1.2 Implementation of monetary policy in the euro area and Finland
The Bank of Finland is responsible for implementing the Eurosystem’s monetary policy in Finland. In 2019, several measures were adopted to ease the stance of the Eurosystem’s monetary policy. The European Central Bank lowered the deposit facility rate by 10 basis points, adjusted its forward guidance on interest rates, launched a third series of targeted longer-term refinancing operations, adopted a two-tiered deposit facility rate and recommenced net purchases under the asset purchase programme.
Implementing monetary policy means putting into action the monetary policy decisions taken by the ECB Governing Council. The Eurosystem uses two types of instruments to implement its monetary policy, standard and non-standard measures. Open market operations conducted as collateralised tender procedures, standing facilities, and a minimum reserve system comprise the Eurosystem’s standard monetary policy measures. These measures are primarily used to steer short-term interest rates.
Since the financial crisis, non-standard measures have also played a key role in monetary policy. These measures include the expanded asset purchase programme, targeted longer-term refinancing operations, forward guidance and a two-tier deposit facility rate.
Interest rate policy relaxed further; deposit facility rate at lowest level on record
In September 2019, the Governing Council of the European Central Bank (ECB) decided on a comprehensive package of monetary policy stimulus measures. Regarding its standard instruments, the Governing Council decided to lower the interest rate on the ECB deposit facility by 10 basis points, to -0.5%. This was the first time the Governing Council had decided to change the key ECB interest rates since 2016. The interest rate on the Eurosystem's deposit facility is now at its lowest level on record.
The Governing Council has emphasised that the key ECB interest rates, including the deposit facility rate, may be lowered further, as appropriate. In 2019, the interest rate on the main refinancing operations and the rate on the marginal lending facility each remained unchanged, at 0.00% and 0.25%, respectively.
The Governing Council’s decision to lower the deposit facility rate passed through effectively to short-term money market rates. Because of the abundance of excess liquidity in the Eurosystem, short-term money market rates closely tracked the interest rate on the ECB's deposit facility.
The Eonia and €STR benchmark interest rates fluctuated in a narrow range, averaging -0.46% and -0.54%, respectively after the deposit facility rate was lowered. The lower deposit facility rate was also reflected in the Euribor rates, with the 3-month and 12-month Euribors averaging -0.40% and -0.28%, respectively, at the end of 2019 (Chart 1).
Non-standard measures also deployed to further ease monetary policy
The stimulus measures announced in September largely comprised non-standard measures of monetary policy. Regarding these instruments, the Governing Council decided to restart net purchases under the asset purchase programme as from November, adopt a two-tier system for reserve remuneration and adjust its forward guidance on interest rates.
In addition, the Governing Council decided to ease the modalities of the new series of targeted longer-term refinancing operations (TLTRO III) announced in March. The maturity of the operations was extended from two years to three, their interest rate was lowered by ten basis points, and an early repayment option was added beginning no sooner than two years after settlement.
Third series of targeted longer-term refinancing operations
TLTRO III began in September 2019 and will comprise a total of seven quarterly refinancing operations. The last operation will be conducted in March 2021. Under these operations, monetary policy counterparties to the Eurosystem's national central banks may apply for 3-year loans against eligible collateral. These loans will thus mature at quarterly intervals beginning from September 2022 and ending in March 2024.
In principle, the interest rate for each operation is based on the average rate applied to the Eurosystem’s main refinancing operations (MROs) over the life of the respective TLTRO. However, the rate applied to TLTRO III operations will be lower for counterparties whose net lending has exceed their benchmark net lending, and can be as low as the average interest rate on the deposit facility prevailing over the life of the respective operation.
The first two TLTRO III operations were conducted in September and December of 2019. In the September operation, a total of 28 Eurosystem counterparty banks or banking groups received loans, while the December operation saw 122 participants. A total of EUR 3.4 billion was sought from the September operation, while the volume for the operation in December stood at EUR 97.7 billion. Some of the Bank of Finland’s monetary policy counterparties participated in the December operation.
Outstanding amount of longer-term refinancing contracted slightly
In 2019, early repayments of TLTRO II loans came to EUR 208.1 billion across the entire Eurosystem. Consequently, the outstanding amount of TLTRO II funds fell to EUR 510.8 billion. Together, the outstanding amount of TLTRO II and III loans declined from EUR 718.8 billion to 611.9 billion during 2019.
Outstanding TLTRO II funds will begin to mature as of June 2020, with the last operation maturing in March 2021.
Demand for regular refinancing operations still muted
Regarding its standard monetary policy measures, the Eurosystem continued to conduct its main refinancing operations (MROs) and 3-month longer-term refinancing operations as fixed-rate tender procedures with full allotment.
Outstanding 1-week MRO volumes stood at about EUR 4.4 billion, on average, in 2019, up from an average of about EUR 3.6 billion in 2018. By contrast, 3-month longer-term refinancing operations, which are conducted each month, declined on the previous year. These operations provided new liquidity of about EUR 3.4 billion, on average, in 2019, compared with some EUR 6.3 billion in 2018.
In sum, the outstanding amount of the Eurosystem's regular refinancing operations declined to some EUR 7.8 billion in 2019, compared with about EUR 9.9 billion in 2018. As in 2018, only a small number of counterparties participated in these operations.
The Eurosystem continued to conduct 1-week dollar-denominated refinancing operations in 2019, with their liquidity ranging from nil to about USD 3.7 billion and averaging USD 0.3 billion per operation (Chart 2).
