Speech
Embargo
9 November 2023, 6.30 pm
Implementing monetary policy with positive interest rates and a
large balance sheet: First experiences
Money Market Event
Thomas Moser*
Alternate Member of the Governing Board
Swiss National Bank
Geneva, 9 November 2023
© Swiss National Bank
*
The speaker would like to thank Florian Böser and Dirk Faltin for their support in writing this speech. He also thanks Toni Beutler, Lucas
Fuhrer, Kerstin Kehrle, Mico Loretan, Alexander Perruchoud, Raphael Reinke and Michael Schäfer for their valuable comments as well as
the SNB Language Services for their translations of the text.
Ladies and gentlemen
Good evening. I am delighted to welcome you to this year's Swiss National Bank
Money Market Event in Geneva. It is great to see so many of you here this evening.
After a decade with almost no inflation and nearly eight years of negative interest rates, the
Swiss National Bank (SNB) raised its policy rate back into positive territory in September
2022. At the same time, we adopted a new approach to implementing monetary policy in the
money market. At last year's Money Market Event, Andréa Maechler and I discussed the
SNB's transition to a positive policy rate and our newly adopted implementation approach.1
Today, I would like to share our first experiences with this new approach. In doing so, I
would also like to touch on the question of whether the new approach should be applied in the
longer run, once the size of the balance sheet has been reduced sufficiently. This is a question
that other central banks are also concerned with, and one that is currently being debated at
international level among academics and practitioners.
Before I come to these topics, I would like to briefly discuss the current economic
environment and the SNB's monetary policy.
Current economic environment and SNB's monetary policy
Inflation is retreating in Switzerland and abroad. The decline in consumer price inflation over
the last year came after a period of about 18 months during which inflation rates increased
significantly, reaching multi-decade highs in the second half of 2022. Slide 3 shows US (blue
line) and euro area (orange line) year-over-year headline inflation rates. As you can see, by
the third quarter of 2022, inflation in these two economic regions had reached around 10%. In
Switzerland (red line), year-over-year inflation peaked at 3.5% in August 2022. Since then,
Swiss inflation has declined, and in June this year it returned to the SNB's price stability
range of between 0% and 2% per annum.
This decline in inflation is due to the moderation of several inflation drivers and the
significant tightening of monetary policy. Global supply bottlenecks, which had emerged in
the wake of the COVID-19 pandemic, have eased markedly of late. Furthermore, after
reaching long-term highs in 2022, the rates of energy and food price increases have returned
to lower levels. Importantly, in addition to the fading of these inflation drivers, central banks'
tightening of monetary conditions has contributed significantly to reducing inflation. In
Switzerland, this tightening was achieved via SNB policy rate increases and an appreciation
in the exchange value of the Swiss franc.
Central banks have not only raised their policy rates, but also reduced their balance sheets.
The chart on the left-hand side of Slide 4 shows that the US Federal Reserve and the
European Central Bank have raised their policy rates rapidly and substantially over the last
two years. Similarly, the SNB has increased its policy rate by 2.5 percentage points since June
2022 to its current level of 1.75%. At our most recent monetary policy assessment, in
September 2023, we decided to leave the SNB policy rate unchanged.2 However, we also
signalled that a further tightening of monetary policy could not be ruled out to ensure price
stability over the medium term. In addition, as the chart on the right-hand side shows, the
SNB - like other central banks - has started to reduce its balance sheet.3 At the peak in 2022,
the SNB's balance sheet was seven times larger than it had been before the Global Financial
Crisis in 2008, and stood at close to 150% of Swiss GDP. Since then, the balance sheet has
shortened by about 23%.
In the case of the SNB, the reduction of the balance sheet has been achieved through foreign
exchange sales.4 Over the last few years, we have repeatedly stated that we are willing to
intervene in the foreign exchange market as needed to ensure appropriate monetary conditions
in Switzerland. Hence, market participants are well aware that foreign exchange market
intervention is an additional monetary policy instrument in the SNB's toolkit. Slide 5 shows
the foreign exchange interventions undertaken by the SNB since 2020. Since the second
quarter of 2022 up to and including the second quarter of 2023, we have sold foreign
exchange worth approximately 101 billion Swiss francs. These sales supported the
appreciation of the Swiss franc and thereby helped to counter inflationary pressures from
abroad.
