully neutralized, the system
could be left in a larger surplus or deficit position at the end of the day, requiring at least
6
II. Reinforcing the Target for the Overnight Rate
one LVTS participant to leave funds on deposit at the Bank’s deposit rate or to take an
overnight advance at the Bank Rate.
7
III. Supporting the Efficient Functioning of Canadian Financial Markets
III. Supporting the Efficient Functioning of Canadian
Financial Markets
The Bank’s holdings of financial assets are generally driven by its role in issuing bank
notes. The issuance of bank notes creates a liability for the Bank, the largest on its
balance sheet. Government of Canada deposits, including those supporting the
government’s prudential liquidity plan, typically represent the second-largest liability for
the Bank. To offset these liabilities, the Bank needs to hold financial assets. These
assets are mainly denominated in Canadian dollars, given that the Bank’s liabilities are
mainly denominated in Canadian dollars and composed mostly of investments in
Government of Canada securities and term repos.
The Bank also undertakes financial market transactions with eligible counterparties in
support of monetary policy and the efficient functioning of Canadian financial markets.
The Bank’s transactions are typically repurchase agreements, where the Bank injects or
withdraws liquidity and acquires or sells financial assets.
The Bank’s holdings of financial assets help to promote its operational independence
and support the execution of its responsibilities. This is accomplished in two ways:
•
the financial assets provide a means for the Bank to carry out its responsibilities
without being dependent on government appropriations, and
•
the Bank avoids investments that might impair the process by which the federal
government allocates funds or credit to the private sector or other levels of
government.
The Bank’s Statement of Policy Governing the Acquisition and Management of
Financial Assets for the Bank of Canada’s Balance Sheet (“Statement of Policy”)
establishes the policy governing the Bank’s acquisition and management of domestic
financial assets for its balance sheet. As set out in the Statement of Policy, decisions
about the acquisition and disposition of financial assets and the management of the
Bank’s balance sheet are based on the following guidelines:
•
Neutrality: The Bank limits potential market distortions from its investment
activities by acting in as broad and neutral a fashion as possible. The
composition of the Bank’s balance sheet should be structured such that the
impact on the market prices of those assets from routine purchases of specific
securities should be minimal.
•
Prudence: The Bank mitigates financial risks to its balance sheet that could arise
from valuation losses or credit losses through a risk-management framework.
The framework includes collateralization, with appropriate haircuts, of any lending
7
III. Supporting the Efficient Functioning of Canadian Financial Markets
or advances, and minimum credit-quality requirements for securities eligible for
collateral, repurchase transactions or outright purchases.
•
Transparency: Any purchase or sale of assets by the Bank should be
transparent to the public. 4
While the Bank of Canada Act allows for the acquisition of a broad range of eligible
assets, the objectives and guidelines outlined above effectively limit the types of
financial assets that the Bank should acquire for its portfolio of financial assets in the
normal course of business. 5 The Bank primarily acquires Government of Canada
nominal bonds and treasury bills for its balance sheet outright through non-competitive
bids at government securities auctions, and it may also acquire these securities in the
secondary market. While the Bank’s investments in Government of Canada nominal
bonds are held to maturity, the Bank may sell treasury bills in the secondary market to
fulfill its monetary policy and financial stability responsibilities.
The Bank also conducts a program of term repos that make up a portion of the assets
on the Bank’s balance sheet. These term repos are short-term transactions with Primary
Dealers against high-quality securities.
1. Government of Canada Securities Portfolio
The Bank’s outright holdings of Government of Canada nominal bonds and treasury
bills are structured to broadly reflect the composition of the federal government’s stock
of nominal domestic marketable debt. The Bank does not purchase or hold Government
of Canada Real Return Bonds, given the low level of issuance of such bonds and to
avoid any perceived conflict with monetary policy.
Typically, a fixed percentage of Government of Canada bonds is acquired on a noncompetitive basis at each bond auction to achieve the target structure for asset
allocations. The Bank’s minimum purchase amount is disclosed in the Call for Tenders
of the relevant bond auction, and the actual amount purchased is disclosed in the bond
auction results. The public would also be notified of any change to this fixed percentage
of purchases.
