'Less is more' or 'Less is a
bore'? Re-calibrating the
role of central bank reserves
Given at Kings College London's Bank of England Watchers'
Conference, the Institution of Engineering and Technology, London
03 November 2023
Speech
Introduction
-
Central banks today face many challenges but three of the biggest are:
•
First, how to judge where central bank balance sheets should settle in the medium
- -
term as monetary policy makers return inflation which remains far too high to
target, through a combination of higher interest rates and unwinding Quantitative
and other 'unconventional' policy
Easing (QE) interventions;
• that banks' liquidity
Second, on the micro-prudential side, how to ensure
insurance remains appropriate as technological change increases the risk of larger
and faster deposit runs, of the kind seen this Spring in the US; and
•
Third, on the macro-prudential side, how to ensure the stability of the financial
system as a whole in the face of the growing incidence of systemic liquidity shocks,
not just in banks but increasingly in non-bank market finance too.
-
These questions span the full width of the central banking remit and their discussion
therefore usually involve different people, with different goals, analytical frameworks and
-
policy tools. But there is one important common factor and that is central bank reserves,
the ultimate form of settlement and hence the safest and most liquid of all financial assets.
In most economies, including the UK, the stock of reserves has risen materially over the
'unconventional'
past 15 years as the result of monetary easing. As that process reverses,
the question is what contribution should reserves make to maintaining micro- and
macro-prudential stability, given the changing nature of risks to those goals?
On one view, less is more. Generous reserves supply is argued to have exposed central
banks to heightened financial, operational and reputational risk, impaired the functioning of
markets, and incentivised inappropriate private sector risk-taking, amplifying some of the
liquidity stresses of recent years. While that may have been a price worth paying to deal
with the slump in nominal activity caused first by the Global Financial Crisis (GFC) and
then Covid, a very different future steady state is needed. Proponents of this view argue
that, during normal times, central banks should return the supply of reserves to levels
-
closer to those seen pre-GFC sufficient to lubricate payment systems and provide a
modest buffer for unanticipated liquidity needs, but placing primary responsibility for
-
managing idiosyncratic liquidity risk judged to be the primary cause of most stress
-
events on banks, through private markets. Central banks would continue to stand ready
to intervene in a genuinely cataclysmic system-wide stress, but this was felt to be very
much in the tail of the distribution.
vision, emphasising a return to what is seen as central banks' core
This stripped-back
functions, has more than a little echo of the thinking of Ludwig Mies van der Rohe, the
first popularised the phrase 'less is more'. let's call this highly
modernist architect who So,
stylised position the 'Modernist' view.1
In central banking, as in architecture, Modernism is out of fashion, however. Public
authorities and market participants alike express real uncertainty about how far market
mechanisms can be relied upon to help manage liquidity risk. Some note the limits that
post-GFC structural vulnerabilities pose to the capacity of markets to provide ready
liquidity, in sufficient size and speed, in a stress. Others go further, arguing that a key
lesson of the GFC (and more recent events, including the 2020 'dash for cash' and the
2022 LDI crisis) was that markets can be stress amplifiers, particularly when there is a
generalised shift in liquidity preference. On such views, central banks have a much larger
role to play in helping to ensure effective system-wide liquidity management than they did
-
pre-GFC with the main debate being over how best to design that role. Some feel that
central banks should ensure the system has an ample supply of reserves at all times,
minimising the need for firms to rely on marketable assets of unproven liquidity in a stress,
and maximising their capacity to meet runs in scale and at speed. Others believe it may
-
be possible to run with a leaner stock of reserves in calm times but only if banks, and
increasingly non-banks too, can call on a well-developed set of central bank liquidity
facilities, allowing them to convert a range of assets into reserves, in size and at speed,
when they have to meet unexpected outflows.2
Returning to the architectural metaphor, this alternative, also highly stylised, perspective
echoes that of the Post-Modernists, who saw Modernism as excessively austere,
architecture could achieve. They updated 'less is more' to 'less is a
underselling what
bore.'
