1. of the Eurosystem, liquidity and Collateral Management
The Monetary Policy Framework
of the Eurosystem, liquidity and
Collateral Management
Richard Derksen Conference Financial Sector of Macedonia on Payments and Securities Settlement Systems
Ohrid June 2008
De Nederlandsche Bank

2. Contents Topics Collateral management framework
The ESCB (Euro System of Central Banks) monetary policy framework
Collateral management framework
Trends in collateral: European and NL
Mobilising collateral

3. Monetary policy strategy:
Why central banks?
What targets have central banks?
Why to fight inflation?
Monetary policy implementation:
How to implement these strategies?
Role and functions of official interest rates?
How can a central bank generate stable interest
rate movements?

4. Monetary policy strategy:
The monetary strategy determines which money
market interest rate level is required to maintain
price stability.
Monetary policy implementation:
The operational framework determines how to
achieve this interest rate level using the available
monetary instruments.

5. Functions of the operational framework
Eurosystem sets and stabilises interest rates in
the short term money market in two ways:
Signalling its monetary policy stance to the money
market
Managing the liquidity situation in the money

6. How to set (money market) interest rates?
Step 1: determine official interest rates
Step 2: make banks dependent on credit by the ECB
Step 3: extend credit to banks with the appropriate
interest rate
Step 4: design framework to stabilise very
short-term interest rates

7. Monetary policy instruments:
Minimum reserve requirements
Credit extension to banks via
Open Market Operations
Main refinancing operations
Long-term refinancing operations
Fine-tuning operations
Structural operations
Standing facilities
Marginal lending facility
Deposit facility

8. Basic requirements for successful monetary policy implementation:
Confidence market players
Demand and supply
Regulatory framework ……

9. Liquidity management Eurosystem:
Demand
- Reserve requirements
- Excess reserves
- Autonomous factors
factors (net)
- deposit facility
Supply
Open market operations
MROs (policy rate)
LTROs
Fine tuning
Structural operations
marginal lending facility

10. Liquidity management Eurosystem:
Demand
- Reserve requirements
- Excess reserves
- Autonomous factors
factors (net)
- deposit facility
Supply
Open market operations
MROs (policy rate)
LTROs
Fine tuning
Structural operations
marginal lending facility =
(over a
reserve
mainte-
nance
period)

11. Consolidated Balance Sheet of the Eurosystem (July 2007 and March 2008) (EUR bn)
factors affecting the liquidity of the banking system
432.6
478.0
692.0
737.9
net foreign assets (including gold)
316.7
350.5
banknotes in circulation
639.6
660.8
other assets (net)
115.9
127.5
government deposits with the Eurosystem
52.3
77.1
monetary policy operations of the Eurosystem
451.8
486.0
192.4
226.1
main refinancing operations
301.7
216.0
current accounts - minimum reserves
192.0
225.1
longer-term refinancing operations
150.0
270.0
deposit facility
0.4
1.0
marginal lending facility
0.1
0.0
other operations
total
884.4
964.0

12. Future challenges:
the management of the volatility of short term interest rates
determining the optimal size and composition of central bank balance sheet
the appropriate level of communication with the financial markets
contribute to further integration of financial markets by harmonising and expanding collateral instruments

13. Contents Topics Collateral management framework
The ESCB (Euro System of Central Banks) monetary policy framework
Collateral management framework
Trends in collateral: European and NL
Mobilising collateral

14. Guiding Principles of the Collateral Framework
Article 18.1 of the Statute requires all credit operations by the Eurosystem to be “based on adequate collateral”. The concept of adequacy has 2 notions:
Collateral must be able to protect the Eurosystem from incurring losses in its credit operations
There must be sufficient collateral potentially available to ensure that the Eurosystem can carry out its tasks
To reconcile both notions of “adequate collateral” may not be easy:
1. The range of assets must be broad to ensure the sufficiency of
collateral
2. This may be in conflict with the desire for operational efficiency and transparency
To what extent compromises on the principle of operational efficiency need to be made depends on the structure of financial markets

15. Single list of collateral
Operational on January 1st, 2007
Drawbacks 2-tiers list ( ): heterogeneity and no transparency
2 asset classes:
marketable assets and
non-marketable assets (no quality difference)
Marketable assets: high credit standards (single A↑), located in the euro area, denomination euro

16. Single list of collateral
Marketable assets: listed on regulated markets or certain accepted non-regulated markets
Non-marketable assets: credit claims and Irish non-marketable retail mortgage backed debt instruments, no market criterion
For both asset classes -> Eurosystem credit assessment framework

