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The LVTS (introduced in 1999) electronic, real-time net settlement network designed to provide immediate finality and settlement to time-critical transactions LVTS participants know in real time their large-value, wholesale transactions (over $50,000). Transactions account for < 1% of the total number of transactions They make up 94% of the value of transactions in Canada
Copyright 2011 Pearson Canada Inc. 17 - 1 Chapter 17 Tools of Monetary Policy Copyright 2011 Pearson Canada Inc. 17 - 2 The Large Value Transfer System (LVTS) I • The LVTS (introduced in 1999) – electronic, real-time net settlement network – designed to provide immediate finality and settlement to time-critical transactions • LVTS participants know in real time their large- value, wholesale transactions (over $50,000). • Transactions account for < 1% of the total number of transactions • They make up 94% of the value of transactions in Canada Copyright 2011 Pearson Canada Inc. 17 - 3 The Large Value Transfer System (LVTS) II • The LVTS uses multilateral netting — only the net credit or debit position of each participant vis-à-vis all other participants is calculated for settlement Copyright 2011 Pearson Canada Inc. 17 - 4 Systemic Risk • The LVTS has been put in place to eliminate systemic risk. In fact, participants can make a payment only if: • they have positive settlement balances in their accounts with the Bank of Canada, • posted collateral (such as T-bills and bonds), or • explicit lines of credit with other LVTS participants Copyright 2011 Pearson Canada Inc. 17 - 5 Non-LVTS Transactions • These are non-LVTS (paper-based) payment items, such as cheques • These items are cleared through the Automated Clearing Settlement System (ACSS), an electronic payments system also operated by the CPA • The ACSS aggregates interbank payments and calculates the net amounts to be transferred from and to each participant's settlement account with the Bank of Canada • Direct Clearers are subset of LVTS participants who participate directly in the ACSS Copyright 2011 Pearson Canada Inc. 17 - 6 The Operating Band for the Overnight Interest Rate I • The interest rate at which participants borrow and lend overnight funds to each other is known as the overnight interest rate • The Bank of Canada implements monetary policy by changing the overnight interest rate. • Such changes influence other short-term interest rates and the exchange rate Copyright 2011 Pearson Canada Inc. 17 - 7 The Operating Band for the Overnight Interest Rate II • The Bank’s objective is to keep the overnight rate within a band of 50 basis points • Since December 2000, the Bank operates under a system of eight “fixed” dates throughout the year for announcing changes to the operating band Copyright 2011 Pearson Canada Inc. 17 - 8 The Operating Band for the Overnight Interest Rate III Copyright 2011 Pearson Canada Inc. 17 - 9 The Bank’s Standing Liquidity Facilities I • At the end of each day, each LVTS participant must bring its settlement balance with the Bank close to zero. • The Bank therefore stands ready (standing facilities) to provide or absorb liquidity with an overnight duration to participants facing unforeseen liquidity shocks. Copyright 2011 Pearson Canada Inc. 17 - 10 The Bank’s Standing Liquidity Facilities II • The initiative is on the side of the LVTS participant. A participant may use the Bank’s lending facility to obtain (against eligible collateral) overnight liquidity in case of a shortage, or it may use the deposit facility to make deposits in case of excess liquidity. [...]... rate • The level of short term interest rates and the exchange rate of the Canadian dollar determine the monetary conditions in which the economy operates How Monetary Policy Affects the Economy III How Monetary Policy Affects the Economy IV Nominal Interest Rates and Monetary Policy • Bank of Canada uses nominal overnight interest rate as operating instrument • Effects on the monetary policy on economic... Channel/Corridor System for the Overnight Rate • In terms of Figure 17-2, the equilibrium interest rate will always be within the operating band • The system enables the Bank to keep the overnight interest rate in the narrow channel/corridor with an upper limit of ib and a lower limit of ib- 0.50 How Monetary Policy Affects the Economy I How Monetary Policy Affects the Economy II • Changes in the overnight... Level of Settlement Balances Receiver General Auctions I • Bank of Canada neutralizes public auctions of Receiver General balances • E.g net government receipt of $100 Bank of Canada Assets Liabilities Government Deposits -100 Settlement Balances +100 LVTS Participants Assets Liabilities Settlement Balances -100 Government Deposits +100 Receiver General Auctions II Net disbursement of $ 100 Bank of Canada... Liabilities SPRAs +100 The Mechanics of a Special PRA Operation The Bank’s Use of SRAs to Reinforce the Target ior, I 1 If overnight funds are traded at a rate below the target ior, the Bank enters into SRAs at a price that works out to the target ior 2 Hence, SRAs relieve undesired downward pressure on ior The Bank’s Use of SRAs to Reinforce the Target ior , II Assets Assets Bank of Canada Liabilities Settlement... Primary Dealers Government Securities +100 Liabilities Settlement Balances -100 Advantages of SPRAs and SRAs 1 Bank of Canada has complete control over their volume 2 Are flexible and precise 3 Are easily reversed 4 Can be implemented quickly Settlement Balances Management • Bank of Canada also targets the level of settlement balances in the system • Typically, target level is announced the previous... short and longterm real interest rates under assumption of sticky prices Open Market Operations I • Open market operations relate to the Bank of Canada selling/buying government bonds • Open market purchases expand bank reserves and the monetary base, lowering interest rates and raising the money supply • Open market sales reduce bank reserves and the monetary base, increasing interest rates and reducing... Six and the major investment dealers The Bank’s Use of SPRAs to Reinforce the Target ior I 1 If overnight funds are traded at a rate higher than the target ior, the Bank enters into SPRAs at a price that works out to the target ior 2 Hence, SPRAs relieve undesired upward pressure on ior The Bank’s Use of SPRAs to Reinforce the Target ior,II Bank of Canada Assets Liabilities SPRAs +100 Settlement Balances...The Bank of Canada and the Operating band • If the overnight rate increases toward the upper limit of the operating band, then the Bank will lend at the bank rate to put a ceiling on the overnight rate • If the overnight rate falls toward the lower limit of the operating band, then the Bank will accept deposits from LVTS participants... bank rate less 50 basis points – putting a floor on the overnight rate The Bank of Canada and the Operating band • If the overnight rate increases toward the upper limit of the operating band, then the Bank will lend at the bank rate to put a ceiling on the overnight rate • If the overnight rate falls toward the lower limit of the operating band, then the Bank will accept deposits from LVTS participants... the Overnight Rate Demand for Reserves • Demand Curve – As the overnight interest rate decreases the opportunity cost of holding desired reserves falls and ceteris paribus, the quantity of reserves demanded rises – Rd slopes downward Supply Curve for Reserves • Supply Curve – quantity of reserves supplied is infinitely elastic at ib – Also flat at ib -0.50 because banks would not ledn in the overnight