A private scheme of that kind would not work, however, if the insurer could not afford to subscribe when the call came; or if investment institutions were unwilling to enter into such commitments on a sufficient scale for the insurance to make a difference to the system’s resilience. Another idea circulating currently 30 is that banks would be required by the authorities to issue hybrid-debt-capital instruments that could be converted when needed into loss-absorbing equity. In one variant, the option to require conversion would lie in the hands of regulators provided a systemic-severity test were passed. Summary and conclusions During the current crisis, the normal functioning of the financial system broke down, with profound effects on credit conditions and on the appropriate monetary policy response. Although I have ranged widely today, I have in fact deliberately not covered the operations employed in some countries to lend directly to firms, effectively by-passing the financial system; or the actions by some central banks, including the Bank of England, to expand the money supply in an environment of near-zero policy rates. Instead, I have focused on the repertoire of instruments directed to supporting, and ideally reviving, the financial system itself: funding liquidity, market liquidity, and solvency.
In the case of the DWF, we lend securities (gilts) that are eligible in our OMOs, so they can be turned into cash either in the market or via our repo operations. But, in its usual mode of operation, the DWF does not directly affect the Bank’s aggregate supply of reserves. 15 Indirectly, it may even reduce the demand for reserves, as it gives sound banks a source of liquidity insurance separate from holding precautionary balances with the Bank. By contrast, the wider-collateral LTR OMOs do inject reserves. For a given monthly reserves target, that means that, other things being equal, the Bank has to reduce the size of its weekly short-term OMOs, in order to ensure that its net supply of reserves is equal to the target; otherwise overnight rates would sink below the MPC’s policy rate. But when, as during the current crisis, the scale of wider-collateral repos is massively increased, reducing short-term repos to zero is not always enough to achieve our monetary objective. The Bank of England has therefore introduced the sale, via auction, of very short-term Bank of England bills to drain excess (ie above target) reserves from the market. That has enabled us to make a very significant (order of magnitude) discretionary increase in our cash-liquidity insurance without cutting across monetary policy. (In my view that is preferable, on technical and presentational grounds, to draining the market by HMG depositing with the Bank the proceeds of increased Treasury issuance, which could be confused with deficit-financing operations.)