This package included a reduction in Bank Rate to a new low of 0.25%, and the launch of a Term Funding Scheme to reinforce the pass-through of this cut, alongside a £ increase in our stock of UK government bonds and the purchase of up to £ of investment grade non-financial corporate bonds. As central bankers and money market enthusiasts know, the issue of pass-through is of utmost importance. The paper begins with the premise that a necessary condition for competitive money markets is that any change in the Fed’s policy rate is passed through, one for one, to all market transaction rates. In truth, one can make the much broader statement that the very efficacy of monetary policy and its usefulness as a tool for influencing the economy is premised on the pass-through of changes in policy rates to money market rates. And that’s why some of us have endless appetite to discuss any wedge between them. With that in mind, I’d like to pick up on two of the central themes of Darell and Arvind’s paper. •  The first is the impact of regulation – in particular the leverage ratio – on money market function. I will restate the case for having a leverage ratio, but will also argue that it can be much improved by the exclusion of central bank reserves from the exposure measure. •  The second is the role of central banks in money markets.
In particular, to quote Solvency II directly, “the Matching Adjustment must not include the Fundamental 9  Spread, reflecting the risk retained by the insurance or reinsurance undertaking” . Since the credit rating is the main driver of the Fundamental Spread, this means the credit rating must reflect the risk retained by the insurer. One key characteristic of illiquid assets is that they are not usually externally rated. Instead, Solvency II permits insurers to use internal ratings to determine the Fundamental Spread. Since illiquid assets will often not have market valuations, insurers will often also base the asset valuation on the internal rating by mapping to equivalent traded assets of the same rating. The internal rating may therefore drive both determinants of the Matching Adjustment: the spread over risk-free rates and the Fundamental Spread. Getting it right is important! The PRA set out its views on this subject in a supervisory statement (SS 3/17) last year. 10  We said that  internal ratings must lie within a plausible range of the ratings that would be given by external rating agencies. Individual ratings may vary, depending on credit judgements, but there should be no overall upward bias in internal compared to external ratings. Supervisors are reviewing insurers’ internal ratings and may seek greater assurance where assets have spreads that look large for the rating, leading to a large matching adjustment in absolute or relative terms. We will also consider the complexity of the assets and their materiality to the overall solvency position of the insurer.