Government of Canada treasury bills and cash-management bills are also acquired on a
non-competitive basis but for a variable amount, depending on the Bank’s specific
4
This requirement for transparency may be waived under exceptional circumstances.
When market conditions warrant, the Bank can implement unconventional monetary policy, which may
involve targeted purchases to affect certain segments of the yield curve or purchases of other assets. See
the Annex included in the April 2009 Monetary Policy Report at http://www.bankofcanada.ca/wpcontent/uploads/2010/03/mpr230409.pdf to learn more about the Bank’s framework for conducting
monetary policy at low interest rates.
5
8
III. Supporting the Efficient Functioning of Canadian Financial Markets
balance-sheet needs at the time of each auction. These amounts are based on Bank
staff projections of expected future demand for bank notes and other liabilities and the
amount of treasury bills and bonds that will mature in the following weeks. The actual
amount purchased is disclosed in the results of each treasury bill auction, which is
consistent with the Bank’s principle of transparency. The typical practice is to split the
total amount of treasury bills purchased by the Bank across the various maturities
offered so that the Bank’s purchases broadly reflect the same proportions of issuance
by the government across the three maturity tranches.
2. Term Repo Operations
These operations, where high-quality assets are acquired temporarily through the repo
market, are conducted to manage the Bank’s balance sheet, to promote the orderly
functioning of Canadian financial markets and to provide the Bank with information on
conditions in short-term funding markets.
As explained above, the Bank’s implementation of monetary policy is based on
influencing the overnight interest rate. However, the Bank also conducts money market
operations at longer maturities, provided such operations do not reduce the Bank’s
influence on the overnight interest rate.
Term repos transacted by the Bank typically have approximately 1- and 3-month terms.
In these transactions, the Bank purchases from Primary Dealers Canadian dollardenominated marketable securities that are directly issued or explicitly guaranteed by
the Government of Canada or by a Canadian provincial government. At the end of the
term, the Bank sells these same securities back to the original counterparty at a predetermined price, with the difference between the Bank’s initial purchase and
subsequent sale prices equalling the interest for the term of the transaction. The Bank
may also conduct term repos for different terms—for example, to offset seasonal
fluctuations in the demand for bank notes—and can modify the range of securities
eligible if deemed appropriate.
Term repo operations allow the Bank to acquire assets on a temporary basis for its
balance sheet. This provides the Bank with flexibility in the management of its assets,
and it also helps reduce the need for the Bank to acquire Government of Canada
securities outright for its balance sheet, which may help support the liquidity of the
Government of Canada securities market. These term repo operations also support the
Bank’s monitoring of liquidity conditions in term funding markets and may encourage the
further development of, and liquidity in, the longer-term repo market in Canada.
9
III. Supporting the Efficient Functioning of Canadian Financial Markets
3. Securities-Lending Program
The Bank established its Securities-Lending Program in 2002 to help support the
liquidity of Government of Canada securities by providing a secondary and temporary
source of these securities to the market. Under this program, the Bank can lend a
portion of its holdings of Government of Canada securities to Primary Dealers when the
Bank judges that a specific bond or treasury bill is trading below a certain threshold, or
is unavailable, in the repo market. Securities are lent through a tender process for a
term of one business day.
This program helps support the liquidity of the Government of Canada securities market
and is designed to support efficient clearing and price discovery. A liquid and efficient
market for Government of Canada securities is important to the efficient functioning of
Canadian financial markets. It helps the Government and other borrowers in their
financing activities and supports the Bank’s objectives in the transmission of monetary
policy.
The Securities-Lending Program is structured such that when the program intervention
threshold is triggered, the Bank can make up to 50 per cent of its portfolio of
Government of Canada bonds and bills available on any given day. The securities are
offered through a tender process, once a day (typically at 11:15 a.m. ET) and for a term
of one business day.
10
IV. Providing Liquidity Under Extraordinary Circumstances
IV. Providing Liquidity Under Extraordinary Circumstances
Under exceptional circumstances, the Bank has the authority to provide extraordinary
liquidity to support financial system stability.
