As we have already discussed, the first component of the insurance aspect of the framework is the reserves averaging mechanism itself, which permits banks, within reason and without penalty, to vary their reserves account balances day-to-day in the face of small and/or short-lived liquidity shocks – provided they hit their reserves target on average over the maintenance period. The second component is the OSFs which allow banks to cope with larger, expected (frictional) payments shocks day-by-day. A third component comes through longer-term OMOs to which we now turn. Longer-term Open Market Operations The most routine method for ensuring there is the correct amount of sterling in the system, consistent with reserves targets, is via short-term OMOs. Prior to the start of QE, the Bank carried out weekly short-term reverse repo operations (STRs) against a pool of “narrow” collateral comprising highly liquid sovereign or near-sovereign bonds from a small selection of countries. At that frequency, the scale of the operations could be judged fairly precisely so as to offset any autonomous factors which affected the net supply of sterling to the market. But relying solely on short term OMOs could have meant carrying out very large repo operations every week. To avoid that degree of churn, some longer term reverse repos (LTRs) were also used precrisis – at maturities from 3 to 12 months.
That means that the Bank has to supply excess reserves to the system in aggregate, such that no firm has any incentive to pay more than  7  4  And the OSF Deposit Facility rate was set to zero. BIS central bankers’ speeches  Bank Rate for the marginal unit of reserves. In that world, banks’ incentives to trade with one another in the overnight markets are largely diminished. A third model for implementing monetary policy is the “zero corridor” system. In this case there would be no reserves targets and banks could both lend to and borrow from the Bank in unlimited amounts at Bank Rate every day. Although short term market interest rates should always equal Bank Rate precisely, this system has several drawbacks. First, banks would never need to transact with each other; they simply transact with the central bank via the OSFs: there would be little or no commercial overnight interbank money market. That would be unwelcome. For example, the information the Bank deduces from movements in overnight market interest rates would be lost. It might also disrupt functioning of longer-term money markets, given implicit links to the overnight market. Second, if the Bank can always be relied upon to meet daily liquidity needs, then commercial banks have less incentive to actively manage their liquidity. And the Bank would be unable to distinguish between banks using the OSFs to manage their day-to-day liquidity buffers, and those facing more fundamental shocks.