of options on u. s. interest rate swaps. source : bloomberg. unclassified unclassified acute episodes of market illiquidity are relatively infrequent and obvious when they do occur. but there can also be instances of a more chronic deterioration in market liquidity. liquid markets require large numbers of willing buyers and sellers. when the number of participants is small, or heavily skewed to one side of the market, this can make it challenging to find counterparties. we saw, and more so heard, evidence of this during the rapid global monetary policy tightening that occurred over 2022. as interest rates re - priced to the new inflation and monetary policy reality, markets became increasingly one - sided ( figure 5 ). figure 5 : new zealand dollar 2 - year interest rate swap rate7 in the new zealand interest rate swap market, major banks are typically on the same side of the market as they look to hedge interest rate risks arising from originating fixed rate mortgages. this “ pay - side ” flow, if not met with an equivalent “ receiving ” interest8, will all else equal tend to put upward pressure on swap rates. often it is offshore market participants that provide this receiving interest, but in late 2021 and into 2022, as global interest rate volatility exploded, the willingness and ability of these participants to engage in new zealand dollar interest rate trading was diminished. this resulted in an illiquidity premium in new zealand swap rates. this has implications at the margin for monetary policy, as market - based expectations for policy rates, which help to inform policymakers, will include this illiquidity premium. furthermore, the increased cost of hedging faced by banks may ultimately be passed through to the retail interest rates faced by their customers, impacting monetary policy transmission at the coal face. we are confident, informed by our market intelligence gathering, that an illiquidity premium exists, though it varies over time and can be difficult to quantify. it adds noise to the signal that we get from market pricing and may impact, at the margin, the financial conditions that policymakers are seeking to influence. _ _ _ _ _ _ _ _ _ _ _ _ 7 daily nzfma swap close rate for 2 - year swap. source : reuters 8 the “ payer ” or “ pay side ” of an interest rate swap refers to the counterparty who pays a fixed rate of interest and receives a floating rate. a “ receiver ”

could be forgiven for feeling confused. we need to understand the difference between salt water and fresh water to appreciate the cruel irony that befell the ancient mariner. in the same way, we also need to understand the different forms of liquidity to appreciate why it is possible to have both an abundance of liquidity in the financial system, and a lack of liquidity in financial markets. unclassified unclassified in my remarks today i will differentiate between three types of liquidity and how at te putea matua we have an interest in each of them. i will also talk to how these forms of liquidity interact with one another and how efforts to improve some can have an adverse effect on others. the three forms of liquidity i will cover are : funding liquidity : which for our purposes today, will refer to how well banks are funded and their ability to meet their financial obligations as they fall due1. system liquidity : which refers to the amount of settlement cash in the banking system. market liquidity : which refers to how easy it is to transact in markets without moving prices. funding liquidity this is obviously important for any entity, but it is core to the business of banking. banks generally do a good job of it, but we really notice when they don ’ t. during the global financial crisis ( gfc ) we learned that banks had become too reliant on short - term wholesale funding and when those markets froze, it came at a great cost to the global economy. more than a decade of global regulatory reform has sought to reduce the risks of that happening again. in new zealand, we were at the forefront of that regulatory change when the reserve bank published its liquidity policy ( bs13 ) in 2010. this policy introduced two types of liquidity ratio that banks would need to measure and maintain. the first, the core funding ratio ( cfr ), considers how much of a bank ’ s lending is funded from stable sources, including capital, retail deposits and long - term wholesale funding. the second, mismatch ratios ( mmr ), consider how adequate a bank ’ s stock of liquid assets is to meet their net cash outflows over a one - week and one - month horizon during a period of stress. in combination, the cfr and mmr are designed to ensure that banks maintain a sufficient stock of high - quality liquid assets and that they have a sufficiently stable, diverse, and distributed funding profile. this ensures that