Monetary policy instruments

Money market operations play an important role in the Eurosystem's monetary policy. They are used to steer the money market interest rates, manage free liquidity as well as to signal the ECB's monetary policy stance. Open market operations are usually executed by the national central banks and initiated by the ECB.

The Eurosystem can conduct four types of market operations providing euro liquidity to counterparties in exchange for eligible and clearly defined collateral securities:

Monetary operations of the Eurosystem are usually decentralised. That means that the Board of the ECB takes decisions concerning monetary policy operations, whereas the central banks of the Eurosystem implement those decisions in practice.

Main refinancing operations are weekly liquidity-providing operations executed through fixed and variable rate tenders. Usually, the maturity of those operations is one week. At fixed rate tenders, the interest rate on the central bank money is specified in advance in accordance with the monetary policy stance. Variable rate tenders are organised based on a minimum bid rate serving as the lowest limit for the price of the central bank money. 

Longer-term refinancing operations are liquidity-providing operations conducted on a monthly basis. Usually, their maturity is 3 months and banks have the opportunity to satisfy their longer-term liquidity needs.

The Eurosystem may also conduct non-standard longer-term refinancing operations with a maturity over 3 months. These operations are aimed at providing market participants with long-term resources, but there may be also other monetary policy related goals. On 7 March 2019, the Governing Council of the ECB decided to launch new targeted longer-term refinancing operations (TLTRO-III) with a maturity of two years from September 2019 onwards on a quarterly basis until March 2021. These operations will boost lending as, under TLTRO-III, banks are entitled to borrow up to 30% of their loan portfolios.

Fine-tuning operations are conducted in specific cases to manage the liquidity situation in the market and to steer interest rates, in particular in order to smooth the effects on interest rates caused by unexpected liquidity fluctuations in the market. In addition to providing additional liquidity, fine-tuning operations can be also used to attract term deposits from credit institutions. Most fine-tuning operations are conducted on the last days of reserve maintenance periods. Fine-tuning operations are normally executed by the national central banks through quick tenders or bilateral procedures. The Governing Council of the ECB can decide, under exceptional circumstances, to have bilateral fine-tuning operations executed by the ECB.

Longer-term structural operations can be conducted when it is necessary to adjust the structural liquidity position of the Eurosystem vis-á-vis the financial sector. Issuance of debt instruments or sales and purchase of securities can be used for this purpose.

Overview of the types of open market operations used by the Eurosystem

Standing facilities are aimed at steering the overnight money market rates and signalling the general stance of monetary policy. Two standing facilities are available to counterparties at their own initiative: the marginal lending facility (a euro loan from the respective national central bank in exchange for eligible collateral securities) or the deposit facility (an overnight euro deposit with the respective national central bank).

The standing facilities enable the counterparties to smooth the daily liquidity fluctuations. Considering the movements of the balance sheet items that are not directly affected by the monetary policy, it is impossible to provide an accurate amount of money through open market operations which would satisfy the overall minimum reserve requirements. Moreover, every working day the demand for central bank money depends on the ability of money market participants to distribute the liquidity among themselves.

The interest rate on the marginal lending facility usually provides a ceiling for the overnight market interest rate. Counterparties can use the deposit facility to make overnight deposits with national central banks. Under normal circumstances, the interest rate on the deposit facility provides a floor for the overnight market interest rate. Thus the interest rates on the standing facilities usually form a corridor for the interbank overnight rate, limiting the fluctuations.

Table 2. Overview of the types of standing facilities used by the Eurosystem

Reserve ratio is used to stabilise short-term money market interest rates and create (or change) a structural liquidity shortage, thereby also influencing the credit institutions' demand for the central bank money.

The Eurosystem's minimum reserve system primarily pursues monetary functions: stabilisation of the money market interest rates and enlarging a structural liquidity shortage. According to the ECB regulation, all credit institutions are required to hold a certain amount of minimum reserves with their national central banks. The credit institutions' holdings of required reserves are remunerated at the rate of the Eurosystem's main refinancing operations.

Euro area credit institutions are required to hold liquidity in the amount of 1% of their collected non-bank deposits with their national central banks. Normally, credit institutions also hold a small amount of excess reserves with their central banks, which may grow significantly in periods of financial market tensions.

Minimum reserves are one of the instruments of ECB operational framework for monetary policy, which is designed primarily to stabilize money market interest rates and to create or enlarge structural liquidity shortage.

ECB requires all credit institutions and credit unions established in the euro area to hold compulsory minimum reserves on accounts with the National Central banks (NCBs).

The reserve requirement of each individual institution is calculated by applying the corresponding ECB reserve ratio to the amount of deposits and other liabilities, included in the reserve base.

Credit institution or credit union fulfils reserve requirements if the average end-of-day balance on its reserve account with the NCB is not less than reserve requirement for the given reserve maintenance period.

The remuneration of the minimum reserve holdings is calculated, using the Eurosystem marginal rate of the main refinancing operations for the given period.

In case of non-compliance, NCB imposes penalty, which is calculated using the marginal lending facility rate of the Eurosystem and the daily average amount of the non-compliance.

Related links:

Legal framework for minimum reserves

General documentation on Eurosystem monetary policy instruments and procedures

Key ECB interest rates

List of MFI subject to minimum reserves

Reserve ratio

Indicative calendar of reserve maintenance periods

Statistics on minimum reserves

The asset purchase programme (APP) was launched in March 2015, and the period of net asset purchases ended in December 2018. The APP comprised the third covered bond purchase programme, the asset-backed securities purchase programme, the public sector purchase programme and the corporate sector purchase programme. All countries participated in the expanded asset purchase programme, albeit not in all sub-programmes. The public sector purchase programme was the largest programme (and the only one) in which Latvia participated. Security purchases under this programme were allocated across countries based on the ECB's capital key.

New net purchases have been discontinued as of 2019, but principal payments from maturing securities are reinvested by the national central banks holding the particular securities. The coupon or interest payments are not reinvested. The Eurosystem members will try to distribute reinvestment amounts for the PSPP across the months, so that to enable regular and balanced market presence.

Lending of Latvijas Banka holdings purchased under the PSPP and PEPP

The securities purchased under the Public Sector Purchase Programme (PSPP) and Pandemic emergency purchase programme (PEPP) should be made available for lending in a decentralised manner. The aim of securities lending is to support bond and repo market liquidity without disrupting normal repo market activity.

Latvijas Banka makes its holdings in the PSPP and PEPP available for securities lending by participating in the strategic lending facility (ASLplus) and Automated Securities Lending (ASL) programme of Clearstream Banking Luxembourg (CBL) for purposes of mitigating settlement fails.

Currently Latvijas Banka makes the following bonds, which were bought under the PSPP and PEPP, available for securities lending via the ASLplus and ASL programme of CBL