6  BIS central bankers’ speeches  Changes in market prices can, of course, affect the value of the collateral the Bank has taken in its operations. As a result, the Bank calls margin on any shortfall.8 In its sterling operations, the Bank calls margin daily and is moving to that standard for all other transactions. Limits The Bank also manages the risk on its balance sheet using concentration limits. Those serve two purposes. First, they help the Bank diversify across institutions – for example, counterparties can only bid for a maximum of 30% of the funds on offer in the Bank’s ILTRs. That helps ensure that any single counterparty doesn’t corner the market for reserves (intentionally or by accident). Second, they help diversify across instruments in the wider collateral pool – for example, the Bank requires that the adjusted market value (AMV) of securities that any single issuer delivers to the Bank as wider collateral in OMOs is less than the greater of £ million or 25% of its total OMO collateral delivered. Other recent policy initiatives The Bank has, for a number of years, been refining and improving its collateral policy. In November 2010, the Bank announced that it would allow counterparties to use “raw” (i.e. unsecuritised) loans as collateral in the DWF. By removing the need to securitise assets, that initiative expands the range of collateral that banks would be able to use in times of stress.
In particular, there are policy decisions required in the following dimensions: (i)  eligibility (what collateral should be accepted, and what should not);  (ii)  valuations and haircuts (how much is the collateral worth? );  (iii)  what fees should apply, if any, and  (iv)  limits (how much diversification should we seek across the collateral delivered?). These are important questions for the banking system as a whole, and have presented new and complex risk management challenges for central banks over the past few years. It is on these issues that we focus in this paper.3 To start with, we briefly outline some of the main features of the Bank’s lending operations. The sterling monetary framework The Bank’s main activity in the sterling market prior to the financial crisis was via its shortterm repo open market operations (STR OMOs). Those regular weekly operations provided the banking system with the right level of reserves such that short-term market interest rates would remain close to Bank Rate set by the MPC.4 In addition, in order to reduce the size of weekly STR OMOs to a manageable size, the Bank undertook longer-term repo OMOs (LTR OMOs) of 3, 6, 9 and 12 months maturity. The remaining operation of note was the Standing Facilities in which a commercial bank could borrow from, or lend to the Bank overnight, albeit at a less attractive rate than Bank Rate.