The rationale for remunerating reserve holdings
I will now discuss the SNB's implementation approach and, in particular, explain why we
remunerate the commercial banks' reserve holdings.5
The SNB implements monetary policy by setting the SNB policy rate and steering secured
short-term interest rates in Swiss francs close to the SNB policy rate. The most important
secured short-term interest rate in Swiss francs is SARON (Swiss Average Rate Overnight)
(cf. Slide 7). Since the discontinuation of Libor, SARON has become the Swiss franc
reference rate, and it is this rate that the SNB focuses on when implementing its interest rate
policy in the money market. A sufficient volume of interbank money market activity is
necessary to ensure that the calculation basis for SARON, which is predominantly based on
actual interbank transactions, is robust.6 Against this backdrop we employ two levers to
implement our monetary policy. The first is the tiered remuneration of reserves - also referred
to as reserve tiering - and the second is the absorption of reserves via temporary open market
operations, or OMOs for short. The tiered remuneration of reserves provides incentives for all
banks to trade with each other, thereby generating interbank money market activity. But why
is it necessary to remunerate the commercial banks' reserve holdings?
Ever since the Global Financial Crisis, the liquidity situation at commercial banks has
changed fundamentally. After many central banks lowered their policy rates to zero, or even
into negative territory, they continued to ease monetary policy even further, mainly by
conducting asset purchases. At that time, the SNB repeatedly faced strong upward pressure on
the Swiss franc. To alleviate this pressure and ensure appropriate monetary conditions, the
SNB bought foreign exchange against Swiss francs. These purchases inevitably increased the
supply of reserves. As a result, a structural liquidity surplus has developed, as the supply of
reserves significantly exceeds the commercial banks' structural demand for reserves.7
In an environment with a structural liquidity surplus, paying interest on reserves is the only
practical instrument for achieving positive money market interest rates. This is because, for
banks, the main alternative to lending reserves to other banks in the money market is to hold
these reserves with the central bank. The remuneration that banks can earn on holding their
reserves with the central bank therefore becomes the relevant reference point for money
market interest rates, and by remunerating banks' reserves, central banks can steer money
market interest rates towards the policy rate. In the reserve tiering approach chosen by the
SNB, not all reserves held by commercial banks are remunerated at the SNB policy rate; this
rate is only applied up to bank-specific thresholds. Reserves in excess of these thresholds are
remunerated at a lower interest rate.
Steering money market interest rates without remunerating reserves would have required the
restoration of a structural liquidity deficit and thus a very large reduction in reserves. For the
SNB, this would have required a very large sale of foreign exchange reserves or similarly
sized reserve-absorbing OMOs. It would have been unfeasible to accomplish this in a short
period, and we would have been unable to steer money market interest rates effectively for
some time. We therefore decided on a two-pronged approach, namely to deploy reserve
tiering combined with reserve absorption in order to control short-term interest rates and
maintain an adequate volume of interbank money market trading. For reserve absorption, we
enter into reserve-absorbing repo transactions and issue SNB Bills.
First experiences with new monetary policy implementation
approach
How has our new approach fared so far? The short answer is 'very well'. It has allowed us to
implement monetary policy effectively both in normal times and in times of financial market
stress. Let me elaborate on this.
Since the return to a positive interest rate environment, SARON has traded close to the SNB
policy rate and interbank trading has remained robust. As Slide 9 shows, SARON (red line)
has deviated by only a few basis points from the SNB policy rate (blue line) since September
2022. SARON's deviations from the SNB policy rate are comparable in size to those we
observed during the last few months of the negative policy rate regime.8 The SNB policy rate
has also been transmitted well to other money market segments as well as to longer-term
interest rates. Concerning interbank activity, trading in the overnight segment of the repo
market (shaded area) has been robust at all times since the switch to a positive policy rate.
The average daily trading volume in the overnight segment was 14 billion Swiss francs. Both
the tiered remuneration of reserves and the reserve absorption via OMOs were crucial to
achieving this outcome.