To respond to severe system-wide liquidity stress, the Bank can provide market-wide
liquidity in a number of ways, including by:
•
•
•
•
•
increasing the level of settlement balances;
conducting exceptional buyback transactions, to a maximum term of 380 days,
using an expanded range of securities provided that certain criteria are met;
lending to a broader range of financial institutions than participants in the LVTS
and for terms longer than overnight;
engaging in outright purchases of an expanded range of securities provided that
certain criteria are met and subject to amending the Bank of Canada Policy for
Buying and Selling Securities under subsection 18.1(1) of the Bank of Canada
Act; and
typically lending on a market wide-basis, but could also lend on a bilateral basis.
To address funding shortages at specific financial entities, the Bank can also provide
secured advances through Emergency Lending Assistance (ELA) subject to the Rules
Governing Advances to Financial Institutions.
1. Providing Market-Wide Liquidity
To support the efficient functioning of Canadian financial markets in response to a
severe system-wide liquidity shortage, the Bank could expand existing operations (e.g.,
Overnight Repo/Overnight Reverse Repo operations, Term Repos) along different
dimensions or introduce additional facilities to provide extraordinary market-wide
liquidity. If the liquidity shortage is system-wide rather than due to an idiosyncratic
liquidity shock at an individual institution, ELA would not necessarily be needed.
In determining the form and quantity of extraordinary market-wide liquidity to provide,
the Bank would consider the following five guiding principles for central bank
intervention:
1. Targeted: Intervention should target market failures (liquidity distortions) that are
of system-wide importance and that can be rectified by a central bank.
2. Graduated: Intervention should be commensurate with the severity of the
problem.
11
IV. Providing Liquidity Under Extraordinary Circumstances
3. Well designed: Use the right tools for the right job. Market-based transactions, in
most cases provided through auction mechanisms, should be used to alleviate
market-wide liquidity problems, while loans should be used to address liquidity
shortages affecting specific institutions.
4. Efficient and non-distortionary: Central bank transactions should be at marketdetermined prices to minimize distortions.
5. Mitigation of moral hazard: The risk of creating adverse incentives that could
impair the functioning of the financial system over time should be considered
carefully, and measures should be taken to mitigate such risks. For example,
such measures can include limited, selective intervention and penalty pricing,
where appropriate.
In terms of expanding existing operations, which are auction-based and subject to
minimum bid rates, the Bank could increase the size or overall amount of liquidity
provided (possibly alongside an increase in the level of settlement balances), the term
of the operations and/or their frequency. Additional enhancements to existing
operations could include broadening the set of eligible collateral and/or expanding the
list of eligible counterparties, subject to any criteria deemed appropriate by the Bank.
Amid the 2007–09 global financial crisis, the Bank expanded its provision of liquidity and
activated a number of temporary market-wide liquidity facilities. In accordance with the
five guiding principles outlined above, these facilities varied along different parameters,
including eligible counterparties, eligible securities and terms. 6 As of April 2010, all of
these temporary facilities had been deactivated; however, the Bank retains the ability to
reactivate any of these facilities or to introduce new operations to deal with severe
market-wide liquidity stress.
An additional area where the Bank could expand flexibility in response to severe
market-wide liquidity stress is to activate its standing, or non-auction based, bilateral
facility, the Contingent Term Repo Facility.
Contingent Term Repo Facility
The Bank’s standing facility to respond to severe market-wide liquidity stress is the
Contingent Term Repo Facility (CTRF). Upon activation, the CTRF would offer eligible
counterparties liquidity on a standing, bilateral basis. This facility would provide flexibility
to the Bank to offer liquidity beyond Primary Dealers and their affiliates, at the Bank’s
discretion, should the Bank deem it necessary to support the stability of the Canadian
financial system. Counterparties beyond Primary Dealers and their affiliates would need
6
These temporary market-wide liquidity facilities included the Term Purchase and Resale Agreement
(PRA); the Term PRA for Private Sector Money Market Instruments, which was replaced by the Term
PRA for Private Sector Instruments; and the Term Loan Facility.