Excess liquidity still abundant
Excess liquidity refers to deposits made by banks to their central bank current account in excess of the minimum reserve requirement. In 2019 the volume of excess liquidity in the euro area banking system declined by about EUR 74.3 billion, down to EUR 1,785.9 billion. Among other factors, this was due the contraction of outstanding TLTRO loans. However, despite being slightly lower than in 2018, the overall volume of excess liquidity remained abundant.
The abundance of excess liquidity in the banking system explains why regular refinancing operations have seen such little demand. Because of the liquidity surplus, few counterparties need to turn to regular refinancing operations for finance (Chart 3).
Eurosystem adopts two-tier system for reserve remuneration
As from 30 October 2019 the Eurosystem introduced a two-tier system for reserve remuneration. Under the new arrangement, banks’ current account holdings that exceed the minimum reserve requirement (i.e. excess reserves) are divided into two tiers.
The first, or exempt tier, is in volume terms six times a bank's minimum reserve requirement. The exempt tier is remunerated at an annual rate of 0%. Reserves that exceed this threshold fall into the non-exempt tier, which will continue to be subject to the ECB's deposit facility rate for as long as it is negative. The two-tier system does not apply to overnight deposits held with the Eurosystem’s deposit facility. The ECB Governing Council has announced that it may change the details of the system as needed.
The aim of the system is to support the bank-based transmission of monetary policy by lowering the costs to banks from negative interest rates. Because the interest rate on the deposit facility is negative, banks have to pay for holding excess reserves and overnight deposits with the Eurosystem.
The minimum reserve requirements of euro area banks amounted to about EUR 134.1 billion and EUR 134.5 billion in the seventh and eighth maintenance periods of 2019, respectively. Minimum reserves were remunerated at the MRO interest rate, at 0% in 2019. The newly introduced exempt tiers stood at about EUR 804.6 billion and EUR 807 billion in the seventh and eighth maintenance periods, respectively. Banks made almost full use of their exempt tiers.
Strict eligibility criteria for monetary policy counterparties
The Bank of Finland’s circle of monetary policy counterparties remained unchanged in 2019. At the end of the year, the Bank of Finland had a total of 16 counterparties, comprising both Finnish credit institutions and branches of Nordic banks operating in Finland.
Strict eligibility criteria are applied to counterparties to the Eurosystem's monetary policy operations. These credit institutions must be financially sound and are subject to a minimum reserve requirement and financial supervision.
Monetary policy counterparties have the right to seek funding against eligible collateral by participating in the Eurosystem's liquidity operations. Counterparties may also apply for overnight liquidity against eligible collateral through the marginal lending facility, which has to be settled the following business day. In addition, intraday credit to guarantee smooth payment flows may be sought against collateral.
The Eurosystem has specified eligibility criteria for assets that can be put up as collateral towards central bank funding. These criteria are outlined in the ECB's guidelines and are the same for the entire euro area. The Bank of Finland has supplemented these guidelines with additional domestic requirements for its own counterparties. The Bank of Finland last updated its provisions and guidelines in August 2019.
Collateral deposited with the Eurosystem declined slightly
In 2019, the volume of collateral deposited with the Eurosystem contracted only slightly compared with 2018 (Chart 4). Eurosystem national central banks held a total average of EUR 1,562 billion in collateral in 2019, compared with an average of EUR 1,594 billion in 2018.
Similarly, there was little change in the distribution of collateral by asset class, with only covered bank bonds increasing relative to 2018. Together with credit claims, covered bank bonds were in fact the largest asset class put up in 2019, with each comprising 24% of all delivered collateral. Credit claims are loans that banks have issued to their clients and are categorised as non-marketable assets in the collateral framework. The third largest asset class put up as collateral were asset-backed securities, at 23%.
Liquidity position of Bank of Finland counterparties remained solid
In 2019, the Bank of Finland’s counterparties deposited EUR 17.2 billion in collateral with the central bank, on average, compared with EUR 19.6 billion in 2018.
The Bank of Finland counterparties continue to favour covered bank bonds as collateral, comprising on average 38% of all collateral put up in 2019 (Chart 5). The second and third largest asset classes were credit claims and securities issued by central and regional government, at 29% and 18%, respectively.
The volume of funding sought by Bank of Finland counterparties through the Eurosystem's refinancing operations almost halved in 2019. Consequently, the average volume of excess collateral delivered by counterparties reached 41% in 2019, up from 27% in 2018.
Voluntary early repayments of TLTRO II continued in 2019. Bank of Finland counterparties paid back EUR 6.1 billion worth of these loans in 2019. In contrast, new funding sought from TLTRO III operations stood at EUR 2.1 billion.
At the end of 2019, Bank of Finland counterparties held EUR 4.6 billion in targeted longer-term refinancing loans (TLTRO II and III volumes). In 2018, the equivalent figure was EUR 8.6 billion. In addition to this, counterparties made use of intraday credit.
Volume of central bank deposits remained unchanged
As in previous years, Bank of Finland counterparties held a substantial amount of deposits with the Bank of Finland, averaging EUR 96.4 billion (Chart 6).
Excess liquidity, i.e. banks’ deposits with the Bank of Finland in excess of their minimum reserves, remained unchanged in 2019, at about EUR 93.4 billion on average. Similarly, the Bank of Finland's share of excess central bank deposits within the Eurosystem as a whole remained unchanged in 2019, at about 5% on average.
Finnish banks made almost full use of their exempt tiers under the new two-tier system for reserve remuneration. Overnight deposits contracted by 21% in volume. During the last maintenance period of 2019, EUR 21.9 billion of deposits were remunerated at 0% and EUR 73.0 billion at a negative interest rate.