SNB reverse repos and SNB Bills have proved themselves as effective tools for absorbing
reserves, and they have become well integrated into the universe of money market
instruments. The SNB issues financial instruments that absorb liquidity from commercial
banks in an amount that suffices to steer SARON close to the policy rate without jeopardising
a robust level of interbank trading. The SNB pays a market interest rate on these instruments
in order to generate sufficient demand. When we first transitioned to a positive policy rate in
September 2022, it was necessary to absorb a large volume of reserves in a fairly short period
of time. This is shown in the left-hand chart on Slide 10. A year later, at the end of September
2023, the outstanding amount of SNB OMOs totalled 155 billion Swiss francs. The SNB's
one-week reverse repos accounted for 41% of the total, while SNB Bills accounted for 59%.
SNB Bills have succeeded in attracting a broad investor base. SNB Bills are tradable money
market debt register claims that can be held by both banks and non-banks. As shown by the
chart on the right-hand side of the slide, SNB Bills were initially acquired mainly by domestic
banks. However, demand from other market participants has risen as they have become
increasingly familiar with this financial instrument. Foreign banks and non-banks alike have
begun investing more and more heavily in SNB Bills, thereby contributing to a broad
transmission of the SNB's monetary policy. As of August 2023, domestic banks held 28% of
all outstanding SNB Bills (dark red), while other investors held 72% (light red).
Our implementation approach has not only worked well in normal times, but it has also
proven itself in times of financial market stress. In March of this year, the SNB had to provide
significant liquidity assistance to Credit Suisse. This led to a corresponding increase in total
reserves, as indicated by the blue line on Slide 11. While Credit Suisse faced large-scale
outflows of customer deposits, other banks experienced large liquidity inflows. This resulted
in a higher supply of, and lower demand for, liquidity in the money market. Consequently,
SARON (red line) as well as other Swiss franc money market interest rates experienced some
downward pressure and started to deviate more significantly from the SNB policy rate.
Initially, the SNB absorbed the additional liquidity to mitigate the downward pressure on
money market interest rates by conducting overnight reverse repo transactions. Specifically,
in addition to continuing to conduct the 'regular' reserve-absorbing operations (one-week
reverse repos and SNB Bills with maturities ranging from 28 to 336 days), we set a 'hard
floor' in the overnight segment of the repo market by offering overnight reserve-absorbing
repos - the blue diamonds in the chart. This countered the downward pressure on money
market interest rates, including SARON. As a result, during this period SARON never
deviated by more than ten basis points from the SNB policy rate.
Following the initial phase, the SNB stabilised money market conditions further by increasing
the outstanding volume and variety of its reserve-absorbing operations. Between March and
June, we issued SNB Bills with a seven-day maturity, in addition to the regular longer
maturities. This short maturity was attractive for investors during this period of financial
market stress. The wide range of reserve-absorbing instruments allowed the SNB to increase
its absorption volume very rapidly. As a result, SARON moved closer to the SNB policy rate
once more as overall money market conditions normalised. By June, the distortions in Swiss
franc money market conditions due to the crisis at Credit Suisse had dissipated.
Role of threshold factor in SNB's implementation approach
Given this positive assessment of our implementation approach, why have we recently
announced an adjustment to our so-called threshold factor? Or more generally, what is the
role of this threshold factor in our monetary policy implementation approach?
The threshold factor determines the volume of reserves that is remunerated at the SNB policy
rate. As I noted previously, the SNB remunerates reserves up to a bank-specific threshold at
the SNB policy rate, while reserves that exceed the threshold are remunerated at the SNB
policy rate minus a discount of 50 basis points. For each bank that is subject to the minimum
reserve requirement, the individual threshold corresponds to the product of the moving
average of the minimum reserve requirements over the preceding 36 reference periods and the
applicable threshold factor. Hence, the threshold factor is the primary tool for determining the
volume of reserves remunerated at the SNB policy rate. Currently, this factor is 28; however,
as announced last week, it will be 25 as of 1 December 2023.9 How will this change affect
banks?
