Q&As on liquidity-providing repo operations
- What are liquidity-providing operations used for?
- What liquidity-providing operations has the CNB conducted in the past, and under what conditions?
- Why do the operations have different maturities, and are they also offered to non-bank financial institutions?
- Which financial institutions have access to the CNB’s liquidity-providing operations?
- At what interest rate can institution borrow from the CNB? How will changes to monetary policy interest rates affect this rate?
- How often does the CNB conduct such operations?
- For what period can institutions borrow using the operations? And can they borrow repeatedly?
- What are the minimum and maximum amounts for individual operations?
- Why do some parameters of the liquidity-providing operations differ for credit and non-bank institutions?
- What form of collateral does the CNB require from institutions?
- How large a haircut on the nominal value of collateral should institutions expect?
- In what currency must the collateral be denominated?
- Must the securities used as collateral have an external rating?
- Does the CNB bear any credit risk in liquidity-providing operations?
- May the conditions applying to liquidity-providing operations change in the future?
- Doesn’t the use of liquidity-providing repo operations indicate that an institution has liquidity management problems?
- What does the fact that some of the CNB’s powers under the Act on the CNB will only be in effect until the end of 2021 imply for liquidity-providing repo operations?
- How much liquidity does the CNB expect to provide in the new liquidity-providing operations?
The CNB uses liquidity-providing operations to supply koruna liquidity to financial institutions. It also supports liquidity on markets in the instruments used as collateral, especially the government bond market (i.e. it supports the smooth functioning of those markets). The CNB provides koruna liquidity on the basis of its mandate to maintain price and financial stability. Koruna liquidity-providing operations are an important pillar for the smooth transmission of monetary policy measures into the local financial system. Such operations are not often used in normal times in systems with surplus liquidity such as the domestic financial system. They naturally increase in importance at times of market stress, when liquidity shortages and disruptions to liquidity flows may occur on financial markets.
The CNB introduced liquidity-providing repo operations for credit institutions in autumn 2008. Until May 2020, the CNB conducted repo operations solely with domestic credit institutions (banks, foreign bank branches and credit unions), accepting Treasury notes, CNB notes and government bonds as collateral. From May 2020, credit institutions may also use mortgage bonds as collateral. In addition, domestic non-bank financial institutions (insurance companies, pension management companies and management companies) can now obtain liquidity in liquidity-providing repo operations. The eligible collateral will be the same as that in the current operations with credit institutions. Information about liquidity-providing repo operations is available on the CNB website at https://www.cnb.cz/en/financial-markets/money-market/parameters-of-the-liquidity-providing-repo-operations/.
By providing liquidity to various financial institutions at various maturities, the CNB seeks to facilitate balance-sheet liquidity management according to institutions’ specific needs. In doing so, the CNB indirectly supports the smooth transmission of liquidity across the Czech financial system. In periods of market stress, various liquidity shortages and disruptions to liquidity flows may occur on financial markets due to a lack of information and a high degree of uncertainty. This leads to growth in counterparty risk. In such a situation, it could become more difficult not just for banks, but also for non-bank financial institutions to access liquidity through standard financial market operations. This would make it harder for them to conduct their asset operations.
Until May 2020, access to two-week repo operations for credit institutions was limited to domestic credit institutions that had entered into a Master Agreement on trading on the financial market with the CNB. This will continue to apply for two-week repo operations and for the new three-week ones. From May 2020, the CNB has prepared new liquidity-providing repo operations for non-bank financial institutions, which can be used by insurance companies, pension management companies and management companies.
The CNB satisfies bids from credit institutions at the 2W repo rate and bids from from non-bank institutions at the 2W repo rate + 0.2%. Where the 2W repo rate changes, the new liquidity-providing operations will be conducted at the changed 2W rate.
The CNB conducts liquidity-providing repo operations for credit institutions twice a week for two-week maturity and once a week for three-month maturity. For non-bank financial institutions, these operations are announced twice a week for two-week maturity, although on different days than the operations for credit institutions.
Credit institutions can borrow for two weeks or three months. Eligible non-bank institutions can borrow for two weeks. Institutions can borrow against eligible collateral repeatedly and in unlimited amounts.
The minimum accepted bid is CZK 10 million for credit institutions and CZK 100 million for non-bank institutions.
The central bank regularly carries out transactions with credit institutions, transactions through which it implements monetary policy. Repo operations are the main instrument used to steer interest rates on the interbank market and, in turn, other macroeconomic variables through the individual monetary policy transmission channels (available in Czech only). Non-bank institutions do not play such a role. They usually satisfy their liquidity needs via credit institutions. In this sense, making liquidity-providing repo operations available to non-bank institutions is a preventive non-standard measure for the event of irregular and unexpected disturbances in market mechanisms.
The CNB normally accepts Treasury notes, CNB notes and government bonds. From May 2020, credit institutions can also use other instruments, specifically mortgage bonds, as collateral.
The haircut has been set at 2% for notes (Treasury notes and CNB notes) and 4% for government bonds. The CNB sets the haircut for other instruments based on an assessment of their riskiness; in these cases, it may be as much as tens of per cent.
Liquidity-providing repo operations are conducted in Czech koruna and the instruments used as collateral must also be denominated in this currency.
An external rating is not a condition of eligibility. Nevertheless, the CNB takes the existence of a rating into account when setting the required haircut on the nominal value of the collateral. However, the security must always comply with the terms published by the CNB.
The way in which liquidity-providing operations are conducted minimises the risk to the CNB. The instruments accepted are used as collateral in the event of bankruptcy of the institution to which liquidity is provided. The CNB therefore only accepts instruments of high credit quality. The CNB has the right to sell the collateral if the counterparty goes bankrupt. And because the price of the collateral may change, the CNB sets and regularly evaluates the necessary haircut on the nominal value of the collateral.
The amendment to the Act on the CNB approved by Parliament in April 2020 gives the CNB significant flexibility in its liquidity-providing operations. The conditions, including the eligible collateral, may therefore change. The amendment also broadens the range of assets and financial market participants with which the CNB may carry out transactions, although only until the end of 2021. Unless the Act on the CNB is amended again, the CNB will return to the original arrangement that was in effect until May 2020.
Liquidity-providing repo operations have been a standard, and in recent decades the predominant, monetary policy instrument of the central banks of advanced countries. The different banks operating on the Czech market have different business models. This is reflected in a need to manage liquidity in different ways. It is natural that some banks will need to adjust their liquidity situation using operations with the central bank, especially at times of increased market volatility. At present, this may also arise because banks’ liquidity is being significantly affected by the loan moratorium declared in connection with the COVID-19 pandemic.
Unless the CNB’s powers are extended or enacted permanently in the Act on the CNB, liquidity-providing repo operations involving collateral other than Treasury notes, CNB notes and government bonds will be discontinued at the end of 2021. In such case, liquidity-providing operations with non-bank financial institutions will be also ended.
It should be stressed that this is not a massive quantitative easing programme defined by the amount of transactions conducted. It is primarily intended to enhance financial stability in the banking sector, the non-bank financial institutions sector, and the markets in assets which the CNB accepts or will accept as collateral in its liquidity-providing operations. The important thing here is the signalling role of the existence of such liquidity-providing operations. This role works even if the amount of liquidity provided is small or even zero. The CNB’s experience gained in 2008 clearly demonstrates this. Given the large structural liquidity surplus in the Czech banking sector and the still favourable situation in the non-bank financial institutions sector, the CNB is not currently expecting to supply a large amount of funds through the new liquidity-providing operations. However, this does not reduce the importance of these operations.