Explanatory Notes - Wholesale
BANK RATE
MINIMUM LENDING RATE
BAND 1 DEALING RATES
REPO RATE
THE OFFICIAL BANK RATE PAID ON COMMERCIAL BANK RESERVES
Official Bank of England rate
Prior to September 1971, the main policy objectives of the authorities
had been control over the supply of credit available to the private sector
and control over the level and structure of interest rates. The former
objective was attained by the imposition of quantitative and qualitative
restrictions on bank lending and setting the conditions for hire purchase
credit. The latter was achieved by an interest rate set by the Bank of
England - Bank Rate.
A net flow of funds from the Bank and Government to the Banking
Sector created a surplus of funds in the money market. Conversely,
a net flow of funds in the opposite direction created a shortage.
Since Government
receipts do not match Government expenditure, the Bank intervened
in the markets through the Discount Houses, by issuing and buying
Treasury Bills
to ensure that the banking system was in balance at the end
of the day.
Bank Rate had a direct influence on interest rates in the domestic
banking system, being the rate at which the Bank of England,
acting as lender of last resort, would normally lend to members of the
discount
market against security (e.g. Treasury Bills and eligible bills).
It was also a conventional reference point for the rates which the London
Clearing
Banks paid on deposits and charged on advances.
Bank Rate had less influence on the rates of non-resident and
other banks operating in the UK, which then, as now, were linked
to market rates, especially those in the interbank market.
The monetary reforms which became effective in September 1971 were designed
to introduce more competition amongst the clearing banks and choose the
rate of growth of the money stock as a main policy objective. A logical
continuation of these measures was the replacement of Bank Rate on 13
October 1972 by Minimum Lending Rate (MLR).
MLR represented the minimum rate at which the Bank, acting as
lender of last resort, normally lent to members of the discount market
against specific security. Until 24 May 1978, the rate was normally set
1/2% higher than the average rate of discount for Treasury bills established
at the weekly tender, rounded to the nearest 1/4% above and effective,
for lending by the Bank, from the following working day. However, special
changes in the rate were not precluded under this system; in this event
the announcement was normally made at midday on Thursdays. A new rate
determined in this way was effective immediately and the operation of
the normal formula suspended until market rates had moved into line. On
11 March 1977, these arrangements were modified in one respect: in cases
where the operation of the formula would have brought about a reduction
in the rate, the Bank reserved the right, exceptionally, either to leave
the rate unchanged, or to change it by less than would have resulted from
the operation of the formula.
While MLR was the means of implementing interest rate policy
from day to day, the principal instruments that reinforced MLR in accomplishing
monetary control over a longer period were the special deposit scheme
(this had existed since 1960 with modifications), the reserve assets ratio
(which applied from 1971 to 1981) and, on occasions between 1973 and 1980,
the supplementary deposits scheme.
Each had direct implications for the money markets: a call for
special or supplementary special deposits withdrew cash from the banking
system while the reserve ratio arrangements ensured that some of the short-term
assets were not available to meet cash shortages.
On 25 May 1978, it was announced that the rate would in future
be determined by administrative decision and any change would normally
be announced at 12.30 pm on a Thursday; the new rate would become effective,
for lending by the Bank, immediately.
Two main short-comings became apparent in these arrangements.
First, developments such as higher and more variable rates of inflation
worldwide and the increased attention given to the monetary growth were
associated with higher and more volatile interest rates. Second, there
were insufficient holdings of Treasury bills to sell to the Bank to fund
the market ’s shortages or to buy in surplus.
Following discussion papers and consultation with relevant parties, the
Bank’s operating techniques in the money market were changed in
stages, beginning in October 1980. The formal arrangements were set out
in the Bank’s paper "Monetary Control Provisions"; these
began to take effect on 20 August 1981 when MLR was suspended. The Bank
was able, however, at its discretion, to announce in advance the minimum
rate which it would apply in any lending to the market. MLR has been invoked
on numerous subsequent occasions for one day only. The reserve ratio requirements
were discontinued and the cash ratio scheme introduced. The special deposit
scheme remained available.
The Bank’s initial aim was to keep very short-term interest rates
within an unpublished band, set by the authorities, to establish a specific
level of interest rates. Any lending would normally be at a rate above
comparable market rates, but within the band. There were 4 dealing bands
ranging from Band 1 to Band 4 with maturities of 1-14 days, 15-33 days,
34-63 days and 64-91 days. Most typically the Bank dealt in Band 1. Operating
in such maturity ranges was necessary for outright purchases because if
the Bank had specified a single maturity date, the market may have had
difficulty mobilising sufficient paper maturing on that specific date
at short notice.
The Bank’s intervention in the money markets placed greater emphasis
on open-market operations (as opposed to direct lending) in the bill markets,
principally through members of the London Discount Market Association
(LDMA). The Bank operated with the broad intention of offsetting daily
cash flows, in either direction, between the Bank and the money market.
There was an extension of the list of eligible banks that were
required to hold a minimum proportion of their eligible liabilities in
secured deposits with members of the LDMA. This ensured that during periods
of extreme money market shortages, the Discount Houses could effectively
perform their role as intermediaries.