What does this all mean for us at the Bank of England? To cut to the chase, our head is
Post-Modern: maintaining monetary control, micro- and macro-prudential stability in a
world of structurally larger and more volatile liquidity unavoidably requires a much higher
standing level of reserves than we supplied pre-GFC. But our heart is Modernist, at least
-
in parts forged by a Charter that seeks no larger a role in commerce than strictly
necessary,3 and warmed by the thoughts of lower financial, operational and reputational
risk that being smaller could bring. The question is how far we can go to reconciling head
-
and heart and that is the subject of my remaining remarks today.
Monetary policy implementation: reserves supply
At any point in time, the quantity and market price of reserves is determined by the
interaction between demand and supply. Reserves supply is set exclusively by the central
bank. Reserves demand, predominantly from banks, can be split into the three classical
motives: (i) transactions (to meet known or predictable outflows); (ii) precautionary (to
2
For a recent assessment of vulnerabilities in financial markets see Financial Stability in Focus: The
FPC's approach to assessing risks in
market-based finance | Bank of England. The view that there
should an ample supply of reserves at all times is set out in 2016steingreenwoodhanson.pdf
(harvard.edu); see also Settlement Liquidity and Monetary Policy Implementation-Lessons from the
Financial Crisis - FEDERAL RESERVE BANK of NEW YORK (newyorkfed.org) and How Abundant Are
Reserves? Evidence from the Wholesale Payment System | NBER. State contingent liquidity facilities for
-
banks have been widely developed since the GFC see for instance Bank of England Market Operations
for a description of the Bank's toolkit. Discussions about tools for
Guide | Bank of England non-banks are
-
more recent but see for instance From Lender of Last Resort to Market Maker of Last Resort via the
dash for cash: why central banks need new tools for dealing with market dysfunction | Bank of
England and A journey of 1000 miles begins with a single step: filling gaps in the central bank
liquidity toolkit - speech by Andrew Hauser | Bank of England. In response to the events of Spring
2023, in which SVB struggled to make effective use of its central bank facilities, some have re-advocated the
adoption of a much more radical approach, sometimes known as the 'Pawnbroker For All Seasons', in which
banks are required to pre-position sufficient assets at the central bank to ensure they can back all of their
runnable deposits with drawing capacity in central bank liquidity facilities. See for instance More Deposit
Insurance Is No Way to Make Banks Safe - Bloomberg; We need a new approach to bank regulation |
Financial Times (ft.com); and Former BoE deputy calls for radical overhaul of bank funding |
-
Financial Times (ft.com). For an opposing view, see The pawnbroker for all seasons an expensive
and excessive solution to liquidity risk management in the banking system - Macroprudential
Matters.
3
As discussed, for example, in 'Till Time's Last Sand: A History of the Bank of England', by David Kynaston.
meet potential outflows in a stress); and (iii) speculative (capturing the idea that reserves
demand will also depend on the rate of return relative to other liquid assets).
Although the Bank of England has a range of ways to supply reserves, in recent years by
The lion's
far the dominant driver has been unconventional monetary policy (Figure 1).
Policy Committee's (MPC) QE
share of that reflected funding for the Monetary programme,
via an overnight loan to the Asset Purchase Facility (APF). Most of the remainder
financed term funding schemes aimed at ensuring effective pass-through of low interest
-
rates most recently the Term Funding Scheme with incentives for small and medium
sized enterprises (TFSME). Taken together, these schemes saw reserves reach a peak of
at the start of 2022. That's
nearly £980bn equivalent to 40% of annual UK GDP and is
more than fifty times the level in Autumn 2006, when reserves were just £17bn.