12
IV. Providing Liquidity Under Extraordinary Circumstances
to demonstrate significant activity in the Canadian money and/or bond markets, be
subject to federal or provincial regulation, and meet any other conditions the Bank
requires.
Activation and deactivation of the CTRF would be at the Bank’s sole discretion, as
conditions warrant. This facility would not be used to address idiosyncratic liquidity
shocks at individual institutions. Terms and conditions for the CTRF would be published
upon activation.
2. Advances
Emergency Lending Assistance
Emergency Lending Assistance, or ELA, is a loan or advance to eligible financial
institutions (FIs) and financial market infrastructures (FMIs) at the Bank of Canada’s
discretion. 7 The provision of ELA is extraordinary and designed to provide last-resort
liquidity to individual FIs or FMIs that are facing serious liquidity problems.
These entities — FIs and FMIs — are critical players in the financial system susceptible
to large and sudden liquidity shocks. Deposit-taking FIs make loans to individuals and
businesses, partially financing them through redeemable retail deposits and short-term
wholesale funds. If an otherwise sound FI experiences a large and sudden withdrawal
of deposits and wholesale funds, it can become illiquid because of a mismatch in the
timing of cash inflows and outflows. Payment clearing and settlement systems, or FMIs,
can also experience liquidity shortages under extreme scenarios such as multiple
member defaults. 8 While an FMI must have adequate financial resources and
arrangements to manage extreme but plausible scenarios, these may not be sufficient
under every scenario.
ELA is not intended to address broader, more severe system-wide liquidity shortage
and is distinct from other extraordinary liquidity facilities that may be activated during
times of funding market stress and made available to a broad set of participants. 9
ELA can play a role in both the recovery and resolution of an individual FI or FMI:
•
Recovery: An FI or FMI under extreme stress can trigger a process known as
recovery, whereby the entity takes actions to restore the market’s confidence in
7
The power to provide ELA to FIs comes from the Bank of Canada Act, s. 18(h). The power to provide
ELA to FMIs comes from the Payment Clearing and Settlement Act (PCSA), s. 7(a) and 7(b) and from the
Canadian Payments Association Bylaw No. 7 Respecting the Large Value Transfer System.
8
A member participant is usually a type of financial institution but can include other types of entities.
9
During the 2007–09 financial crisis, the Term Purchase and Resale Agreement (PRA) Facility, Term
PRA Facility for Private Sector Instruments and Term Loan Facility were activated as part of the Bank’s
extraordinary liquidity facilities.
13
IV. Providing Liquidity Under Extraordinary Circumstances
its financial soundness. ELA can provide liquidity in support of recovery actions
undertaken by an FI. 10
•
Resolution: Should recovery actions be insufficient to mitigate stress faced by
an FI or FMI, the firm’s resolution authority could place the FI or FMI into
resolution. At the point of entering resolution, the FI or FMI would be deemed
“non-viable.” Through the resolution process, the resolution authority would seek
to maintain functions that are critical to the economy and return the firm to
viability, or liquidate the firm in an orderly fashion. 11 ELA could serve as a source
of temporary public sector liquidity to support the broader efforts of authorities to
conduct an orderly resolution of the firm.
In both recovery and resolution, the Bank retains its discretion to provide ELA.
Figure 2 illustrates how ELA may support an FI or FMI’s return to long-term viability.
This serves to highlight important differences between the role of ELA in recovery and
resolution.
The provision of ELA can create the risk of moral hazard, where FIs and FMIs
mismanage their liquidity risk because they assume central bank support will be
available. Supervisory scrutiny and liquidity regulations can help to mitigate moral
hazard. 12 Nevertheless, the Bank imposes eligibility requirements and terms and
conditions for ELA to encourage FIs and FMIs to manage their liquidity safely and to
rely on private funding sources.
Terms and Conditions
The terms and conditions of ELA loans are framed by the Bank of Canada Act, the
Payment Clearing and Settlement Act (PCSA), the Bank’s lending policies, and its loan
and security agreements. 13 The terms and conditions are designed to provide the
appropriate safeguards to protect the Bank from financial and legal risk and to mitigate
moral hazard.
