The growth in TARGET balances after 2009 has given rise to intense academic and public debate. Our paper offers a systematic exposition of the necessary conditions for TARGET balances to emerge and provides a clear link to monetary policy. We show that large TARGET balances can only arise with excess liquidity. The interpretation of TARGET balances therefore depends on the monetary policy context in which excess liquidity is created. We distinguish three phases of TARGET balances growth and propose some easy-to-derive metrics for policy makers and academics to assess developments in TARGET balances. We develop a comprehensive econometric framework to account for relevant factors driving TARGET balances in the different phases. We find that while financial market stress and economic imbalances were the drivers of TARGET balances during the great financial and sovereign debt crises, the implementation of Eurosystem asset purchases was the driving force since March 2015. As excess liquidity is likely to persist on account of higher demand for central bank reserves compared to the pre-crisis period, TARGET balances have the potential to remain sizeable in the future.

Repo markets are an important first stage of monetary policy transmission. In the European repo market, the majority of participants, including non-dealer banks and non-banks, do not have access to centralized trading platforms. Rather, they rely on OTC intermediation by a small number of dealers that exert significant market power. Dealer market power causes the passthrough of the ECB's policy rate to be inefficient and unequal. Allowing market participants access to centralized trading platforms, or a secured deposit facility with the central bank, could improve the transmission efficiency of monetary policy while reducing the dispersion in repo rates across customers.

Download This Paper Open PDF in Browser Add Paper to My Library Share: Permalink Using these links will ensure access to this page indefinitely Copy URL Two-Tier System for Remunerating Excess Reserve Holdings ECB Occasional Paper No. 2022/302 53 Pages Posted: 13 Sep 2022 See all articles by Miguel BoucinhaMiguel BoucinhaEuropean Central Bank (ECB)Lorenzo BurlonEuropean Central Bank (ECB)Marco CorsiEuropean Central Bank (ECB)Guido della ValleEuropean Central Bank (ECB)Jens EisenschmidtMorgan StanleyIwona MarmaraEuropean Central Bank (ECB)Sebastiaan PoolEuropean Central Bank (ECB)Julian SchumacherEuropean Central Bank (ECB)Olivier VergoteEuropean Central Bank (ECB) Date Written: September 1, 2022 Abstract This paper reviews the experience of the ECB with the two-tier system for excess reserve remuneration that exempted a portion of banks' excess liquidity (EL) holdings from the negative interest rate of the ECB's deposit facility. Keywords: excess liquidity, exemption scheme, monetary policy transmission, negative interest rates, two-tier system JEL Classification: E41, E43, E52, E58, G11, G12 Suggested Citation: Suggested Citation Boucinha, Miguel and Burlon, Lorenzo and Corsi, Marco and Valle, Guido della and Eisenschmidt, Jens and Marmara, Iwona and Pool, Sebastiaan and Schumacher, Julian and Vergote, Olivier, Two-Tier System for Remunerating Excess Reserve Holdings (September 1, 2022). ECB Occasional Paper No. 2022/302, Available at SSRN: https://ssrn.com/abstract=4217220 Miguel Boucinha (Contact Author) European Central Bank (ECB) ( email ) Sonnemannstrasse 22Frankfurt am Main, 60314Germany Lorenzo Burlon European Central Bank (ECB) ( email ) Sonnemannstrasse 22Frankfurt am Main, 60314Germany Marco Corsi European Central Bank (ECB) ( email ) Sonnemannstrasse 22Frankfurt am Main, 60314Germany Guido della Valle European Central Bank (ECB) ( email ) Jens Eisenschmidt Morgan Stanley ( email ) 1585 BroadwayNew York, NY 10036United States Iwona Marmara European Central Bank (ECB) ( email ) Sebastiaan Pool European Central Bank (ECB) ( email ) Julian Schumacher European Central Bank (ECB) ( email ) Sonnemannstrasse 22Frankfurt am Main, 60314Germany Olivier Vergote European Central Bank (ECB) ( email ) Sonnemannstrasse 22Frankfurt am Main, 60314Germany Download This Paper Open PDF in Browser Do you have a job opening that you would like to promote on SSRN? Place Job Opening Paper statistics Downloads 1 Abstract Views 15 PlumX Metrics Related eJournals European Central Bank Research Paper Series Follow European Central Bank Research Paper Series Subscribe to this free journal for more curated articles on this topic FOLLOWERS 8,474 PAPERS 2,979 Feedback Feedback to SSRN Feedback (required) Email (required) Submit If you need immediate assistance, call 877-SSRNHelp (877 777 6435) in the United States, or +1 212 448 2500 outside of the United States, 8:30AM to 6:00PM U.S. Eastern, Monday - Friday. Submit a Paper Section 508 Text Only Pages SSRN Quick Links SSRN Solutions Research Paper Series Conference Papers Partners in Publishing Jobs & Announcements Newsletter Sign Up SSRN Rankings Top Papers Top Authors Top Organizations About SSRN SSRN Objectives Network Directors Presidential Letter Announcements Contact us FAQs Copyright Terms and Conditions Privacy Policy We use cookies to help provide and enhance our service and tailor content. To learn more, visit Cookie Settings. This page was processed by aws-apollo-5dc in 0.308 seconds

