Paul Fisher: Central bank policy on collateral Paper by Mr Paul Fisher, Executive Director, Markets, and Member of the Monetary Policy Committee of the Bank of England, summarising recent discussions with a range of market contacts, London, 14 April 2011. This paper sets outs the Bank of England’s approach to collateral policy, which is driven by a combination of monetary and financial policy objectives and the need to protect the Bank’s balance sheet. *  *  *  I would like to thank Simon Ainsworth, Ronnie Driver, Charles Gundy, Sarah John and Alan Sheppard for their help in preparing this paper. The Bank of England, like most central banks, has two core purposes. The first is to maintain price stability, defined by a 2% CPI inflation target, mandated by the government on an annual basis. The second is financial stability, which entails detecting and reducing threats to the financial system as a whole. The Bank meets these objectives through the use of its balance sheet. It supplies banknotes and central bank reserves (the most liquid and risk-free forms of payment in the economy) to the banking system, in a process which helps to anchor short-term market interest rates around the Bank Rate set by the Monetary Policy Committee (MPC).1 And to support financial stability, the Bank provides liquidity insurance to the banking system as a whole.
DWF collateral is divided into four sets, depending on its underlying liquidity. Levels A and B are the same as the “narrow” and “wider” sets allowed in OMOs. Levels C and D go wider still (Table 1). The price for drawing depends on the collateral a firm has to offer: the less liquid the collateral, the higher the fee. Essentially, the haircuts play the role of protecting the Bank’s balance sheet while the fee plays the role of discouraging use except under stressed conditions and therefore avoiding market distortions in normal times. It also compensates the Bank for taking the liquidity risk. Table 1 Collateral eligible in post-crisis Bank operations  The Bank has been encouraging counterparties to “pre-position” collateral in the DWF, which allows us to conduct ex-ante due diligence and advise on the eligibility and likely advance rate of the collateral (ie the amount we would lend against it) were it to be called upon in a live draw. Pre-positioning provides counterparties with the insurance they need were an unexpected risk to suddenly crystallise. In that scenario, having a pool of collateral that has  5  4  See Fisher (2010), “Recent developments in the sterling monetary http://www.bankofengland.co.uk/publications/speeches/2011/speech487.pdf  framework”,  available  at  BIS central bankers’ speeches  already been assessed and is ready for use might significantly reduce the delay between an DWF draw-down application and the release of funds.6 That could be vital in a crisis.