Second, banks can increase the size of the precautionary balances or buffer they hold with the Bank by altering their reserves targets in our voluntary reserves system. 3 And, third, in the face of, say, a  1  “Managing the central bank’s balance sheet: where monetary policy meets financial stability”, Lecture to mark the fifteenth anniversary of Lombard Street Research, London, July 2004, Bank of England Quarterly Bulletin, Autumn 2004, pp359-382. 2  So I am using the expression in its older, broader sense, not narrowly to mean bespoke support operations. 3  Under the Bank of England’s Sterling Monetary Framework, individual reserves banks choose each month a level of reserves they wish to target on average over a month-long maintenance period running between Monetary Policy Committee meetings. The Bank supplies, via OMOs, the resulting aggregate level of reserves. In stressed circumstances, the Bank can permit a revision to the target during the monthly  BIS Review 67/2009  1  9/11-type event that disrupted the financial infrastructure and effectively closed the money markets, the Bank could temporarily substitute itself for the markets by allowing banks to borrow from, and deposit with, us at no charge relative to Bank Rate. 4 Beyond monetary policy All of those contingencies involve events affecting either the demand for reserves or their distribution around the system. And the measures designed to cope with them are therefore part and parcel of the Bank’s management of the banking system’s day-to-day sterling liquidity in the course of implementing monetary policy.
That would be a regime in which central banks would, in effect, be lender of second resort (ie as soon as some markets closed up) rather than LOLR (broadly understood). The equilibrium would surely be one in which less of banks’ balance sheets were liquid in the markets than is desirable; and in which the banking system in aggregate could run excess liquidity risk from a systemic perspective. Haven’t we seen the results of that already? Isn’t the purpose of regulatory standards to avoid that? Our own favored approach is that the regulators should define the “liquidity buffer” to comprise high-quality securities that can reliably be traded or exchanged in liquid markets, including in stressed circumstances. In practice, that would mean focusing on government bonds in many economies. 22  21  See Chapman G, Emblow, A and Michael I (2000), “Banking System Liquidity: Developments and Issues”, Financial Stability Review, Issue 9, December 2000.