Figure 1: Bank of England reserves supply and backing assets
Source: Bank of England. Coloured areas summarise the Bank's main on-balance sheet sterling facilities. The gap between the sum of
'Term Funding'
those facilities and reserves primarily reflects sterling banknotes. includes the Term Funding Scheme (TFS) and the
Term Funding Scheme with additional incentives for SMEs but excludes the Special Liquidity Scheme and the Funding for Lending
to APF backing QE' excludes lending
Scheme (which were funded off-balance sheet). To avoid double counting, 'loan backing the TFS
while it was in the APF (pre-2019); prior to 2013 Q3, the series shows the quantity of assets financed by the creation of central bank
reserves on a settled basis. 'Other sterling facilities' includes Short-Term Open Market Operations, Long-Term Repos, the Contingent
Term Repo Facility and the Covid Corporate Financing Facility; it excludes the Sterling Bond Portfolio used to fund the Bank.
Similar increases have been seen across a wide range of other central banks (Figure 2).
Figure 2: Changes in international central bank balance sheets since pre-GFC
Sources: Bank for International Settlements and Bank of England calculations. Chart shows a standard 'box and whisker' plot for a
sample of 30 central banks. The coloured areas are the interquartile range (25th to 75th percentiles); the solid white line is the median;
and the 'whiskers'
are the outer edge of the plot range (defined as 1.5 times the interquartile range either side of the 25th and 75th
percentiles). The white dots show central banks that lie beyond that range; all operated fixed or managed exchange rate regimes in the
pre-GFC period.
That process has now gone into reverse. In the UK, reserves are now £170bn below their
'Quantitative Tightening
2022 peak as QE unwinds (so-called (QT)') and TFSME loans
-
mature and are set to fall by another £110bn or so in the coming twelve months. Beyond
that point, the future path for reserves supply implied by these operations is uncertain, and
depends on the MPC's future
QT decisions, and the extent of any voluntary TFSME
repayments. Figure 3 shows two purely illustrative scenarios, combining contractual
TFSME maturities with the range of annual QT paces so far chosen by MPC.
Figure 3: Illustrative future paths of reserves supply backing QT and TFSME
Source: Bank of England. Chart shows illustrative paths for reserves supply under the following assumptions: (a) TFSME follows
contractual maturities (with no further early repayments); (b) MPC's QE unwind continues at a pace of either £80bn or £100bn -
a year
the paces they have so far chosen in the first two years of operation; and (c) there are no other influences on reserves supply, including
any operations to meet reserves demand - the core issue of the remainder of the speech. The steps in the lines reflect anticipated gilt
redemptions as part of QT.
-
But that is only half the story to determine what happens next, we need to bring reserves
supply and reserves demand together.
Figure 4: Monetary control under a floor system
Figure 4 shows a stylised reserves demand curve for the system as a whole. If reserves
supply lay below the sum of banks' transactions and precautionary demand -
a concept
we call the 'Preferred Minimum Range of Reserves (PMRR)' -
banks would try to bid up
Such conditions of 'reserves
for reserves, driving short term market rates upwards.
scarcity' are
shown on the left-hand side of the Figure. When reserves supply amply
- - banks' behaviour is
exceeds the PMRR as it clearly has in recent years determined by
their speculative demand. If reserves had a relatively low rate of return, banks would try to
economise on their reserves balances, by lending them out or investing in other liquid
assets, driving short-term interest rates downwards. To avoid that, we remunerate
MPC's chosen policy rate - -
reserves at the Bank Rate removing the incentive to
This 'floor'
economise. system, introduced in the early stages of QE, has been highly
effective in guiding market rates (Figure 5).
Figure 5: Monetary control in the UK
Source: Bank of England. 'SONIA' is the Sterling Overnight Index
Average, the benchmark risk free rate for sterling markets: SONIA
interest rate benchmark | Bank of England.
Micro-prudential liquidity needs of banks: quantifying the PMRR
But as reserves supply falls back, we need to be alert to the fact that if we did nothing else,
we would at some point go through the PMRR and hit the upwards-sloping part of the
demand curve. At that point a judgment would need to be made as to how much
short-term interest rate volatility to tolerate as part of monetary control.
Determining where the PMRR might lie requires unpacking the transactions and
-
precautionary demand for reserves and those are heavily influenced by two things:
and (b) banks' liquidity
(a) the size of liquidity claims on banks, in particular deposits;
preference per unit of liquidity claim.
