. in addition, as part of the bank ’ s desire to ensure that commercial banks are adequately incentivised to seek their own liquidity insurance, the cost of borrowing increases with the size of the draw. the resulting matrix of fees is summarised in table 1. table 1 fee table for dwf drawings of gilts fees ( bps ) % of sterling eligible liabilities 0 - 10 % collateral type level a level b level c level d ( e. g. high quality ( e. g. liquid and ( e. g. illiquid ( e. g. own - name sovereign debt ) high quality transferable securitisations mortgage and securitised loans and covered corporate bonds ) and mortgages ) bonds, and loans ) 10 - 20 % 20 - 30 % > 30 % at the bank ’ s discretion there is one further important point to make regarding the policy decisions underpinning the design of the dwf. it relates to the challenges associated with providing liquidity support while not compromising the bank of england ’ s ability to conduct monetary policy. to implement interest rate decisions, the bank must, through its market operations, adjust the supply of central bank money in response to changes in the demand for banknotes and reserves, given the mpc ’ s policy rate ( bank rate ). during periods of stress there may be large shifts in the demand for reserves and so the bank ’ s market operations need to be designed to meet both our monetary policy and financial stability objectives without conflict. in normal times, bank rate is set within a reserves averaging framework, in which commercial banks choose their own targets for reserves balances held at the bank but are then required to meet those targets on average over the monthly maintenance period and are remunerated at bank rate. the bank of england supplies just enough cash to the system so that banks can collectively meet their targets, and a combination of the operational standing facilities and the inter - bank market should guide short - term market interest rates towards bank rate. this framework relies on the bank ensuring the amount of sterling cash in the system is in line with that demanded, given bank rate. the liquidity swap structure of the dwf does not involve an extra injection of cash and so helps to avoid any direct impact on the setting of bank rate. the bank may, however, decide in exceptional circumstances, to lend cash instead. that might be required if, for example, the gilt repo market was

being ‘ in the money ’ small moves in market prices have a big effect on its value. this ‘ dynamic hedging ’ means dealers trying to hedge their positions need to buy more of the underlying asset as prices fall, and sell more as they rise. they can add a stabilising influence to markets. as a result, the decision to sell cheap insurance can appear vindicated : betting on low volatility begets low volatility. all speeches are available online at www. bankofengland. co. uk / speeches second, measures of actual and implied volatility are often used as an indicator of risk to inform investment decisions. when they ’ re low, the world appears less risky, so less compensation appears to be needed for risk. the trouble is that these are not measures of risk. they are a reflection of the risk appetite of those selling insurance. taking on more risk because implied volatility is low is the equivalent of ignoring the road conditions and driving faster because your insurance got cheaper as a herd of new entrants flooded the car insurance market. when accidents start to increase, the whole thing can go into reverse. those who had been selling insurance can incur losses. what might have looked like a profitable insurance business won ’ t do so any more. the terms on insurance can shift abruptly. the result : driving speeds slow down to a snail ’ s pace. in markets, this means price adjustments, whatever triggered them, might be followed by sharp withdrawal of cheap insurance … …. which removes the need for dealers to act as a stabilising influence … … leading to greater market volatility …. … and sharp reduction in risk appetite. market moves are amplified. these dynamics are difficult to size. they may or may not be of consequence. exploration is needed about behaviour in some of the furthest corners of the system in order to take a firmer view on the form and extent of this fragility. as the office of financial research in the united states noted, “ available data on investor portfolios are not sufficient to assess this … adequately ”. that ’ s one reason why the bank of england ’ s financial policy committee has commissioned an in - depth review of how the use of derivatives in the non - bank financial system may be shaping the dynamics of markets. investors who base decisions on value - at - risk ( ‘ var ’ ) and assess those risks using market measures can be guided into thinking their portfolio is safer. in