The tiered remuneration of reserves supports interbank trading. Banks fall into one of two
categories: There are banks with reserves that exceed their threshold, shown in the upper part
of Slide 13, and banks with reserves that are below their threshold, shown in the lower part of
the slide. Banks with reserves above their threshold can place them in the SNB's
reserveabsorbing operations, or they can lend them to banks whose reserves are below their
thresholds, as shown on Slide 14. This ensures a certain level of interbank money market
trading.
As the SNB sells foreign exchange, the volume of reserves declines, which can potentially
reduce interbank trading. The reason for this is shown in Slide 15. Some banks - those in the
upper part of the slide - end up with fewer reserves above their threshold. The other banks -
those shown in the lower part of the slide - end up with fewer reserves below their threshold.
When the volume of reserves above the thresholds falls, the affected banks have less of a need
to place these reserves in SNB reserve-absorbing operations or to lend them to other banks.
As a result, and all things being equal, the more foreign exchange the SNB sells, the more
likely it becomes that interbank trading will decline. However, an excessive decline in
interbank trading would ultimately jeopardise the robustness of the calculation basis for
SARON. What can the SNB do to avoid this situation?
The SNB can counter the effect of declining reserves on interbank trading by reducing reserve
absorption via temporary OMOs and by lowering the threshold factor. By reducing the
system-wide threshold factor, the SNB lowers an individual bank's threshold, as illustrated on
Slide 16. As a result, some banks will end up with more reserves in excess of their threshold,
which can then be traded in the interbank money market or placed in the SNB's
reserveabsorbing operations. Importantly, such adjustments are of a purely technical nature and do
not affect the SNB's monetary policy stance.
Longer-term outlook for monetary policy implementation
Let me now take a longer-term view and turn to the ongoing international debate about
different approaches to monetary policy implementation.
Two approaches to implementing monetary policy in money markets are currently being
discussed. As the size of central bank balance sheets - and hence the volume of liquidity
supplied to the banking sector - is declining, two important questions arise: What is the
adequate level of reserves? And how should monetary policy be implemented in the longer
term? The keen interest in these policy issues is reflected in the many articles being published
on the subject by central banks and international organisations.10 At the heart of the debate is
the question of whether central banks should return to the system of structural reserve deficit
that had prevailed before the Global Financial Crisis, or whether they should remain in the
current system of structural reserve surplus. Let me briefly summarise the key features of the
two systems.
The main difference lies in the overall amount of reserves that is available to the banking
sector. As illustrated in the left-hand figure on Slide 18, in a 'floor system' the central bank
provides reserves that significantly exceed banks' structural demand for reserves. As a result,
money market interest rates do not react to changes in the supply of reserves, and the level of
interest rates in the money market is determined by the interest rate the central bank pays on
reserves. It follows that the interbank interest rate is at the 'floor' of the interest rates set by
the central bank, hence the name 'floor system'. A 'corridor system', on the other hand, is one
in which the central bank provides reserves close to the banks' structural demand for reserves,
as illustrated in the figure on the right-hand side. In such a system, money market interest
rates typically react to small changes in reserve supply. Hence, the central bank can steer
interest rates by actively managing the supply of reserves without remunerating the reserves.
So, which of the two systems is preferable? The international debate over the advantages and
disadvantages of the two systems considers a number of questions (cf. Slide 19), two of which
are particularly important: First, how precisely can money market interest rates be controlled?
Second, what are the implications of each system for trading activity in the interbank money
market?
A floor system allows for more control over money market interest rates. The interest rate
paid on reserves in a floor system determines the overnight interest rate in the money market,
regardless of the overall supply of reserves. By adjusting the interest rate on reserves, the
central bank can steer the level of interest rates in the money market. In a corridor system, on
the other hand, small changes in the supply of, or demand for, reserves can result in large
swings in interest rates. As a result, a corridor system is likely to exhibit somewhat higher
interest rate volatility than a floor system.
Reliable control over money market interest rates is important because there are reasons to
believe that banks' structural demand for reserves has become increasingly difficult to predict.