Both have risen significantly since the GFC.4
There are currently £3.2 trillion of sterling sight and time deposits held at banks that are
of the Bank's Sterling Monetary Framework (SMF) -
members nearly 50% higher than
-
mid-2006 (Figure 6). Within that, sight deposits which are the easiest to withdraw, and
-
hence a key source of short-term liquidity risk are currently £2.1 trillion.
sterling
Figure 6: SMF banks' deposits and sources of liquidity
Source: Bank of England. Deposit series include deposits from Monetary Financial Institutions, the public sector, UK residents and
'Banks' at the BoE'
nonUK residents; but exclude intra-group deposits. undrawn loan collateral subtracts collateral used to back borrowing
in term funding schemes and loan collateral used to back Index Linked Term Repo borrowing from total pre-positioned loan collateral.
For more details see: Eligible collateral | Bank of England.
One proxy for banks' reserves demand to cover the
transactions motive is their need for
ready cash to meet predictable intraday payments flows. Adding together the amount
required to meet daily pre-funding requirements in retail payments systems (£40bn), the
average daily liquidity required to settle high value payments (£40bn) and average
settlement balances for other payment and settlement systems (£20bn) gives a number of
£100bn.5
So far, so modest then, when compared to current reserves levels.
Banks'
precautionary demand is likely to be much bigger, however. A central lesson of the
GFC was that banks voluntarily held too few liquid assets to manage potential stress
events. In response, banks have since 2013 been required to hold sufficient liquidity
buffers to cover 30 days of stressed outflows, calculated by applying a set of weights
representing a particular scenario to each type of bank liability.6 The sum of these so-
called 'Liquidity Coverage Ratio (LCR)' requirements across sterling deposit
SMF banks'
liabilities currently amounts to some £570bn (Figure 7).
Figure 7: Estimated aggregated sterling outflows across SMF banks (Summer 2023)
to meet...
Liquidity needed Aggregated As a share of
outflows sight + time
(£bn)
deposits
3%
...intraday payments 100
...LCR requirements: 30 day stressed outflows (LCR weights) 570 18%
......of which runnable on day 1
494 15%
...day 1
stressed outflows (at Silicon Valley Bank UK pace) 960 30%
...all overnight deposits running 2,100 66%
...all sight and time
deposits running 3,200 100%
Source: Bank of England. Deposit series include deposits from Monetary Financial Institutions, the public sector, UK residents and
nonUK residents; but exclude intra-group deposits.
-
Now that is a big number if the PMRR were that large, we could be there soon.
But there are many uncertainties. The LCR is only one way to assess banks' stressed
today's
liquidity needs. And the future steady state PMRR is likely to differ from aggregate
LCR, for a number of reasons. Some point to a lower number:
- First, banks can holds assets other than reserves to meet the LCR. The list of other
eligible 'High Quality Liquid Assets (HQLA)' includes government bonds, multilateral
development bank paper and (at appropriate haircuts) a range of higher-quality
corporate debt, covered bonds and even equity.7 In practice, such assets form only
banks'
a small part of SMF sterling liquid asset buffers today (Figure 8). But that's
unsurprising given how many reserves we have injected into the system. As QT
progresses, banks' preferred holdings
of non-reserves HQLA will depend, amongst
other things, on asset availability, relative rates of risk and return, regulatory rules
(reserves are currently exempt from banks' leverage ratio calculations in the UK)
and perceived ease of monetisation in a stress. I will return to these points shortly.
banks'
Figure 8: SMF sterling HQLA and aggregated LCR-weighted outflows
Source: Bank of England. Data as of Summer 2023. Outflow estimates are on same basis as shown in Figure 7.
- -
- Second, bank deposits a key driver of transactions and precautionary demand
are likely to decline as monetary accommodation is withdrawn and QE unwinds.
The scale of this effect is uncertain. Viral Acharya, Raghuram Rajan and their
co-authors have recently noted that there was no material decline in the US when
the Federal Reserve first tried QT (Figure 9).8 However, deposits have started to
fall in both the UK (Figure 6) and the US (Figure 9) during the current tightening
cycle.
