Why the Marginal MRO Rate Exceeds the ECB Policy Rate?

Abstract

In the Eurosystem, banks' interest rate expectations should no longer have resulted in a non-zero tender spread, the difference between marginal and minimum price for liquidity, when the ECB reformed its operational framework for monetary policy implementation in March 2004 so that the policy rates remain constant within reserves maintenance periods. Yet, the tender spread was wider in 2005 than in any single year after 2000, when the ECB switched from fixed to variable rate tenders. Parts of the relevant literature have argued that because of the ECB's asymmetric preferences over deviations of the market rates up and down from the policy rate, the shortest euro interest rates persistently exceed the policy rate This paper argues, however, that when the central bank applies a quantity oriented liquidity policy, a positive tender spread may result from money market inefficiencies and banks' risk aversion even if the central bank preferences are symmetric and the markets do not anticipate any changes in the policy rates. In such a case, the driving force behind the tender spread is banks' uncertainty about their individual allotments at the marginal rate for the Eurosystem main refinancing operations (MROs). Furthermore, the allotment uncertainty is shown to be significantly related to the amount of liquidity supplied in each operation. Hence, the expansion in the MRO volumes experienced since 2002 may have had a major contribution to the emergence and observed growth of the tender spread.

What Explains the Spread between the Euro Overnight Rate and the ECB's Policy Rate?

“…Interestingly, this variable does not play a significant role under the old framework. The result could be brought in accordance with the model of Välimäki (2006) in the sense that allotment uncertainty as a crucial variable for the tender outcome is the necessary condition for the liquidity deficit being significant. Given the liquidity buffer banks had in the old framework period, allotment uncertainty may have existed but may have played a less important role for the bidding decision of banks.…”

“…The hypothesis by Välimäki (2006), which predicts that an increasing total liquidity deficit (d t ) exerts pressure on the spread, is supported by the results in the period of the new framework. This confirms the notion that the risk of receiving no liquidity in the tender is likely to increase as the banks' desired liquidity grows.…”

Liquidity Shocks in the Eurosystem Interbank Market

“…Depending on whether they constitute liquidity supply or draining, they take the form of either variable or fixed rate tenders. In variable rate tenders, the rate at which funds are supplied is typically higher than the minimum bid rate, which has been discussed in detail by Välimäki (2006). Liquidity draining operations are performed in the form of fixed rate tenders that efficiently anchor the rate at the target level.…”

Overnight interbank markets and the determination of the interbank rate: A selective survey

“…Larger borrowers may incur increased asset monitoring or recall costs, such as early sales of bills on the following day. Some banks may limit their exposure to interbank trading for capital adequacy reasons (Välimäki, 2006). Linzert and Schmidt (2011) argue that banks may be less willing to lend money in unsecured interbank trading at times of greater aggregate uncertainty.…”

“…Collateralisation costs are likely to include a fixed and a variable element, especially because the form of acceptable collateral will vary across lenders (Välimäki, 2006). Second are the costs of participation in the central bank repo auction.…”