17. Eurosystem Credit Assessment Framework
ECAF sources:
ECAI – External Credit Assessment Institutions
ICAS – NCBs in-house credit assessment systems
IRB – counterparties internal ratings-based systems
RT – third-party providers rating tools.
Additionally:
PSE-list and guarantees
(ECAF principles: consistency, accuracy and comparability)

18. ECAF benchmark/threshold
´Single A` (A-Fitch and S&P, A3 Moody´s) Or
Probability of default (PD) over a one-year horizon of 0,10%
Default definition from EU Capital Requirements Directive (CRD)

19. Valuation principles Marketable assets
Define the most representative price source
Rules for non-availability of prices
Treatment of income flows
Non-marketable assets
Theoretical price or outstanding amount

20. Present collateral framework (NL)
Legal technique: pledge
Pool of collateral - total market value minus haircut (+interest) = credit line
- integrated use of the collateral pool on request of credit institutions like supporting services, e.g. CCP margin and guarantees for special purposes
Legal setting credit claims: public pledge, physical delivery loan documentation, ex ante notification of debtor
[Situation before EMU/1999: extensive collateral list: equities, private loans, loans in other currencies]

21. Stabilising features of the Eurosystem’s collateral framework
Key features of the Eurosystem’s collateral framework:
Acceptance of a broad range of debt instruments as collateral
No collateral differentiation between tender operations and standing facilities
Single auction rate applicable to different types of collateral in tender operations
Performance during the turmoil:
Sufficiency of collateral ensured, facilitating broad access to central bank money
Low consumption of high opportunity cost collateral
Mitigation of asset refinancing risk through large scale acceptance of ABS in the main refinancing operations

22. Contents Topics Collateral management framework
The ESCB (Euro System of Central Banks) monetary policy framework
Collateral management framework
Trends in collateral: European and NL
Mobilising collateral

23. Evolution of eligible marketable and non-marketable collateral by asset type (€ billion)

24. Trend towards use of more illiquid collateral

25. Situation NL: Statistics on collateral in the pool
(end December 2006 versus end March 2008)
Total
(Marketvalue, before haircuts)
€ 74 bn € 138 bn
Credit claims
± € 2,3 bn ± € 2,9 bn
vault
Via link:
± € 2,7 bn € 2,8 bn
Domestic
± € 17 bn ± € 78,3 bn
ENL
Eurobonds
± € 19,6 bn € 31 bn EB
DE ± 8/ IT ± 11
± € 32,4 bn € 23 bn
CCBM

26. Infrastructure Collateral management domestic DNB vault
Euroclear Netherlands (CSD)
Foreign (cross border)
Direct links
Euroclear Bank
CCBM
CCB
CCB

27. Structure of domestic safekeeping
DNB 2 1
3 (= €) 1
Euroclear
Netherlands
Bank A

28. Structure of eligible links1
Bank A
DNB
3 (= €) 1 2
Euroclear Netherlands
(I)CSD
(Monte Titoli)

29. CCBM
Dutch Eurosystem counterparty sends Swift MT540 to DNB (and MT542 to its own custodian)
DNB sends MT540 to the respective CCB
Upon receipt of the securities, the CCB sends an MT544 to DNB
DNB updates its collateral management system and increases the credit facility for the Dutch Eurosystem counterparty

30. CCBM Structure of CCBM 4 CCB HCB 3 1 CSD 2 1 Bank A 5 (= €) Custodian/
Agent
Bank A
CCBM - Correspondent Central Bank Model
CCB - Correspondent Central Bank
HCB - Home Central Bank
CSD - Central Securities Depository

31. Confirmation/receipt
The current framework for the use of collateral
Step1: Request
for credit
Step2:
Matching
National domestic procedures
SSS A
CPY A
NCB A
Step4:
Release credit
Step 3:
Confirmation/receipt
Step2: transfer instruction
Step3:
Matching
Step1: Request
for credit
Step2: CCBM message
A common procedure with minimum harmonisation for cross-border use (level of automation, communication protocols)
CPY A
NCB A
NCB B
SSS B
Step6:
Release credit
Step 4:
Confirmation
Step5: Receipt
Step3: transfer instruction

32. CCBM2 – A single procedure for domestic and cross-border use of collateral
CPY A
NCB A
SSS A
CPY B
NCB B
NCB A
SSS A
CCBM2 platform
Single procedure for domestic and cross-border
Harmonised procedures for counterparties
PSSC/SWG/2007/414

33. Single Eurosystem Interface
Synergies with other Eurosystem initiatives
TARGET2-Securities
Single Eurosystem Interface
Securities accounts
Sub -Cash accounts
Custody accounts
CCBM2
TARGET2
Cash accounts