Figure 9: US bank deposits and central bank reserves
Source: Federal Reserve Bank of St. Louis.
- Third, higher longer term interest rates are driving a shift from sight to time deposits
(which have lower outflow rates), as depositors seek higher returns and banks bid
up for funding. In the UK, the ratio of sight to total deposits has already fallen from
70% to 64% and would have a lot further to fall to hit the 40-50% pre-QE range.9
Other factors may push up on the true PMRR. In particular, banks tend to want to hold
further liquidity buffers above their LCR requirements. In part that might be to capture
liquidity risks they judge are not fully captured by the LCR. Some of the outflows seen in
the wave of bank runs this Spring were materially faster and/or larger than those assumed
in the LCR, for example (Figure 10). Banks may also want to hold additional buffers to
signal their financial resilience to investors.10 While the supply of reserves remains
is hard to know where banks' -
abundant, it true desired buffers lie but that should become
clearer as QT proceeds.
Figure 10: Selected distressed bank outflow rates
Source: Bank for International Settlements Report on the 2023 banking turmoil (bis.org)
obvious way to get a handle on banks' PMRRs is simply to ask them -
One and we run a
twice-yearly survey to do just that. The latest aggregate PMRR estimate from this
a bit lower than most of - but it's
exercise is £335-495bn.11 That's the numbers in Figure 7
the Bank's balance sheet would be
still big. Indeed, if reserves did settle there, as large as
it has been at any time in its history, including the South Sea Bubble and World War 2
10
Global regulators have been at pains to highlight that the whole point of the LCR is to provide adequate
liquid assets to use in a stress, and hence it would be entirely appropriate for banks to fall below LCR
-
minima in such circumstances: see for instance DP1/22 The prudential liquidity framework:
-
Supporting liquid asset usability | Bank of England and FS1/23 The prudential liquidity framework:
Supporting liquid asset usability | Bank of England. However, many banks and their investors remain
frustratingly resistant to this view.
11
More background on the survey, and an analysis of the previous six-monthly estimate, can be found at
What do we know about the demand for Bank of England reserves? | Bank of England.
(Figure 11).12 Combine that with the illustrative profiles for reserves supply shown in
Figure 3, and we could be there in as little as two or three years.
12
These projected ratios are somewhat larger than those published by the Federal Reserve for their own
-
balance sheet (see eg Open Market Operations During 2022 (newyorkfed.org)) but that primarily
reflects the fact that the ratio of banking assets to GDP is much larger in the UK than in the US. Adjusting
for that difference, the reserves ratios are in similar ballparks.
Figure 11: Bank balance sheet if reserves settled at current survey-based PMRR
Source: Bank of England. Green swathe shows an estimate of the Bank's balance sheet size if reserves were to settle around the
similar to today's
current survey-based estimate of the PMRR, and banknotes and other non-reserves liabilities were levels, as a share
of nominal GDP.
From micro (prudential) to macro (prudential)
-
But we need to pause again at this point, because PMRR estimates whether based on
-
LCR calculations or surveys have another key limitation when considering optimal
balance sheet size. And that is that there is no reason to assume that the sum of
banks' reserves demand
individual should necessarily be the same as the level of
reserves needed to maintain stability of the financial system as a whole.
To see how this potential fallacy of composition comes about, we need to return to the
numbers in Figure 7. Such aggregated firm-level outflows can only be outflows for the
banking system as a whole if they are all transferred into banknotes or some other external
payments medium. But that is not how most bank runs work: depositors that become
suspicious of their bank tend to transfer their funds to another bank, perceived to be
one bank's deposit outflow another bank's inflow
stronger.13 That means that tends to be
- that's
something always true of reserves because they can by definition only be used by
one bank to pay another. So, to the extent that the system can provide the right
infrastructure and incentives to recycle reserves from surplus to deficit banks, the stock of
reserves required to meet banks'
net transactions and precautionary demand can be much
of banks' gross
lower than the sum of their gross needs.14 And supplying only a fraction
-
needs could mean a smaller steady state central bank balance sheet appealing to those
of us with Modernist hearts!