Negative interest rate policy (NIRP) is associated with a particular friction. The remuneration of banks´ retail deposits tends to be floored at zero, which limits the transmission of policy rate cuts to bank funding costs. We investigate whether this friction affects banks’ reactions under NIRP compared to a standard rate cut in the euro area. We argue that reliance on retail deposit funding and the level of excess liquidity holdings may increase banks’ responsiveness to NIRP. We find evidence that banks highly exposed to NIRP tend to grant more loans, i.e. NIRP is indeed expansionary for the levels of interest rates seen in the euro area so far. This confirms studies pointing to higher risk taking by banks under NIRP and sheds some new light on results that associate NIRP with a contraction in bank loans, albeit in specific market segments. We are the first to document the importance of banks’ excess liquidity holdings for the effectiveness of NIRP, pointing to a strong complementarity of NIRP with central bank liquidity injections, e.g. via asset purchases.

The massive recourse to quantitative easing (QE) calls for a better understanding of its effects on safe assets. Based on a simple balance sheet framework, we show how QE impacts the total amount, cross-sectional distribution, and composition of safe assets in the economy. Analyzing the ECB’s Public Sector Purchase Programme (PSPP), we find that the amount of universally accessible safe assets decreases and there is a transfer of safe assets from the non-bank to the banking sector. We call this phenomenon the safe asset illusion. The sectoral shift in the holding structure of safe assets has important implications for financial stability and the cost of secured liquidity.

The credit risk of the sovereign affects the financial health of its banking sector and vice versa, creating an adverse feedback loop known as “sovereign- bank nexus”. We show that Quantitative Easing can effectively mitigate the sovereign-bank nexus. Our results indicate that the ECB’s Public Sector Purchase Programme reduced the co-movement of sovereign and bank credit risk by almost 80%. The mitigation is driven by the euro area periphery and works through three channels: (i) a reduction in government bond holdings of banks, (ii) an increase of government bond prices, and (iii) an increase in excess liquidity holdings of banks.

The last review of the ECB's monetary policy strategy in 2003 followed a period of predominantly upside risks to price stability. Experience following the 2008 financial crisis has focused renewed attention on the question of how monetary and fiscal policy should best interact, in particular in an environment of structurally low interest rates and persistent downside risks to price stability. This debate has been further intensified by the economic impact of the coronavirus (COVID-19) pandemic. In the euro area, the unique architecture of a monetary union consisting of sovereign Member States, with cross-country heterogeneities and weaknesses in its overall construction, poses important challenges. Against this background, this report revisits monetary-fiscal policy interactions in the euro area from a monetary policy perspective and with a focus on the ramifications for price stability and maintaining central bank independence and credibility. The report consists of three parts. The first chapter presents a conceptual framework for thinking about monetary-fiscal policy interactions, thereby setting the stage for a discussion of specifically euro area aspects and challenges in subsequent parts of the report. In particular, it reviews the main ingredients of the pre-global financial crisis consensus on monetary-fiscal policy interactions and addresses significant new insights and refinements which have gained prominence since 2003. In doing so, the chapter distinguishes between general conceptual aspects – i.e. those aspects that pertain to an environment characterised by a single central bank and a single fiscal authority and those aspects that pertain to an environment characterised by a single central bank and many fiscal authorities (a multi-country monetary union). ...

The market for central bank reserves is mainly over-the-counter and exhibits a core-periphery network structure. This paper develops a model of relationship lending in the unsecured interbank market. Banks choose to build relationships in order to insure against liquidity shocks and to economize on the cost to trade in the interbank market. Relationships can explain some anomalies in the level of interest rates – e.g., the fact that banks sometimes trade below the central bank's deposit rate, as we find using data from the ECB. The model also helps understand how monetary policy affects the network structure of the interbank market and its functioning.