34. Summing up Basics on monetary and collateral framework
Single list and ECAF
NL situation
Collateral mobilisation

35. Thank you very much !
Qu€stions?

36. Some detailed slides

37. Minimum reserve requirements:
During a reserve maintenance period banks have on average to maintain a certain percentage of certain banks’ balance sheet items (2%) on an account at the central banks
Create / increase money market shortage
(counterparties vis à vis Eurosystem)
Averaging feature helps stabilising overnight and
intraday money market rates

38. Minimum reserve requirements:
Interest paid over required reserves
Excess reserves not remunerated, giving incentive to go to the market
Penalty in case of non-compliance
Banks with large payment flows prefer large
reserve requirements

39. Minimum reserve requirements:
Current amount reserve requirements for the
Eurosystem ± EUR 202 billion
(The Netherlands ± EUR 20 billion,
largest 5 counterparties account for ± 90% in NL)

40. Open markt operations:
Main refinancing operations (MROs)
about 70% of total credit extension
Long term refinancing transactions (LTROs)
about 30% of total credit extension
Fine-tuning operations (FTOs)
nowadays last day of the reserve maintenance
period
Structural operations

41. Main refinancing operations (MROs):
Open for all banks with a minimum reserve
requirement (cf US system of primary dealers)
Interest rate on MROs is main ECB interest rate
Main source credit extension Eurosystem
Variable rate tender (opposite to fixed rate tender)
Marginal rate few base points above min. bidrate

42. Main refinancing operations (MROs):

43. Long term refinancing transactions (LTROs):
Liquidity providing
Monthly auction via variable rate tender
Three month maturity

44. Long term refinancing transactions (LTROs):
Reverse transactions
Pre-announced 50 billion euro size each
Particularly designed for smaller banks
Amount allotted is sufficient to balance supply
and demand

45. Fine-tuning operations (FTOs):
Smooth out effects on interest rates of unexpected
liquidity fluctuations
Liquidity providing or liquidity absorbing
Ad hoc basis and regular basis i.e. last day of a
reserve maintenance period

46. Fine-tuning operations (FTOs):
Short-term basis
Tender or bilateral operation
Selected group of fine-tuning counterparties

47. Structural operations:
Liquidity-providing or liquidity-absorbing
Conducted on an ad hoc basis (never used yet)
Maturity not standardised
Tender or bilateral operations

48. Types of open market operations:
Reverse transactions
Outright transactions
Foreign exchange swaps
Collection of fixed-term deposits
Issuance of ECB debt certificates

49. Stabilizing money market interest rates:
Fine-tuning instruments
Averaging facility on the reserve requirements
Standing facilities

50. Standing facilities : Deposit facility overnight liquidity absorption
at relatively low (official) interest rate
floor for market rates
normally no restrictions
Marginal lending facility
overnight liquidity provision
at relatively high (official) interest rate
ceiling for market rates
normally no restrictions except collateral

51. Standing facilities : General:
Providing / absorbing liquidity at the discretion of
banks/at the initiative of counterparties
Limiting maximum interest volatility
Signal general stance of monetary policy

52. MARKETABLE ASSETS Type of assets
ECB debt certificates; other marketable debt instruments
Credit standards
Asset of high credit standard; using ECAF rules
Place of issue
EEA
Settlement/handling procedures
Settled in euro area; centrally deposited in book-entry form with central banks or SSS fulfilling ECB’s minimum standards
Type of issuer/debtor/guarantor
Central banks; public sector; private sector; international and supranational institutions
Place of establishment of
Issuer/debtor/guarantor
Issuer: EEA or non-EEA G10 countries; Guarantor EEA
Acceptable markets
Regulated markets; non-regulated market accepted by ECB
Currency
Euro
Cross-border use
Yes
(No minimum size; no governing law)

53. NON-MARKETABLE ASSETS: CREDIT CLAIMS
Type of assets
Credit claims
Credit standards
High credit standard for debtor/guarantor; using ECAF rules
Settlement/handling procedures
Eurosystem procedures
Type of issuer/debtor/guarantor
Public sector; non-financial corporations; international and supranational institutions
Place of establishment of
Issuer/debtor/guarantor
Euro area
Currency
Euro
Minimum size
Until Dec 2011: NCB choice for domestic use; 500,000 for cross-border use. After 1 Jan 2012: 500,000
Governing law
Law of a euro area Member State;
Cross-border use
Yes
(Additional legal requirement: verification of existence, notification of debtor or registration, no restrictions from banking secrecy, no restrictions on
mobilisation or realisation). (Not applicable: place of issue; acceptable markets)

54. Risk control measures Marketable assets Credit claims
Valuation haircut
Liquidity category
Coupon type
Residual maturity
Type of interest rate payment
Valuation methodology (NCBs)
Variation margin
Trigger point (0.5%)
Assets or cash (depends on NCBs)
Risk control
measures