Interest rate: The minimum rate that the Bank charges on ELA loans is the Bank Rate,
which is the rate of interest that the Bank charges on one-day loans to major financial
10
Examples of recovery actions that a financial institution could take are restructuring business lines and
raising capital or funding.
11
Examples of resolution actions with respect to an FI or FMI include recapitalization and restructuring.
The resolution authority could also choose to wind down the firm in an orderly fashion.
12
For example, new Basel III regulations such as the Liquidity Coverage Ratio and the Net Stable
Funding Ratio help to mitigate moral hazard and reduce the probability that institutions will require ELA.
13
View the Bank of Canada Rules Governing Advances to Financial Institutions for further information on
ELA provision to financial institutions.
14
IV. Providing Liquidity Under Extraordinary Circumstances
Figure 2: Emergency Lending Assistance in recovery or resolution
The following assumptions apply:
1. Eligibility conditions for ELA are satisfied: Eligibility conditions depend on the type
of entity making the ELA request (see Table 1).
2. The Bank decides to offer ELA: The provision of ELA complements either the
recovery actions of the FI/FMI or the resolution actions of the resolution authority.
15
IV. Providing Liquidity Under Extraordinary Circumstances
institutions. While the Bank has the discretion to charge an interest rate higher than the
Bank Rate, historically, the Bank has charged the Bank Rate for ELA.
Term: Under the Bank of Canada Act, the Bank can provide ELA for a maximum term
of six months. The loans can be renewed for a period of up to six months, at the Bank’s
discretion, as many times as the Bank deems necessary. In practice, ELA loans would
typically be structured as one-day loans, to be rolled over daily.
Collateral: The Bank of Canada Act requires that all Bank lending be secured. 14 As
with lending under the Bank’s Standing Liquidity Facility (SLF), the Bank must be able
to obtain a valid first-priority security interest in any collateral pledged or assigned to
support ELA. 15 If the counterparty fails to repay the ELA loan, the Bank can then sell or
retain the collateral to address any losses it may face. The Bank is willing to take a
broader range of collateral for ELA than it accepts for credit under the SLF. This can
include but is not limited to
•
•
•
the Canadian-dollar non-mortgage loan portfolio (NMLP);
less liquid securities, including collateralized own-name securities; and
Canadian-dollar mortgages, both residential and non-residential.
Because there are additional challenges inherent in accepting mortgages, the Bank
expects FIs to consider preparing alternative forms of collateral to ensure that ELA can
be readily accessed if needed. The Bank therefore generally expects to take mortgages
as a last resort to maintain financial stability. To protect the Bank from loss, the Bank
retains the right of refusal for any asset, accepting only that collateral for which it can
manage the associated legal, financial and operational risks.
Haircuts will be applied to collateral accepted so that the Bank lends an amount less
than the current value of the collateral it takes. This protects the Bank against valuation
risk and potential future declines in collateral value. For consistency, the haircuts
applied to SLF-eligible collateral pledged for ELA would generally be set according to
the Bank’s SLF collateral policy, although the Bank reserves the right to impose
different haircuts for collateral accepted under ELA. 16,17 For loan collateral and for
14
See the Bank of Canada Act, s. 23(d).
An institution would need to provide the Bank with acceptable legal documentation to support the
Bank’s security interest in pledged or assigned collateral. See Rules Governing Advances to Financial
Institutions for further details on the documentation required.
16
Collateral that is acceptable under the Standing Liquidity Facility (SLF) will also be accepted for ELA.
For more information on the Bank’s SLF collateral policy, see
http://www.bankofcanada.ca/2015/06/assets-eligible-collateral-under-bank-canadas-standing-liquidity-15june-2015/.
17
For example, haircuts applied to the non-mortgage loan portfolio may be different under ELA than
under SLF.
