Bank of England Market Operations Guide: Our objectives

A summary of the Bank’s market operations

To deliver the Bank’s statutory responsibilities for monetary and financial stability we use our balance sheet to provide a range of facilities and operations, available on public, market-wide terms to eligible financial firms. These activities all involve the creation or management of central bank money.

Our sterling facilities start with Sterling Monetary Framework (SMF) operations in short-term sterling money markets. These include unsecured deposits and funding instruments, repo (repurchase) operations, and securities lending.

To support our objectives, we can provide longer term sterling liquidity, in the form of term funding. We can also create sterling to undertake asset purchases of high quality liquid assets, which can later be unwound via maturities and sales of those assets. We also provide a deposit facility for UK banks which face formal restrictions on engaging in interest-bearing activity. And, through our network of bilateral swap lines with other central banks, we can offer liquidity in certain non-sterling currencies.

Overview

Our mission is to promote the good of the people of the United Kingdom by maintaining monetary and financial stability. Parliament gives us statutory responsibility for this work.

This is part one of our Market Operations Guide. It explains how we use the assets and liabilities on our balance sheet to achieve our mission.

Part two of our guide gives more details of our individual operations, including who can apply to use them.

Using our balance sheet to support our mission

We are the UK’s central bank. Our balance sheet is special for one key reason – the nature of our liabilities. Central bank money, whether in the form of banknotes or central bank ‘reserves’ (deposits held with us by financial institutions), provides the ultimate means of settlement for all sterling payments in the economy.

This gives our balance sheet a central role in supporting monetary and financial stability.

Maintaining monetary stability

Our monetary policy objective is to maintain price stability in the UK. Subject to that, we support the Government’s economic policy, including its objectives on growth and employment.

We set monetary policy to achieve the Government’s target of keeping inflation at 2%. Our Monetary Policy Committee (MPC) decides what policy action we should take to reach that target.

To maintain monetary stability, we need to influence monetary conditions. This includes, for example, the level of prices of goods and services, and the availability of credit. The MPC can do this in two main ways. First, it sets Bank Rate (and takes steps to ensure it is passed through to households and businesses). Second, it can use asset purchases, also known as ‘quantitative easing’ (QE). Those asset purchases can also then be unwound, which is sometimes called ‘quantitative tightening’ (QT).

We apply Bank Rate to reserves balances held with us by eligible financial firms. The MPC usually sets Bank Rate eight times a year, and its level remains fixed between each MPC announcement.

Between 2009 and 2021, the MPC also used asset purchases or QE to help meet the inflation target. When we made new purchases, we created central bank money and used it to buy UK government debt (‘gilts’) and eligible corporate bonds from private investors in secondary markets. Those assets are held in the Asset Purchase Facility (APF).

Our stock of purchases includes assets in the form of government and corporate bonds with the aim of lowering the effective interest rates or ‘yields’ on those assets. This incentivises a re-balancing of investors’ funds into other types of riskier assets. That then in turn pushes down on the interest rates offered on loans, since rates on government bonds tend to affect other interest rates in the economy.

By holding these assets, we aimed to make it cheaper for households and businesses to borrow money, which encouraged spending. In addition, QE can stimulate the economy by boosting a wide range of financial asset prices.

In February 2022, the MPC decided to begin to reduce its stock of asset purchases by no longer reinvesting maturing government and corporate bonds, and by a programme of corporate bond sales. In August 2022, the MPC announced its intention to commence a programme of UK government bond sales, subject to economic and market conditions being judged appropriate at the time of a confirmatory vote. In September 2022, the MPC agreed to reduce its stock of UK government bond purchases, by an amount of £80 billion over the next twelve months, comprising both maturing gilts and gilt sales, to a total of £758 billion. As these maturities and sales of assets take place, we are repaid the central bank money created to purchase them and we remove it from the financial system. The effects on economic conditions will also be gradually reduced.

Maintaining financial stability

Our economy is only healthy if people have confidence in the institutions, markets and infrastructure which make up the UK’s financial system.

We work to maintain financial stability by protecting and enhancing the resilience of the system as a whole. And we supervise banks and insurers, to ensure that individual firms are run in a safe and sound way.