One way to recycle reserves is via financial markets. Government bonds and other forms
of non-reserves HQLA can be highly effective ways for banks to meet unanticipated
outflows, to the extent that they can be converted into cash, quickly and in scale. Daily
volumes in cash gilts have ranged from £30bn in normal conditions to a maximum of
- (Figure 12). That's big
£100bn in extremis and overnight gilt repo from £60-90bn
-
enough to meet a range of firm-specific outflows and firms can hold non-UK HQLA too,
further expanding the potential asset pool.
Taken together, this suggests there is certainly some room for banks to hold more of their
-
liquidity buffers in non-reserves HQLA as the supply of reserves falls a process that will
to some extent happen naturally, and to some extent central banks can incentivise. But
the extent of any such adjustment will need careful testing. Extended settlement periods
and hedging and leverage ratio costs make non-reserves HQLA imperfect substitutes for
events, including the 'dash for cash'
reserves. Recent and the LDI crisis, have posed new
questions about the structural resilience of these markets in a stress. And sterling market
depth is clearly nothing like the size of the larger numbers in Figure 7. It is possible that
some of these constraints may ease somewhat over time, as programmes to strengthen
non-bank financial intermediary (NBFI) resilience, core market infrastructure and central
bank toolkits make more progress, and QT returns more collateral.15 But in current
-
similar point could be made about the current potential for outflows into other media eg non-bank digital
-
currencies most of which remain in their infancy.
14
identity 'MV≡PT'. As a thought experiment, if it were
This is of course just a variant of the old monetarist
possible to have near-infinite velocity, the job could be done with a single £1 of reserves. That is of course
-
science fiction though some old hands do recall, somewhat wistfully, an earlier time when it was felt to be a
sign of honour for a bank to end each trading session holding no reserves at all!
15
For a summary of NBFI resilience reform see Non-Bank Financial Intermediation - Financial Stability
Financial Stability in Focus: The FPC's approach to assessing risks in
Board (fsb.org) or
marketbased finance | Bank of England; for an assessment of the implications of QT on market functioning see
Quantitative tightening: the story so far - speech
by Dave Ramsden | Bank of England; for details on
the IAWG see Collaboration Toward Increased Resilience of the Treasury Market - FEDERAL
RESERVE BANK of NEW YORK (newyorkfed.org); and for discussions of the central bank toolkit see
Preventing and responding to dysfunction in core markets - Dallasfed.org and A journey of 1000
circumstances, there are limits to the extent that banks can rely on private markets to
monetise non-reserves HQLA in a stress.
Figure 12: Bank of England facilities and daily volumes in selected sterling markets
Source: Bank of England, MiFID II. Repo and unsecured daily volumes are for overnight maturity transactions only.
There is however another way for banks to monetise their assets, and that is by using
central bank liquidity facilities. Huge advances have been made in this area since the
GFC.16 As Figure 12 shows, UK banks have built up the capacity to borrow over £1⁄2 trillion
-
of reserves from us against a range of prepositioned, mostly less liquid, collateral and
they can borrow a great deal more than this against more liquid collateral, including HQLA,
That collateral can be used across most of the Bank's
if the underlying markets freeze.
lending facilities, including the weekly Index Linked Term Repo facility, the Discount
'open for
Window Facility, and the Contingent Term Repo Facility. We are definitively
business.'
On the face of it, an aggregate borrowing capacity of £1⁄2 trillion is enough to meet most of
shouldn't we be considering
the outflows in Figure 7. So a radically different setup in
which the stock of reserves is relatively small in normal times, but expands rapidly and at
via usage of the Bank's
scale when needed, facilities?