15
16
IV. Providing Liquidity Under Extraordinary Circumstances
securities for which market prices are unavailable or judged to be unreliable, the Bank
will value the collateral and set haircuts on a case-by-case basis to reflect their risk
characteristics. 18
Currency: FIs and FMIs are responsible for ensuring that they have reliable
arrangements for liquidity support in foreign currencies important to their businesses,
either through private sector support or foreign central bank facilities. For FIs qualified
for ELA, the Bank could lend Canadian dollars on a collateralized basis to the illiquid
institution, which could in turn exchange those Canadian dollars for the needed foreign
currency. Where foreign exchange markets are also constrained, the Bank may provide
foreign currency liquidity to eligible FIs. For FMIs, where it is operationally feasible, the
Bank could provide foreign currency ELA, if needed, to prevent a Canadian-domiciled
designated FMI from failing to meet its obligations to a foreign FMI. 19
Eligibility Criteria
The Bank sets eligibility criteria for each type of financial entity. These criteria help
protect the Bank from loss and minimize moral hazard while ensuring that ELA can fulfill
its role in supporting the recovery or resolution of financial entities.
The Bank determines whether the preconditions for ELA are met prior to an ELA
request and updates its judgment at the time of an ELA request. The opinions of the
relevant supervisors and resolution authorities will be a key determining factor in this
judgment.
Table 1 lists the eligibility criteria for the three types of entities that are eligible for ELA:
federally regulated FIs, provincially regulated deposit-taking institutions (DTIs) and
FMIs. 20
Entities that would not generally be eligible for ELA include the following:
•
•
Insurance companies, mutual funds, and investment dealers. These entities do
not issue deposits and hold a significant share of their assets in illiquid, hard-tovalue claims.
Foreign bank branches. Foreign bank branches should look to the central bank of
their home jurisdiction for emergency liquidity.
18
Because the Bank has the flexibility to accept any collateral for which it can manage the associated
risks, it does not publish a complete list or haircut schedule for collateral accepted under ELA.
19
A domestic FMI could require intraday access to a foreign currency to meet its obligations to a foreign
FMI, and a foreign currency ELA could therefore prevent an unnecessary and costly default of the
domestic FMI.
20
A deposit-taking institution is a type of financial institution that accepts deposits, which are fixed-value
promises to pay, often redeemable at short notice.
17
IV. Providing Liquidity Under Extraordinary Circumstances
•
Foreign FMIs. Lead central banks overseeing foreign-domiciled FMIs are
responsible for ensuring that emergency liquidity is available to those systems.
However, the Bank could facilitate the lead central bank’s provision of Canadiandollar liquidity should the lead central bank choose to do so.
Table 1: Eligibility criteria for access to Emergency Lending Assistance
Type of financial entity
Eligibility criteria
Federally-regulated FI 21
1. Member of the Canadian Payments Association (CPA)a
2. Credible recovery and resolution framework
Provincially-regulated
DTIs
1.
2.
3.
4.
Financial market
infrastructure
Canadian-domiciled FMI designated for Bank of Canada oversight
Member of the Canadian Payments Association (CPA)b
Provincial indemnity
Important to the stability of the broader financial system
Credible recovery and resolution framework
a
For FIs, ELA funds would generally be disbursed through Canada’s Large Value Transfer System
22
(LVTS). Only CPA members can be LVTS participants. For federally regulated FIs that are not LVTS
participants, ELA funds would be received through an LVTS participant clearing on their behalf.
b
For credit unions or caisse populaires that are not members of the CPA but meet all other eligibility
conditions, the Bank can lend to their provincial central with CPA membership. The central could then
pass on the liquidity to the individual credit unions or caisses populaires that are not themselves CPA
members.
Each of the eligibility conditions from Table 1 is described in further detail below.
Member of the Canadian Payments Association: The Bank of Canada Act provides
the Bank with the power to make secured loans or advances to members of the CPA.
Every bank is required to be a CPA member. Provincial centrals are entitled to be
members and can become a member upon application to and approval by the CPA. 23
Credible recovery and resolution framework: A recovery and resolution framework
consists of the powers, governance arrangements, strategies and facilitating tools that
21
In the case of trust companies, the “in-trust” nature of the assets held by such a firm means that ELA
could be provided only through a loan secured by company assets, or through an outright purchase of
assets, associated with provisions to sell the assets back to the trust company at predetermined prices.
