Central Bank and Commercial Banks' Liquidity Management – What is the Relationship?

Abstract

The paper explores the relation between individual banks' liquidity management in the euro area and the ECB's management of the aggregate current accounts held by banks with the Eurosystem. It is argued that, in the case of the euro area with its large, remunerated reserve requirements that have to be fulfilled only on average over a one‐month period, the banks' demand for working balances to serve as a buffer against market imperfections is always below reserve requirements. It is therefore normally sufficient for the ECB when steering short‐term interest rates to control aggregate liquidity in a way that the aggregate banking system is in a position to fulfil adequately its reserve requirements. In particular, the ECB normally does not need to take care of any factors that affect temporarily the demand for working balances, such as the level and uncertainties of interbank payment flows. However, two exceptions are noteworthy and are discussed in the paper: the banks' balance sheet management activities implying a regular end of month peak of the EONIA rate; and the liquidity situation in the case of substantive market tensions as in the days following the terrorist attacks of 11 September 2001. The need of the ECB's liquidity management to address the associated deviations from a model of perfect markets is discussed.

Determinants of the EONIA Spread and the Financial Crisis

“…Volatility also tends to increase at the end of the month. This result is in accordance with previous studies and relates mainly to the increase in payments and activities of balance sheet management (Bindseil et al ., ; Wurtz, ; Moschitz, ; Benito et al ., ; Linzert and Schmidt, ). The effect of the maintenance period is captured in the mean at the beginning of the period, with a 2 b.p.…”

The eurosystem money market auctions: A banking perspective

“…In contrast, a bank that offers lines of credit and simultaneously provides payment system services to other smaller banks is more likely to need liquidity. For such a bank, a large liquidity buffer 1 See Bindseil et al (2003) for a broader discussion. 2 As Nyborg et al (2002) show, the interest rate in the interbank market is on average higher than the marginal rate at which liquidity is allotted in money market auctions.…”

Multiple equilibrium overnight rates in a dynamic interbank market game

“…Angelini (2002) and Bindseil, Weller and Wuertz (2002) for example Þnd that the EONIA rate is on average relatively high at the end of the month. However, all in all the martingale hypothesis seems to work quite well.…”