The Financial Policy Committee

Our Financial Policy Committee (FPC) oversees our work on financial stability. It identifies, monitors and takes action to remove or reduce systemic risks to the UK financial system. It also has a secondary objective to support the economic policy of the Government.

The Prudential Regulation Authority

Our Prudential Regulation Authority (PRA) is responsible for the prudential regulation of individual financial firms.^{footnote [1]} These rules require financial firms to hold sufficient financial resources, and have adequate risk controls in place. Close supervision of firms ensures that we have a comprehensive overview of their activities, so that we can step in if necessary.

Resolution

The Bank is the UK’s Resolution Authority and is responsible for the Resolution Liquidity Framework (RLF). This is a flexible tool which can be used in addition to the published facilities detailed in this guide. The RLF can be used to lend to banks, building societies or certain investment firms, where the entity or its holding company is in a Bank-led resolution.

Liquidity support

In addition to our policy, supervisory and resolution activities, we stand ready to use our balance sheet to provide liquidity support.

In normal times, firms typically rely on private markets to ensure that liquidity is distributed appropriately across the system, finding its way to those that need it. But those markets may not always be sufficient or work smoothly, particularly during periods of market volatility or dysfunction. And the cost of self-insuring against liquidity risks which are very low probability but high impact (‘tail’ risks) can be prohibitively high.

Our presence means firms know that, as long as they meet threshold conditions and have the right type and amount of collateral, they will have access to predictable and reliable sources of liquidity, at a predictable price, both on a day to day basis and when they experience or anticipate an interruption to private markets.

By offering these market-wide facilities, we aim to reduce the cost of disruption to critical financial services, including the liquidity and payment services that some participants provide to the broader economy.

How we implement monetary policy

The Bank’s balance sheet is used to implement the Monetary Policy Committee’s (MPC) decisions in order to meet the inflation target. Once the MPC makes a decision, the Bank’s Markets Directorate implements that policy. This section explains how we do that.

Bank Rate

The main way in which monetary policy is implemented is by applying interest, at Bank Rate, to deposits placed with us overnight by eligible firms in reserves accounts.

In turn, the level of Bank Rate is the key reference rate for all other sterling interest rates. Bank Rate (and expectations about the future level of Bank Rate) influences the interest rates that financial institutions pay to borrow from one another in wholesale money markets. And this in turn affects the rates paid more widely on commercial bank loans to, and deposits from, households and businesses.

Changes in longer-term interest rates can affect the price of bonds and other financial assets. And changes in domestic monetary conditions can also influence the exchange rate.

Taken together, all of these impacts on financial markets and associated changes in expectations affect spending decisions and inflationary pressures in the economy.

Purchasing assets – quantitative easing (QE)

Between 2009 and 2021, the MPC also used asset purchases to help meet the inflation target.

Central bank purchases of assets in the form of government and corporate bonds are intended to lower the effective interest rates or ‘yields’ on those assets. This pushes down on the interest rates offered on loans because rates on government bonds tend to influence other interest rates in the economy.

So, one of the ways in which QE worked is by making it cheaper for households and businesses to borrow money, encouraging spending.

Our purchases also incentivised investors that previously held the bonds we purchased to move their funds into other assets. This increase in demand for a broader range of financial assets tended to boost prices (and hence lower the yields) of those assets, which encourages spending.

Selling assets to unwind QE

In February 2022, the MPC decided to begin to reduce its stock of asset purchases by no longer reinvesting maturing government and corporate bonds, and by a programme of corporate bond sales. In August 2022, the MPC announced its intention to commence a UK government bond sales programme, subject to economic and market conditions being judged appropriate at the time of a confirmatory vote. In September 2022, the MPC agreed to reduce its stock of UK government bond purchases, by an amount of £80 billion over the next twelve months, comprising both maturing gilts and gilt sales, to a total of £758 billion. The corporate bond sales programme concluded in June 2023 and a small number of very short maturity bonds will continue be held in the portfolio until April 2024.

As set out by the MPC in August 2022, the strategy for asset sales is guided by a set of key principles; first, the MPC’s preference is to use Bank Rate as its active tool when adjusting the stance of monetary policy. Second, sales will be conducted so as not to disrupt the functioning of financial markets. Third, to help achieve this, sales will be conducted in a relatively gradual and predictable manner over a period of time. As maturities and sales take place, we remove the central bank reserves originally created to purchase them from the financial system. Further details on the programme of UK government bond sales has been set out in a Market Notice.