22
The Large Value Transfer System is the large-value payments system operated by the Canadian
Payments Association and forms the core of Canada’s national payments system. For further details, see
http://www.bankofcanada.ca/core-functions/financial-system/canadas-major-payments-systems/#lvts.
23
For a list of CPA members, see
https://www.cdnpay.ca/imis15/eng/Membership/Member_List/eng/mem/Member_List.aspx.
18
IV. Providing Liquidity Under Extraordinary Circumstances
would be used by a firm to recover from stress, as well as the powers, governance
arrangements, strategies and facilitating tools that authorities would use to support
orderly resolution. 24 A recovery and resolution framework is credible if it provides the
relevant authorities, including the Bank of Canada, with a high degree of confidence that
the long-term viability of a troubled institution can be maintained or restored, or the
institution can be liquidated in an orderly manner, without systemic disruption. This is
consistent with the Financial Stability Board’s Key Attributes of Effective Resolution
Regimes for Financial Institutions.
The Bank does not intend to develop any specific criteria or requirements for recovery
and resolution frameworks beyond those that have been or will be developed by the
relevant supervisors and resolution authorities. Accordingly, institutions should continue
to respect the guidelines and expectations for recovery and resolution planning
established by their supervisors and resolution authorities. Before providing an ELA
loan to an institution, however, the Bank undertakes the necessary due diligence to
satisfy itself that all ELA preconditions are met.
While it will not develop specific criteria, the Bank generally considers a framework
credible if it
•
•
•
•
seeks to maintain continuity of functions that are important to financial stability;
identifies recovery and resolution strategies that can be readily implemented to
address extreme stress events;
provides for effective coordination and information sharing with relevant
authorities; and
has sufficient funding and liquidity arrangements in place to respond to extreme
stress events while ensuring that ELA, if needed for temporary funding, is used
only after private funding sources are no longer available.
In general, the tools and processes forming the recovery and resolution framework
should be commensurate with the size and complexity of the institutions within its
jurisdiction. Documents describing a firm’s crisis management or contingency planning
would help inform the judgment of the Bank and the relevant authorities regarding the
credibility of the recovery and resolution framework. Recovery and resolution plans
(“RRPs”) are not necessarily required of every financial institution in order to achieve a
credible framework, but as an institution increases in size and complexity such plans
provide greater assurance that a framework is credible.
24
Facilitating tools can include but are not limited to contingency plans, default simulations and stress
testing.
19
IV. Providing Liquidity Under Extraordinary Circumstances
Provincial indemnity: Provinces that have responsibility for the prudential oversight of
provincial institutions will need to indemnify the Bank from any losses if the borrowing
provincial institution were to default on its ELA loan. The requirement reflects the fact
that provincial authorities have the legislative powers to regulate local co-operatives and
therefore are responsible for the stability of the provincial financial sector. The indemnity
would only cover any residual amount should the value of the collateral provided, as
well as any guarantees by other institutions, prove insufficient. 25 Provincial
indemnification is not required for access to the Bank’s SLF or market-wide liquidity
facilities.
Important to the stability of the broader financial system: Bank of Canada ELA
would be available to a provincially regulated institution only if it is deemed, in the
judgment of the Bank, to be important for the stability of the broader broader financial
system. The Bank must be of the opinion that the distress or disorderly failure of the
potential ELA recipient would have important adverse consequences for the broader
financial system and the Canadian economy. This requirement reflects the responsibility
of provincial authorities and the provincial centrals, to establish mechanisms to provide
liquidity to local co-operatives under most circumstances. ELA would only be supplied in
extreme scenarios.
In forming its judgment on the importance of the provincial institution to the broader
financial system, the Bank will consider, among other things, if
•
•
•
stress from the co-operative system is materially contributing to and/or amplifying
adverse financial conditions;
distress from a provincial or regional co-operative system is severely impairing
economic activity in that region; and
distress in one or more co-operative system is actively spreading, or has an
ability to spread, through national co-operative frameworks and infrastructures.