There are three main obstacles to that being a complete answer:
- First, while many banks have strong pre-positioning and test usage regularly, some
do not yet have much drawing capacity, for various reasons. So liquidity facilities
aren't
yet a universal solution.
banks'
- Second, ability, or willingness, to draw from liquidity facilities at the scale and
speed of recent runs (shown in Figure 10) is unproven. Where the constraints are
technological, they should be fixable over time, given appropriate resources. But
some banks still worry that investors, depositors or even supervisors may see
facility usage as 'stigmatising',
amplifying rather than mitigating stability concerns.
Great progress has made in reducing this risk in recent years, including through the
development of market-wide facilities, the issuance of supervisory guidance
stressing that the use of central bank facilities is part of normal liquidity
management, and balanced disclosure regimes. But stigma is hard to eliminate
-
altogether and firms that baulk from drawing quickly and in size when a liquidity
shock hits, and lack alternative sources of liquidity, are exposing themselves and
the system to risk.
- Third, banks can only count access to central bank facilities towards their LCR
requirements as and when they draw from them, adding to their reserves holdings.
That means that, while there are many positive arguments for having such access,
it does not absolve banks from having to make a choice between holding reserves
(however they might be supplied) or other forms of HQLA to meet the LCR.17
Bringing it together: some principles for steady state reserves supply
Where does this all leave us on those big questions I posed at the start?
The marked tightening in post-GFC bank liquidity requirements and the continued growth
in the size, speed and breadth of liquidity shock since then has increased the
demand for reserves: the 'kink' in the reserves
precautionary demand curve in Figure 4
has moved decisively to the right. Against that backdrop,
maintaining monetary control,
micro- and macro-prudential stability means supplying a materially higher standing
stock of reserves than we did pre-2008, when the Bank of England lay near the bottom
of the global distribution (Figure 2). To that extent we are resolutely Post-Modernist.
But we can give succour to our Modernist hearts in three ways.
First, while we know the reserves demand curve has moved to the right, the precise extent
to which it has done so is uncertain. We can't afford to lose monetary control by crashing
part unexpectedly. But that doesn't mean we have to supply an
into the upwards-sloping
unnecessarily excessive level of reserves. So we will use our toolkit to test where the
true aggregate PMRR lies, as QE and TFSME unwind. To achieve that, we introduced
last autumn a weekly market-wide Short Term Repo (STR) facility, offering unlimited
amounts of reserves against gilt collateral at Bank Rate.18 The STR is designed to pick up
emerging scarcity in reserves supply at an early stage, replacing reserves drained through
QT or TFSME (Figure 13). That will allow the MPC to continue to make independent
decisions on the path of QT, focused solely on achieving the inflation target without regard
to the shape of the Bank's balance sheet, or the potential for the loss of monetary control.
Figure 13: Stylised Bank of England balance sheet as QT proceeds
Second, we will continue to work with others to deepen alternative liquidity sources.
Part of that means ensuring banks have gone even further to being ready to use our
-
contingent liquidity facilities, in size and at speed broadening and deepening the stock of
pre-positioned collateral, ensuring firms test regularly, and working with them to tackle any
residual stigma concerns. The readier banks are to use these facilities, the fewer excess
-
reserves they should feel the need to hold in normal times pushing the demand curve to
the left. The same is true of efforts to ensure that core HQLA markets can function in a
stress, including through strengthening non-bank resilience, helping others to improve
market infrastructures and building effective central bank backstops against severe market
dysfunction.
- -
Third, as this work progresses and some of it could take years we will continue to
explore how our toolkit might be calibrated to return market incentives and
disciplines more centrally to firms' liquidity
management. It would be a brave central
bank that placed as much faith in such mechanisms as people did pre-GFC. But that
doesn't and shouldn't mean usurping them altogether -
not least because doing so risks
amplifying rather than reducing risks to financial stability, as well as incurring financial,
operational and reputational risks ourselves from unnecessarily large balance sheets.
Price incentives are one tool: we could, for example, reduce reserves demand in steady
state by increasing the price at which we supply replacement liquidity as QE and TFSME
unwind. But there are real limits to how far we could go in this direction without
destabilising monetary control. Central banks also have non-price levers that could
-
influence reserves demand but judgments on such issues are