The higher volatility is largely due to liquidity regulations that were enacted following the
Global Financial Crisis. As a result, it would likely be more difficult to control money market
interest rates precisely in a corridor system. Ongoing innovation in digital payments and
money, notably fintech and distributed ledger technology, point in the same direction in that
they also impact the structural demand for reserves. In the unlikely event that such
innovations - for example, the widespread use of stablecoins - allowed payments to be settled
without the involvement of central bank money, in a floor system demand for central bank
money should still be sufficiently large to allow central banks to steer money market interest
rates.11
A corridor system provides more incentives for interbank money market activity. As I noted
earlier, in a corridor system the supply of reserves is set in such a way that it is close to banks'
aggregate structural demand for reserves. Thus, banks whose reserves fall short of their
structural needs have a strong incentive to borrow funds in the money market. Conversely,
banks whose reserves exceed their structural needs may find it attractive to lend these excess
reserves at a positive interest rate in the money market rather than holding them without any
remuneration at the central bank. By contrast, a floor system provides fewer incentives for
banks to trade in the money market, because all banks' reserves far exceed their structural
demand for reserves and banks earn interest on their reserves at the central bank. This could
result in a significant reduction in interbank activity or even, in a worst-case scenario, in the
complete disappearance of the interbank market. As mentioned earlier, it is precisely because
we wished to avoid such a scenario that we introduced reserve tiering.
Other important questions in the debate concern the role of reserves in financial stability. For
instance, how important are reserves as high-quality liquid assets for commercial banks? How
might banks' ability to make payments be affected? These questions are currently under
discussion, but one thing is already clear: The advantages and disadvantages of the 'floor' and
'corridor' systems must be carefully weighed up before a final decision about longer-term
monetary policy implementation can be made.
Concluding remarks
This brings me to the end of my remarks. Let me summarise my main points. Our first
experiences suggest that our new approach to implementing monetary policy has succeeded in
steering SARON and in ensuring the pass-through of the SNB policy rate to other money
market segments and longer-term interest rates. At the same time, trading in the interbank
money market has remained robust. SNB reverse repos and SNB Bills have proved effective
in absorbing reserves and have integrated well into the universe of money market instruments.
With our current approach, we were able to implement monetary policy effectively even in
the face of rapidly changing market conditions, such as those that prevailed during the crisis
at Credit Suisse.
In closing let me reiterate that for most central banks it is still undecided which monetary
policy implementation approach - a floor system or a corridor system - will be adopted in the
longer term. The decision will depend on an array of factors, but especially on the answers to
the questions I have raised in my remarks. In any case, the SNB's balance sheet will continue
to primarily reflect the SNB's monetary policy activities. It results from the fulfilment of the
SNB's mandate to ensure price stability while taking due account of economic developments.
References
Afonso, G., Logan, L., Martin, A., Riordan, W. and Zobel, P. (2022), How the Federal
Reserve's Monetary Policy Implementation Framework Has Evolved, Federal Reserve Bank
of New York Liberty Street Economics, 10 January.
Bank of England (2022), Managing the operational implications of APF unwind for asset
sales, control of short-term market interest rates and the Bank of England's balance sheet,
Bank of England Explanatory Note, 4 August.
Borio, C. (2023), Getting up from the floor, BIS Working Papers, No. 1100, May.
Federal Reserve Board (2019), Statement Regarding Monetary Policy Implementation, Press
Release, 11 October.
Hauser, A. (2023), 'Less is more' or 'Less is a bore'? Re-calibrating the role of central bank
reserves, Kings College London's Bank of England Watchers' Conference, 3 November.
Maechler, A. and Moser, T. (2020), Monetary policy implementation: How to steer interest
rates in negative territory, SNB Money Market Event, 5 November.
Maechler, A. and Moser, T. (2022a), Life after Libor: A new era of reference interest rates,
SNB Money Market Event, 31 March.
Maechler, A. and Moser, T. (2022b), Return to positive interest rates: Why reserve tiering?,
SNB Money Market Event, 17 November.
Perli, R. (2023), Implementing Monetary Policy: What's Working and Where We're Headed,
Remarks at the National Association for Business Economics (NABE) Annual Meeting,
10 October.
Schnabel, I. (2023), Back to normal? Balance sheet size and interest rate control, Speech at an
event organised by Columbia University and SGH Macro Advisors, 27 March.