The role of term funding

In March 2020, the Bank’s policy committees announced a comprehensive package of measures to help UK businesses and households manage the economic disruption caused by the Covid-19 virus. Part of this package involved the launch of the Term Funding Scheme with additional incentives for Small- and Medium-sized Enterprises, or SMEs (TFSME).

When interest rates are low, it can be difficult for some banks and building societies to reduce deposit rates much further. This in turn can limit their ability to cut their lending rates. The TFSME is designed to manage this, by helping the pass through of reductions in Bank Rate to the real economy. In doing this, it:

• provides participants with a cost-effective source of funding, to support additional lending to the real economy;
• encourages these participants to provide credit to businesses and households to bridge through a period of economic disruption; and
• focuses on lending to SMEs, which can be affected the most when the supply of credit dries up.

The TFSME offers four-year funding with interest rates at, or very close to, Bank Rate, and the drawdown period ended in October 2021.

The TFSME is similar in calibration to the previous Term Funding Scheme (TFS) introduced in August 2016. The primary objective of the TFS was to reinforce the pass through of the cut in Bank Rate at that time, to the interest rates faced by households and companies in the wider economy. Like the TFSME, this allowed the reduction in already low interest rates to have broadly the same impact as cuts made when rates were further from zero.

The TFS closed to new lending in February 2018 and was fully repaid in February 2022, having made £127 billion of loans. Read more about it in Historic Facilities and Schemes on the Our tools page.

Further details on the monetary policy framework

Our Monetary Policy Committee (MPC) decided to start asset purchases (QE) in March 2009. This continued until December 2021 when gilt purchases ended, with a small programme of corporate bond reinvestments lasting until early 2022. The aggregate level of central bank reserves has been largely determined by the quantity of asset purchases, rather than the amount of reserves eligible financial firms would choose to deposit at the Bank to manage their day-to-day liquidity needs.

In the current environment with an ample supply of reserves, to ensure that short term wholesale money market interest rates remain around the level of Bank Rate, the MPC’s policy decision is implemented using a so-called ‘floor system’. This involves the Bank setting the rate of interest on reserves at Bank Rate (with one minor exception^{footnote [2]}). Further information on this is set out in an Explanatory Note.

Chart 1: The floor system under the current framework

This system keeps wholesale market interest rates close to Bank Rate. That happens because if rates fall significantly below Bank Rate, firms can theoretically borrow reserves cheaply in the market and earn Bank Rate by depositing them with us. In practice, because of the relative costs of borrowing in wholesale money markets, wholesale market rates have tended to settle a little below Bank Rate.

This system has proved successful in ensuring overnight rates in wholesale markets remain stable and close to Bank Rate. Overnight wholesale interest rates were closer to Bank Rate on average in the years following the introduction of the floor system than at any point in the preceding twenty years.

As described in part two of this guide, the Operational Standing Facility (OSF) exists to allow eligible firms to borrow overnight against high quality collateral at a spread of 25 basis points above Bank Rate. This facility is intended to limit the volatility in market interest rates by providing an alternative source of borrowing in case overnight market rates are significantly higher than Bank Rate. But, in practice, the OSF has rarely been used in the current environment of abundant reserves.

A further advantage of the floor system is that it can keep overnight interest rates close to Bank Rate despite large changes in the supply of, or demand for, reserves. This means it is robust to MPC decisions to increase or decrease the quantity of asset purchases.

The regime in place prior to the MPC launching its policy of QE, known as ‘reserves averaging’, was also successful at controlling interest rates when the stock of reserves was relatively stable. But it did not cope as well when demand for reserves spiked, so we injected large quantities of reserves for liquidity insurance purposes during the crisis.

