The pre-crisis weekly liquidity provision through variable rate competitive auctions was thought to be best suited to reveal banks’ “true” liquidity demand, incentivise interbank transactions, and enhance market scrutiny of banks’ credit standing, beyond the quality of the collateral that they could pledge in our lending operations.
But, during the crisis, we have moved to a system in which the central bank is de facto the “market intermediary” of last – and sometimes – first resort. This has further weakened banks’ incentives to trade liquidity in the market. Do we need them to trade in the very shortterm market in the first place?