Woodford, M. (2000), Monetary Policy in a World Without Money, International Finance,
pp. 229-260.
Implementing monetary policy with positive interest
rates and a large balance sheet: First experiences
Thomas Moser
Alternate Member of the Governing Board, Swiss National Bank
Money Market Event
Geneva, 9 November 2023
Current economic environment
and SNB's monetary policy
Inflation is retreating in Switzerland and abroad
3 09.11.2023 Implementing monetary policy with positive interest rates and a large balance sheet: First experiences | Thomas Moser | © Swiss National Bank
Central banks have tightened monetary conditions not only by raising
their policy rates, but also by reducing their balance sheets
4 09.11.2023 Implementing monetary policy with positive interest rates and a large balance sheet: First experiences | Thomas Moser | © Swiss National Bank
SNB's balance sheet reduction is largely due to foreign exchange sales
Foreign exchange sales
5 09.11.2023 Implementing monetary policy with positive interest rates and a large balance sheet: First experiences | Thomas Moser | © Swiss National Bank
The rationale for remunerating
reserve holdings
With a structural liquidity surplus, paying interest on reserves is the only
practical instrument for achieving positive money market interest rates
Environment
Structural liquidity surplus
SARON as new reference rate
Objectives Approach
Steer secured short-term Remunerate reserves
interest rates effectively using a tiering system
Support interbank Absorb reserves
money market activity via temporary OMOs
First experiences with new monetary policy
implementation approach
SARON traded close to the policy rate amid robust interbank trading
9 09.11.2023 Implementing monetary policy with positive interest rates and a large balance sheet: First experiences | Thomas Moser | © Swiss National Bank
SNB reverse repos and SNB Bills were effective in absorbing reserves
and integrated well into the universe of money market instruments
10 09.11.2023 Implementing monetary policy with positive interest rates and a large balance sheet: First experiences | Thomas Moser | © Swiss National Bank
Monetary policy implementation was effective in an environment of
rapidly changing market conditions during the crisis at Credit Suisse
11 09.11.2023 Implementing monetary policy with positive interest rates and a large balance sheet: First experiences | Thomas Moser | © Swiss National Bank
Role of threshold factor in
SNB's implementation approach
Banks with reserves above the threshold can either place them in the
SNB's reserve-absorbing operations or lend them to other banks
Banks with reserves above their threshold
Threshold
Reserves up to
Reserves above
the threshold
the threshold
Banks with reserves below their threshold
Threshold
Reserves
Banks with reserves above the threshold can either place them in the
SNB's reserve-absorbing operations or lend them to other banks
Banks with reserves above their threshold
Threshold
Reserves up to
Reserves above SNB
Reserves lent out
the threshold
the threshold reserveabsorbing operations
Banks with reserves below their threshold
Interbank trading
Threshold
Reserves
Borrowed reserves
SNB's foreign exchange sales lower banks' reserves, which can
potentially reduce interbank trading
Banks with reserves above their threshold
Threshold
Reserves up to
Reserves above Sales of SNB
the threshold
the threshold FX reserves
Banks with reserves below their threshold
Threshold
Sales of SNB
Reserves
FX reserves
By lowering the bank-specific thresholds, the SNB can restore sufficient
scope for interbank trading
Banks with reserves above their threshold
Lowering the threshold factor
Threshold
Threshold
Reserves up to
Reserves above
the threshold
the threshold
Banks with reserves below their threshold
Lowering the threshold factor
Threshold
Threshold
Reserves
Longer-term outlook for monetary policy
implementation
Currently, two approaches to the longer-term implementation of
monetary policy are being discussed internationally
Floor system Corridor system
Supply Supply
% %
Central bank
Central bank
lending rate
lending rate
Demand
Market rate
Market rate
Central bank
deposit rate
Demand
Structural demand Reserves Structural demand Reserves
Several important questions must be answered before central banks
potentially return to implementing monetary policy in a corridor system
How precisely can money market interest rates be controlled?
How will trading in the interbank money market be affected?
How important to banks are reserves as high-quality liquid assets?
How will banks' ability to make payments be affected?
Thank you for your attention
© Swiss National Bank