Norges Bank requires collateral for all lending to banks. Collateral is provided in the form of securities which are pledged to Norges Bank. The list of eligible securities was changed in 2005. The aim of the changes has been to reduce Norges Bank's risk while ensuring that the borrowing facilities available to banks remain sufficient for payments to be settled and monetary policy to be implemented effectively. This article presents the changes that have been made and analyses the effects on Norges Bank's risk and banks' borrowing facilities. We conclude that the changes in the rules have indeed reduced Norges Bank's risk, and that the rules still provide for adequate borrowing facilities.
Banks can raise loans from Norges Bank against collateral in the form of securities. These loans are to help ensure that banks have sufficient liquidity for payments to be settled and monetary policy to be implemented effectively (see Box 1). Norges Bank seeks to avoid losses on its loans to banks and therefore requires that they are collateralised. (2) The collateral must meet various requirements. The collateral may be realised if a bank defaults on its obligations to Norges Bank or is placed under public administration. A bank's borrowing facilities correspond to the market value of the securities pledged less haircuts for various types of risk.
When the requirement of full collateralisation of loans from Norges Bank was introduced in 1999, Norges Bank accepted a wider range of securities than is usual for a central bank. This was due, in part, to few government bonds being issued in Norway. Internationally, government bonds are the most common form of collateral for loans from central banks. Relatively liberal rules on eligible collateral were necessary to ensure that banks had sufficient borrowing facilities. Parts of this eligible collateral entailed a degree of risk for Norges Bank.
In 2005, Norges Bank found that conditions were right for the rules to be amended so that this risk could be reduced. There were several reasons for this. First, banks" borrowing facilities had grown relative to their borrowing requirements. Second, the Financial Collateral Act of 2004 provided for immediate realisation of collateral, allowing banks' borrowing facilities to be calculated on the basis of market value rather than nominal value. The use of market value to calculate borrowing facilities reduced Norges Bank's risk and paved the way for lower haircut rates. For a given volume of pledged securities, reduced haircuts mean increased borrowing facilities. Third, there was reason to believe that banks would gradually begin to use new covered bonds as collateral at Norges Bank.
Box 1. Norges Bank's lending facilities Norges Bank's lending facilities are important instruments in the implementation of its liquidity policy. First, they are to help adjust the supply of liquidity so that Norges Bank's interest rate decisions influence market interest rates. Through auctions of fixed-rate loans (F-loans), Norges Bank ensures that banks have sufficient liquidity to maintain suitably large deposits in the central bank. This means that short-term money market rates remain just above the key policy rate (the sight deposit rate), which is the interest on banks' deposits at Norges Bank. Second, the lending facilities are to help ensure that banks have sufficient liquidity for smooth settlement of payments. Banks settle their dues by transferring funds between their accounts at Norges Bank. If a bank has insufficient deposits in its account to settle a payment, it can use Norges Bank's D-loan facility. (1) This serves as an overdraft facility. Intraday loans are interest-free, while overnight loans attract a rate of interest which is 1 percentage point higher than the key policy rate. As a result, banks normally make sure that they repay D-loans before the end of the day, often with funds borrowed from other banks. F-loans and D-loans are Norges Bank's ordinary lending facilities. The central bank can also issue loans on special terms (S-loans) to a bank running into acute liquidity problems. No such loans have been issued since the banking crisis of the early 1990s. (2) (1) For further information on F-loans and D-loans, see Fidjestol, A.: "The central bank's liquidity policy in an oil economy", Economic Bulletin 4/07, Norges Bank, and "Norske finansmarkeder--pengepolitikk og finansiell stabilitet" [Norwegian financial markets--monetary policy and financial stability], Occasional Papers 34, Norges Bank, 2004. (2) For further information on S-loans, see pp. 36-37 of Financial Stability 2/04, Norges Bank. Some of the changes adopted in 2005 did not enter into force until 1 November 2007. We now have a basis for analysing the consequences of the changes in the rules for banks' borrowing facilities and Norges Bank's risk.
During the turmoil in global financial markets in 2007-08, banks in many countries borrowed more than usual from central banks. Demand for central bank liquidity increased because the markets for interbank lending functioned poorly. The turmoil was triggered by uncertainty about which banks might be hit by losses and liquidity problems as a result of difficulties in the US sub-prime mortgage market. Banks were uncertain about both their own and other banks' future liquidity. To reduce the risk, they therefore sought to limit their lending to other banks. It became harder than usual for banks to raise loans, and interest rates in these markets rose sharply. Many central banks therefore injected additional liquidity into the banking system through market operations and secured loans. Some central banks also extended the range of eligible collateral. Norges Bank ensured a sufficient supply of liquidity to the banking system through a slightly larger allotment of F-loans than usual. (3)
This article is organised as follows. Section 2 summarises the rules on collateral for loans from Norges Bank and compares them with the rules at other central banks. Section 3 looks at the size and composition of banks' borrowing facilities and how these have evolved over time. We also analyse the consequences for banks' borrowing facilities of the changes in the rules adopted two years ago, and the size of banks' borrowing facilities is compared with their need for credit when settling payments. Section 4 analyses changes in Norges Bank's risk, while Section 5 draws conclusions and looks to the future.
2 The rules and the changes in the rules
Norges Bank accepts many types of securities as collateral. When deciding which assets are eligible, importance is attached to three considerations. First, Norges Bank's risk is to be as small as possible. Even if a loan is collateralised, there will be a risk if the issuer of the pledged securities cannot fulfil his obligations, or if the securities are difficult to sell. Second, the rules should be designed in such a way that banks have sufficient borrowing facilities at Norges Bank. Third, there are operational considerations: the collateral should not necessitate a disproportionate amount of manual follow-up at Norges Bank. Box 2 presents the key features of the current rules.
Box 2. Main features of the rules (1) Norges Bank accepts securities issued by public and private issuers in Norway and abroad. Norges Bank also accepts units in funds registered with the Norwegian Central Securities Depository (VPS). Requirements for all securities Securities must not be subordinate to other debt or be linked to credit derivatives. They must have prices available and be registered with an approved securities depository. Securities must not be convertible, be linked to an index, or have a capped floating rate. A bank may not pledge securities issued by a company in the same group (excludes covered bonds). Requirements for securities issued by private Norwegian issuers Securities issued by private Norwegian issuers must have a minimum volume outstanding of NOK 300 million and be registered with an exchange or other approved marketplace. Securities issued by companies must also have a minimum credit rating of BBB--from Standard & Poor's or Baa3 from Moody's. An equivalent credit rating for the issuer may be accepted if the security itself is not rated. The proportion of securities issued by banks and bank-owned mortgage companies (bank quota) must be no more than 35 per cent of a bank's overall collateral. The bank quota does not include covered bonds. Requirements for securities funds Securities funds must be registered with VPS or be confined by their rules to investing in securities which are eligible under Norges...