Where Does Money Come From? by Josh Ryan-Collins & Tony Greenham & Richard Werner & Andrew Jackson

Author:Josh Ryan-Collins & Tony Greenham & Richard Werner & Andrew Jackson [Ryan-Collins, Josh]
Language: eng
Format: epub
Publisher: The New Economics Foundation
Published: 2013-09-23T23:00:00+00:00

From 2006 up to 2009, the UK operated a ‘corridor’ system in which banks set their own reserve targets every month.9* Reserve balances, that on average over the month fell within a relatively narrow range around those targets, were remunerated at Bank Rate. Outside this range, surplus reserves, which had been moved to the deposit facility, were remunerated at the lower deposit rate. In contrast, banks with insufficient reserves had to borrow those reserves at the higher lending rate.

The system worked for a short period with the money market rates staying relatively close to the Bank of England’s rate, but from the summer of 2007, the financial crisis began to unfold and interbank market interest rates moved significantly above the Bank of England’s rate. The Bank responded by making extra loans available, since some banks were hoarding reserves and so the interbank market was not working efficiently. In addition, the Monetary Policy Commission (MPC) started rapidly cutting the Bank Rate, but whilst overnight interbank rates remained close to the policy rate, longer term interbank rates (for three-month loans, for instance) continued to be inflated.

The system of voluntary reserves was suspended in March 2009 following the decision of the Bank to embark on the purchase of financial assets funded through the creation of new central bank reserves, more popularly known as Quantitative Easing (explained in Section 4.7.3).10, 11 The corridor system has now been replaced by a ‘floor’ system with the level of reserves initially being increased in line with asset purchases and all reserves remunerated at Bank Rate.

In December 2009, the Financial Services Authority (FSA) announced a new liquidity regime. Under this, each bank would have to hold a buffer of central bank reserves or gilts. Banks would be required to hold an amount determined by various ‘stress tests’, including an inability to access wholesale funding or rollover loans over a two-week period and a ‘sizeable retail outflow’, in other words unusually large levels of withdrawals by bank customers.12 At the time of the announcement, the FSA said it would wait until the recession was over and banks’ balance sheets had improved before imposing the rules, and agreements have not yet been put in place for individual banks. Persistent funding gaps between banks’ current holdings of highly liquid assets and the new requirements suggest it may be some time before the regulations come into full force.13

This is not the case in many other countries. In the United States, for example, there is still a requirement for larger banks to hold central bank reserves of 10 per cent against certain defined categories of liabilities.14

At the international level, there is a proposal to tighten liquidity regulations by insisting that all banks hold enough easy-to-sell assets to withstand a 30-day run on their funding (similar to the crisis that engulfed Lehman Brothers in 2008) and this is due to come in to force in 2014. At the time of writing, however, it appears likely that this ‘liquidity coverage ratio’ will be softened by

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