The Bank’s balance sheet as QE unwinds

Just as asset purchases increased the quantity of central bank reserves following the financial crisis, the MPC’s decision in February 2022 to begin to reduce its stock of asset purchases by no longer reinvesting maturing government and corporate bonds, and by a programme of corporate bond sales leads to a reduction in the stock of assets previously purchased (so-called ‘Quantitative Tightening’). This lowers the aggregate quantity of reserves in the system. In August 2022, the MPC said it was provisionally minded to commence a programme of UK government bond sales shortly after its September policy meeting, subject to economic and market conditions being judged appropriate and to a confirmatory vote at that meeting. If it proceeds, this will further reduce the aggregate quantity of reserves in the system.

An Explanatory Note was published in August 2022 setting out some of the implications of the unwind of the APF for asset sales, control of short-term market interest rates and the Bank’s balance sheet.

In the early stages of QE unwind, while reserves are still plentiful, the MPC’s policy goals will continue to be met by maintaining the current floor system. But at some point, the supply of reserves could approach the minimum level needed by banks to meet their payment obligations and broader liquidity needs. This scarcity would likely begin to make short-term market rates more volatile, causing them to rise relative to Bank Rate. At this point, if the Bank did not make additional reserves available, the MPC’s decisions for Bank Rate may not be reflected in short-term interest rates.

Chart 2: Relationship between market rates and Bank Rate as reserves decline

In a Discussion Paper published in August 2018, we said that at the appropriate time we would propose to switch from using the current floor system to a framework in which we allowed reserves holders to determine how many reserves they need. Reserves scarcity is probably several years away, but banks’ overall demand for reserves is uncertain and will evolve over time. It is possible that reserves scarcity could arise much sooner than expected.

To ensure that control of short-term interest rates is maintained when that reserves scarcity is reached, the Bank announced in August 2022 a new open market operation, the Short-Term Repo (STR). This allows SMF participants to borrow an unlimited quantity of reserves at Bank Rate. More detail on the STR is included on the Our tools page.

As the level of reserves falls, SMF participants will be able to meet their demand for reserves at Bank Rate through use of the STR. For further reading on this, see our Explanatory Note.

Chart 3: Stylised Bank of England balance sheet during the APF unwind

This framework will also give the Bank the flexibility to expand or contract its balance sheet in the future if needed to achieve its objectives, while maintaining control of short-term interest rates.

The Bank’s future balance sheet

Under this new framework, the future steady state size of the Bank’s balance sheet will be determined not by the size of asset holdings, but by banks’ demand for reserves.

As reserves scarcity approaches the Bank will also need to consider the long-term mix of assets on its own balance sheet. A number of different options are possible, including shorter or longer-term repo operations or asset holdings. These options will require careful evaluation before a final decision can be made. It is likely to be some years before this decision needs to be finalised. But the Bank aims to reach a decision in close consultation with relevant market participants, well in advance.

Underpinning financial stability

Central bank reserves are the most liquid assets in the UK economy. They play a critical role in financial stability by facilitating payments and as part of a bank’s supply of sterling liquidity.

In normal times, private markets typically ensure that liquidity is distributed appropriately across the system, finding its way from those with a surplus to those that need it.

But those markets may not always be effective or work smoothly, particularly during periods of heightened uncertainty or market dysfunction.

Regulators require banks and other financial intermediaries to hold a ‘buffer’ of liquid assets to self-insure against any unexpected outflows. But the cost of self-insuring against ‘tail’ risks which are very low probability but high impact can be prohibitively high.

So, we stand ready to use our balance sheet to complement the self-insurance firms maintain under our liquidity regime.

We do this by offering a range of liquidity insurance facilities. These allow firms who meet our supervisory standards, and who have the right collateral, to access reliable supplies of liquidity at a predictable cost.

Firms can choose to use these liquidity insurance facilities on a day-to-day basis. But the pricing of those facilities means they are likely to be of particular benefit when an interruption to private markets occurs.

What is liquidity risk?

Liquidity risk is the risk that a company cannot meet its financial obligations as they fall due. All companies face this risk in some form and scale.

Banks and some other types of financial intermediary – by virtue of their business models – are exposed to a higher degree of liquidity risk than most types of company. Liquidity risk crystallising in a bank can also have wider impacts on customers and other institutions who find their own funds tied up. If liquidity risk crystallises in a number of financial intermediaries at the same time, this could endanger the stability of the financial system as a whole.