This paper analyses money market developments since 2005, and examines factors that have affected money market functioning. We consider several metrics of activity in both secured and unsecured euro area money markets, and study interactions with new Basel III regulations and with central bank policies (liquidity provision, asset purchases and the Securities Lending Programme). Using aggregate data, we document that, prior to 2015, heightened financial market volatility coincided with worsening money market conditions, while higher central bank liquidity provision was associated with reduced money market stress. After 2015, the evidence is consistent with central bank asset purchases inducing scarcity effects in some money market segments, and with active securities lending supporting money market functioning. Using transactions-level money market data combined with supervisory data, we further document that the leverage ratio regulation impacts money markets at quarter-ends due to “window-dressing” effects, reducing money market volumes and rates. We also consider the macroeconomic impact of changing money market conditions, finding that the impact depends on whether frictions originate in secured or unsecured markets and on central bank policies in place. JEL Classification: E44, E58, G12, G20, G28

TARGET balances have risen during the period of the Eurosystem's asset purchase programme (APP). The APP gives rise to substantial cross-border flows of reserves at the time of asset purchases and beyond, reflecting the interaction of decentralised monetary policy implementation and the integrated euro area financial structure. This financial structure, in which only a handful of locations act as gateways between the euro area and the rest of the world, leads to rising TARGET balances at the time of APP purchases and the persistence of TARGET balances in the context of subsequent portfolio rebalancing. TARGET balances per se are not necessarily an indicator of stress in bank funding markets, financial market fragmentation or unsustainable balance of payments developments.

A growing number of studies have sought to measure the effects of non-standard policy on bank funding markets. The purpose of this paper is to carry those estimates a step further by looking at the effects of bank funding market stress on the volume of bank lending, using a simultaneous equation approach. By separately modeling loan supply and demand, we determine how non-standard central bank measures affected bank lending by reducing stress in bank funding markets. We focus on the Federal Reserve and the European Central Bank. Our results suggest that non-standard policy measures lowered bank funding volatility. Lower bank funding volatility in turn increased loan supply in both regions, contributing to sustain lending activity. We consider this as strong evidence for a 'bank liquidity risk channel,' operative in crisis environments, which complements the usual channels of transmission of monetary policy.

This paper studies the relationship between the size of the banking sector’s refinancing needs vis-a-vis the central bank and auction rates in its open market operations in times of financial market stress. In a theoretical model, it is found that marginal rates at central bank auctions may increase if the share of troubled banks becomes too high relative to the total size of the banking sector’s refinancing needs. An empirical analysis then aims at determining the size of open market operations needed to absorb large stress levels in interbank money markets and hence contain central bank auction rates. Finally, the paper analyses effects of the composition of open market operations of different maturities on auction rates. It is found that a too high share of longer-term refinancing induces a rise in auction rates which is undesirable. Therefore, the analysis suggests that there is a lower bound for the amount of liquidity provided through short-term operations. JEL Classification: G01, G10, G21

Unsecured interbank money market rates such as the Euribor increased strongly with the start of the financial market turbulences in August 2007. There is clear evidence that these rates reached levels that cannot be explained alone by higher credit risk. This article presents this evidence and provides a theoretical explanation which refers to the funding liquidity risk of lenders in unsecured term money markets.

Liquidity provision through its repo auctions has been one of the main instruments of the European Central Bank (ECB) to address the recent tensions in financial markets since summer 2007. In this paper, we analyse banks' bidding behaviour in the ECB's main refinancing operations (MROs) during the ongoing turmoil in money and financial markets. We employ a unique data set comprising repo auctions from March 2004 to October 2008 with bidding data from 877 counterparties. We find that increased bid rates during the turmoil can be explained by, inter alia, the increased individual refinancing motive, the increased attractiveness of the ECB's tender operations due to its collateral framework and banks' bidding more aggressively, i.e. at higher rates to avoid being rationed at the marginal rate in times of increased liquidity uncertainty.

One of the main results of the literature on the effects of uncertainty on trade states that uncertainty should not matter in the presence of well-developed forward markets. Empirical studies, however, do not support this result. We derive the demand for forward cover in a small open economy with terms-of-trade uncertainty. Adopting a standard and more realistic decision structure than the one usually used in this literature, we find that risk-averse agents will not buy forwards at an unbiased price. Agents treat forward contracts as an asset rather than as an insurance. This is the reason why, when calibrating the model, only 17% of imports are covered by forwards.

There is a huge literature on corporate liquidity demand. The implications of this theory for international macro, however, are poorly studied. We extend the Holmstroem-Tirole (1998) model on corporate liquidity demand to a two country world. Introducing dual agency problems as well as differing agency costs allows us to link the share of foreign capital holdings with the extent of liquidity shock resistance of the domestic economy. When capital is scarce, a higher share of foreign capital implies a more vulnerable domestic economy. Thus countries that want to open up their capital account face a trade-off: a higher level of investment versus an increased vulnerability with respect to liquidity shocks. We find that less developed countries are more severely affected by this trade-off and are thus more likely to resort to policy instruments such as capital controls. We further show that domestic capital scarcity will place restrictions on foreign capital inflows. The smaller the domestic capital base, the smaller the amount of foreign capital that can be attracted. This explains why most international capital flows occur between rich countries and offers a fresh view on the missing catch-up predicted in neoclassical growth models.

Abstract