Domestic FMIs designated for Bank of Canada oversight: The PCSA provides the
Bank with the power to lend to FMIs designated as subject to the Bank’s oversight
(designated FMIs). A financial market infrastructure is designated by the Bank if it has
the potential to pose systemic risk to Canada’s financial system or if it is a prominent
payments system that, while not systemically important, is critical for economic activity
in Canada. 26
Managing ELA
25
Federal credit unions would be subject to the same eligibility criteria as other federally regulated
deposit-taking institutions.
26
For designated FMIs, see http://www.bankofcanada.ca/core-functions/financial-system/oversightdesignated-clearing-settlement-systems/.
20
IV. Providing Liquidity Under Extraordinary Circumstances
Coordination with the relevant authorities
It is important to note that central bank lending cannot recapitalize an FI or FMI or
address the underlying problems that lead to liquidity shortfalls. Accordingly, the
deployment of the Bank’s liquidity facilities is just one component of a larger set of
coordinated actions that authorities can take to support the stability of the Canadian
financial system.
The Bank consults with the relevant authorities to determine whether the preconditions
for ELA have been met prior to and at the time of an ELA request. The Bank also
endeavours to keep the relevant authorities informed of prospective ELA situations and
to notify them immediately if ELA is provided to an institution.
For federally regulated FIs, the Financial Institutions Supervisory Committee (FISC) is
the primary forum for the exchange of information and for coordinating strategies, such
as those for contingency planning, among federal authorities when dealing with troubled
institutions that are still viable. 27 Relatedly, federal authorities would primarily coordinate
resolution strategies for non-viable firms through the Board of Directors of the
Canadian Deposit Insurance Corporation’s. The borrowing institution may be required to
provide increased reporting (data and other information) to the Office of the
Superintendent of Financial Institutions or the Bank on the institution’s evolving
situation.
For provincially regulated deposit-taking institutions, the Bank endeavours to establish
formal arrangements for communication with the relevant provincial authorities.
For FMIs that are also overseen by other regulatory authorities, the Bank establishes
co-operative arrangements with those authorities to facilitate communication and
coordination.
Exiting ELA
The ELA loan agreements between the Bank and the borrowing entity would create a
one-day revolving facility in which the Bank would have discretion to decline to make
any further one-day loans. This would allow the Bank to readily cease ELA.
The Bank would cease ELA if this was judged by the Bank to be appropriate. This could
occur, for example, if the borrowing entity no longer met or is unlikely to continue
meeting all necessary ELA eligibility criteria or if the collateral to support ELA was no
longer sufficient.
27
For the legislative basis underpinning FISC, see Section 18 of the Office of the Superintendent of
Financial Institutions Act at http://laws-lois.justice.gc.ca/eng/acts/o-2.7/page-6.html#h-12.
21
IV. Providing Liquidity Under Extraordinary Circumstances
ELA Disclosure
The Bank is legally prohibited from disclosing the identity of borrowing institutions. The
amounts of ELA advances are not included in the Bank’s Weekly Financial Statistics
until public disclosures have otherwise occurred. Any outstanding ELA advances are
included in the Bank’s monthly balance sheet and its annual and quarterly financial
statements at an aggregate level.
The Relationship Between the Standing Liquidity Facility and ELA
The Standing Liquidity Facility (SLF) is part of the Bank’s routine operations and helps
smooth the functioning of the payments system by providing overnight secured
advances to LVTS participants experiencing temporary liquidity shortages due to
unexpected payments system frictions. The Bank monitors SLF usage for any unusual
access that may be a sign of significant and persistent liquidity shortage, which the SLF
is not intended for. In such extraordinary circumstances, eligible financial institutions
may consider requesting ELA from the Bank. ELA is intended to address persistent
liquidity shortages and can provide more substantial and prolonged credit.
Since SLF advances are designed to help resolve day-to-day LVTS payment frictions,
there is no presumption of a protracted liquidity problem or solvency risk with its use. In
contrast, under ELA, there is clearly a significant liquidity problem affecting the
institution, so the risk to the Bank, as its lender, is greater. Consequently, morestringent eligibility conditions and different terms and conditions apply under ELA.
22