Liquidity risk can arise in the financial system a number of ways:

• Commercial banks and building societies engage in ‘maturity transformation’ by accepting short term deposits (eg liabilities in the form of money held in current accounts) and making loans at longer maturities (eg assets in the form of mortgages). This allows households and businesses to finance purchases and investment. But it also increases liquidity risk for the bank if there is unexpected demand for short term liabilities – for instance in the form of a bank ‘run’.
• Broker-dealers intermediate in capital markets and provide risk management products that help others to make more efficient use of their resources. Broker dealers are not exposed to the same ‘run’ as retail banks, but can find themselves facing volatile liquidity conditions in the repo (repurchase) markets from which they obtain funding.
• Central counterparties (CCPs) sit between counterparties to contracts traded in one or more financial markets, becoming the buyer to every seller and the seller to every buyer. By doing so, they can reduce credit and liquidity risk by netting off and simplifying multilateral financial exposures. CCPs seek to mitigate credit risk by collecting collateral, (‘margin’), from all counterparties (‘clearing members’). However, if a clearing member defaults, particularly when markets are volatile, there is a risk the CCP will face challenges in liquidating collateral quickly enough to meet its payment obligations. Equally, during such conditions (even absent a default), a CCP can collect greater than anticipated margin amounts that it will wish to deposit securely.
• International Central Securities Depositories (ICSDs) provide cross-border custodial and settlement services, covering the movement of cash and securities in multiple currencies between different institutions. To aid settlement, ICSDs provide intraday credit to some institutions, and therefore face liquidity risk if one of these firms then fails to meet its obligations. ICSDs hold collateral against these exposures, but there is a risk, particularly when markets are volatile, that they will face challenges in liquidating that collateral quickly enough to meet their payment obligations. Like CCPs, ICSDs also hold balances overnight which they may wish to deposit securely.

We expect firms to self-insure against liquidity risk

The first line of defence against liquidity risk is the buffers of assets that banks and other financial firms hold to absorb shocks or unexpected outflows.

We have set out (through the Prudential Regulation Authority (PRA)), the size and quality of buffers that regulated firms should build up to deliver a prudent level of self-insurance against a range of stressed outflows. Further information on our liquidity rules can be found on the Capital Requirements Directive page.

Changes to liquidity regulation introduced following the financial crisis mean UK banks are now much better placed to withstand liquidity risks. They hold large buffers of cash and liquid assets, calibrated against the Liquidity Coverage Ratio (LCR) but also taking into account longer term factors and idiosyncratic risks. In total, liquidity buffers are now worth a substantive proportion of the UK banks’ balance sheets.

At the same time, reliance on the riskiest forms of funding has also fallen sharply. The shortest duration wholesale funding, which was revealed to be a significant vulnerability when it dried up during the crisis, has fallen significantly as a proportion of total funding for UK banks.

But we also provide liquidity insurance

UK banks and other financial intermediaries are required by regulators to maintain strong liquidity. But it would not be realistic or efficient to expect them to self-insure against every conceivable shock or stress.

For that reason, we stand ready to use our balance sheet to complement the buffers firms maintain on their own balance sheets.

We do this by offering liquidity insurance facilities that allow eligible firms to borrow cash (in the form of reserves) or to swap illiquid assets for more liquid ones (a collateral ‘upgrade’).

We operate a range of published facilities that do this, on both bilateral and market-wide terms. These take place at various frequencies:

• At routine intervals. Firms have the opportunity to bid for reserves (borrow cash) in regular collateralised lending transactions called repo operations, run to a set schedule. For sterling, this is done via the regular Indexed Long-Term Repo (ILTR) facility. We also lend through repo operations in selected non-sterling currencies.
• On demand by firms. In our bilateral Discount Window Facility (DWF) we offer to swap less liquid collateral for more liquid assets. In some cases, these assets may take the form of central bank reserves. In others, they may take the form of securities, which can then be used as higher quality collateral to borrow cash in the wider market.
• At our discretion, as warranted by economic and market conditions. Depending on conditions in private markets, we can provide additional liquidity, by varying the terms of our regular routine operations, or by launching a Contingent Term Repo Facility (CTRF).
• We also make longer term funding available when required. We previously made term funding available through our Term Funding Scheme with additional incentives for SMEs (TFSME), Term Funding Scheme (TFS), Funding for Lending Scheme (FLS), and the Special Liquidity Scheme (SLS).

