In a recent speech, Erik Thedéen, governor of the Sveriges Riksbank, discussed the challenges faced by the Riksbank and other central banks in designing their operational frameworks when normalizing their balance sheets and how this affects the Swedish banks.
For several years, the amount of central bank liquidity in several countries has been at or near record levels, due to monetary policy-driven asset purchases. But that is now changing.
At present, banks mainly choose to balance liquidity among themselves via unsecured overnight loans. “We expect the need for overnight loans to increase as central bank liquidity continues to decline,” Thedéen said.
Banks may then want some of the overnight loans to be collateralized. Liquidity smoothing can equally well be done through overnight repos or collateralised loans if the banks prefer. Regardless of which markets the banks prefer to use, the Riksbank’s policy rate, via the overnight rate, will serve as the anchor for Swedish money market rates.
The overnight market must function well enough to prevent and reduce the risk of liquidity disruptions in the banking system, while facilitating the mitigation of such disruptions when they do occur.
“The Riksbank is prepared to cooperate with market participants to help remove infrastructural barriers (e.g. last time of day for cleared repos) and promote a more liquid repo market and collateralized lending,” he said in the speech.