Official Bank of England rates
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.
Minimum Lending Rate
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.
Band 1 dealing rates
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.
Repo rate
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. These have been further revised over the intervening years, and current details can be found in the Bank of England Market Operations Guide.
One of the primary reforms was the introduction of reserve accounts, held by commercial banks at the Bank, on which the official Bank Rate is paid. Reserves accounts are voluntary, and at the time of introduction all participants undertook to maintain an average target balance over the period between MPC dates (the ‘maintenance period’). Since then, the types of firms which are eligible to apply for reserves accounts has increased, and the ‘reserves averaging’ requirements no longer apply to most of them, ie there is currently no minimum or maximum requirement for most of them.
Reserves accounts are coupled with operational standing facilities (OSFs) for all but the smallest participants, and this has two parts, an operational standing deposit facility and an operational standing lending facility. The lending facility consists of an overnight lending transaction collateralised against high-quality, highly-liquid assets.
The Bank operates a framework of liquidity insurance operations to support the Bank’s financial stability objective. Many of these facilities provide reserves to the market which ultimately end up in commercial banks’ reserve accounts. Some of these facilities are bilateral (ie between the Bank and one firm at a time) and others are market-wide (ie between the Bank and a number of firms at a time). But all SMF facilities operate on published terms that do not vary across participants. These are set out in the Bank of England Market Operations Guide.
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.