We do not expect firms to rely on us for a large part of their liquidity on a day-to-day basis. But our facilities are also not intended to be only a last resort. We have priced them so that in normal times they are, on the whole, unlikely to be cheaper than private markets.

We offer liquidity insurance options on an ‘open for business’ basis, to eligible financial firms which meet our prudential requirements. This means that firms know they will have access to a reliable source of liquidity at a predictable price during periods of actual or expected market stress.

And we convene markets to help ensure they function efficiently

We take an active interest in the effectiveness of financial markets. Markets are more likely to be efficient and effective if they are competitive. So we only allow firms access to our services if they act in a way that supports competitive and fair sterling markets.

An effective way to demonstrate commitment to this is to sign the UK Money Markets Code. We endorse it and commit to its standards and principles. We strongly encourage all participants in our financial market operations to do the same (including firms which are members of the Sterling Monetary Framework (SMF). Read more about our work on fair and effective markets.

We also provide a separate deposit facility on a non-interest-bearing basis

We recognise that some UK banks have formal restrictions on engaging in interest-bearing activity, leaving them with less flexibility in managing their liquidity, as they are unable to place deposits under the Sterling Monetary Framework. For these firms, we operate the Alternative Liquidity Facility (ALF), which enables them to hold a reserves-like asset using a segregated, non-interest-based model.

Liquidity insurance: ‘open for business’

The idea that the Bank should step in when private markets stutter is not new, originating from at least the time of Walter Bagehot^{footnote [3]}, who recognised how a clear framework for central bank involvement in markets could help to reduce the frequency and severity of financial crises.

Our current suite of shorter-term liquidity insurance facilities – encapsulated in our Sterling Monetary Framework (SMF) – is a more recent development, and is one element of a wider response to the last global financial crisis.

Since 2009 regulators in the UK and globally have introduced a complementary package of reforms. These were intended to fix the fault lines that caused the last crisis, and help end the problem of ‘too big to fail’.

These reforms are underpinned by stronger capital and liquidity standards and more proactive micro-prudential supervision; supplemented by macro-prudential tools to account for systemic risks; and supported by resolution regimes that protect financial stability – and public money – from the failure of an insolvent firm.

In the context of those reforms, and on the back of recommendations made by Bill Winters in his review of our system, we made significant changes to our approach to liquidity insurance. As a result, we now offer money and collateral over longer terms, against a wider range of assets as collateral, and at lower cost.

From a market perspective, eligible financial firms have more choice now than they did previously in being able to draw on support according to their needs and preferences:

• They can borrow against a wider range of collateral, including less liquid assets such as raw loans;
• They can borrow over a longer term, when we deem it appropriate; and
• They can borrow in certain non-sterling currencies.

The changes made since the Financial Crisis mean that the financial sector’s ability to continue supporting the economy in bad times as well as good is reinforced at three levels:

• First, by the large buffers of assets firms hold in case private markets cannot provide the liquidity they need (these have increased both at individual firm level and in aggregate);
• Then, by the Bank’s insurance facilities, provided firms are solvent and can meet prudent collateral requirements;
• And finally by resolution, so a firm is able to fail in an orderly way should a shock mean it cannot continue to operate.

To fully realise these financial stability benefits, firms must be willing to manage their liquidity actively and prudently. This guide is intended to support that by explaining the Bank’s facilities. But it also serves to reinforce a very important point: our facilities are there to be used by firms. We are open for business.

In summary, ‘open for business’ means that participant firms which meet regulatory threshold conditions for authorisation, and which have the appropriate type and amount of collateral, have the flexibility to use our facilities as and when they deem appropriate.

When and how to use market sources of funding, existing liquidity buffers, or the ILTR or DWF is a decision for firms to make, based on their expert knowledge of their own liquidity needs and the availability and cost of options.

Provided firms meet threshold conditions and have adequate collateral, they do not have to justify their decision to use these facilities to the Bank or to the PRA. There is no specific or limited list of cases in which firms may use our facilities. And, there is no fixed order in which we expect firms to use one form of liquidity over another.