The Bank of England is raising the pressure on banks to get ready for the moment when things start to get tough.
Banks should ensure that they are ready to borrow at scale through the BoE’s various facilities before its steady withdrawal of excess liquidity starts to create volatility in money markets, Vicky Saporta, the BoE’s executive director for markets, warned on Monday.
To that end, she noted in her first speech since taking over the position that the central bank is stepping up efforts to make its Indexed Long-Term Repo (ILTR) facility — through which it lends liquidity for six months — is “effective and attractive enough so that it is used in business-as-usual consistent with our policy objectives.”
Demand for the ILTR, a relatively new part of the BoE’s toolkit, has been infrequent and limited to what Saporta called “liquidity insurance.” However, Saporta hinted that she expects it to account for a substantial part of the BoE’s liquidity provision in the years to come, as the Bank transitions from away from the system of “excess liquidity” that it created after the 2008 crisis.
Saporta repeated the message delivered a few weeks ago by Governor Andrew Bailey, namely that the BoE wants its repo operations to be the main instruments for regulating the supply of central bank reserves in future.
Most of the liquidity currently circulated has been created by successive waves of quantitative easing, or asset purchases, and by a lending program to support small and medium-sized enterprises, known as TFSME. However, both of those programs are being run down: the Bank’s balance sheet has shrunk from a peak around £1.1 trillion to £763 billion as of last week.
The Bank estimates that in the long term, the banking system’s demand for central bank money will bottom out anywhere between £345 billion and £490 billion, a range that it calls the “Preferred Minimum Range of Reserves,” or PMRR.
Saporta said she didn’t expect to reach the PMRR before the end of next year, but that moment is widely seen as a dangerous one, given its potential to cause liquidity shortages similar to that seen in the U.S. in 2019.
“Before we reach it, we expect frictions in the distribution of reserves to lead to pockets of reserve demand appearing, which could lead to periods of market rates moving upwards,” Saporta said.
Many private-sector analysts see the top end of the range slightly higher, and fear that the moment of transition may arrive sooner than the Bank expects.
“What worries me most is that we may not be ready for it,” Saporta said.
STR alone won’t cut it
Even at the bottom end of the PMRR, Saporta said, “it would not make operational sense either for us or our counterparties to keep rolling over such large amounts in using solely short-term facilities repeatedly.”
As such, she argued, the Bank needs to complement its weekly Short-Term Repo (STR) operations with a longer-term facility. The STR is likewise still in its infancy, but usage has risen steadily throughout the year and hit a new record of £29 billion last week. Saporta said that phenomenon was “very welcome, and as intended.”
Saporta insisted that increased STR usage was not a sign of the system already reaching the top end of the PMRR, but she also stressed both in her speech, and in fielding questions afterwards, that banks and other firms eligible to borrow from the BoE should get all the necessary preparations in place, both by completing all the necessary agreements with it, and in pre-positioning the relevant volume of collateral.
This, she noted, would insure the system against harmful volatility at the time when the overall level of liquidity transitions from being “abundant” to merely “ample.”