In supplying liquidity to the market, the Bank operated primarily
through the discount houses, buying Treasury bills and eligible local
government and bank bills either outright or on ‘repo’ (sale
and repurchase agreements) to meet anticipated surpluses/shortages. The
Bank aimed to supply on a daily basis whatever liquidity was necessary.
Depending on the size of the day’s shortage, the Bank operated up
to three times a day, offering to buy bills. If this was insufficient
to deal with the shortage, the Bank lent on a secured basis to the discount
houses at the end of the day (up to an amount linked to their capital).
With the end of pre-determined dealing rates, the discount houses
competed to sell paper to the Bank, including repo, (or buy from it when
in surplus), through their choice of rates at which they could afford
to do business. The Bank influenced interest rates by its reactions to
these offers. If the Bank was content with these offers, it would accept
sufficient amounts to ensure the market was in balance. However, if these
offers conflicted with the Bank’s higher interest rate objective,
all or part of the offers were rejected. The Bank then declined to deal
in the bill markets or limited its dealings so forcing those houses that
were short of cash to borrow. The Bank then set a lending rate consistent
with the level it was seeking to establish.
After 1991, there was at times a sizeable increase in the amount
of liquidity the Bank has had to supply day-by-day to relieve the banking
system’s shortage. This largely arose from movements in Government
financing and because the discount houses had generally shrunk in size.
To overcome this problem, the Bank introduced a twice-monthly repo operation
in 1994 which built on the temporary arrangements introduced in September
1992 when sterling left the ERM. This repo facility was offered to a wide
range of counterparties (including banks, discount houses, building societies
and gilt-edged market-makers) and used different assets. These were primarily
gilt repo, in which the Bank buys gilts from its counterparties and agrees
to sell them back at a future date at a price set in advance. The liquidity
provided through the repo facility reduced the liquidity the Bank needed
to support its daily operations to a more easily manageable amount.
During 1996, further changes to the Bank’s open money-market operations
were announced. Following discussions with market participants, the Bank
issued a notice "Reform of the Bank of England’s operations
in the sterling money markets", which gave operational details
of the arrangements which were introduced on 3 March 1997.
The Gilt Repo market began in January 1996 and by February
1997 had developed sufficient scale and depth to be included
in the Bank’s
open market operations. The Bank continued to use Treasury
bills and eligible bank and local government bills, both
for repo alongside gilts, and for
outright sale to the Bank. Also included were HM Government
foreign currency marketable debt (including euro notes and
bills issued by HM Government
and the Bank of England), eligible sterling denominated securities
issued by EEA governments and major international institutions
and eligible euro
denominated securities including strips, issued by EEA governments
and major international institutions.
In repo operations, funds can be provided against any acceptable
security with a maturity longer than that of the repo. In the years before
1997 the Bank had been providing funds to the market with an average maturity
of two weeks. The Bank retained approximately this maturity for its repo
dealing operations.
The Bank conducted its open market operations at 9.45 am (or
12noon on those days when the MPC announced its decision) and 2.30 pm.
The Bank also provided overnight repo facilities at 3.30pm for its money
market counterparties and at 4.20pm for the settlement banks, to accommodate
these imbalances.
The Bank ceased to deal exclusively with members of the London
Discount Market Association (LDMA) in its daily operations, dealing instead
with a wide range of financial institutions active in the gilt repo and/or
bill markets who meet the necessary functional requirements for its operations.
The twice-monthly repo facility was suspended in March 1997.
THE OFFICIAL BANK RATE PAID ON COMMERCIAL BANK RESERVES
On 18 May 2006 the Bank introduced some wide ranging reforms
to the framework for its operations in the sterling money markets (details
can be found at: http://www.bankofengland.co.uk/markets/moneymarketreform and http://www.bankofengland.co.uk/markets/money/publications/redbook0506.pdf).
Theses reforms included:
A new timetable for open market operations (OMOs), which are used to supply the right amount of money to allow banks in aggregate to hold their target reserves. In these OMOs the Bank lends by way of repo. Once a week it makes one-week loans. On the last day of each maintenance period it also undertakes a “fine-tuning” overnight operation, lending or borrowing as necessary. Weekly and fine-tuning repos are undertaken at the official Bank rate. In addition the Bank undertakes longer-term repos at maturities of 3-12 months. These longer-term repos are undertaken not at the official Bank rate but at market rates determined in variable rate tenders.The introduction of reserve accounts, held by commercial banks at the Bank, on which the official Bank rate is paid. The reserves scheme is voluntary and members undertake to hold a particular target balance not every day but on average over a monthly “maintenance period”.
Standing facilities which allow a wide range of banks to borrow (against collateral) or deposit money with the Bank at rates which on most days are 1% above and 1% below the official Bank rate, but 25 basis points (¼%) above or below on the last day of each maintenance period.
Changes in Bank Rate, Minimum Lending Rate, Band 1 Dealing Rate, Repo
Rate and the official Bank rate normally signify a marked change in the
level of short-term market rates. As such, they are used as an indicator
of the broad level of market rates.
