Use of liquidity and interest rates for overnight loans: An example of an oversight indicator

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1 Use of liquidity and interest rates for overnight loans: An example of an oversight indicator Bank of Finland PSS Seminar, 26 August 2011 Tatu Laine and Heli Snellman Laine & Snellman

2 Disclaimer The opinions expressed are those of the authors and do not necessarily reflect the views of the Bank of Finland. Furthermore, this presentation is based on a preliminary draft paper. Please contact the authors before referring to the text or presentation. 2

3 Contents Background Findings Liquidity Interest rates on overnight loans Indicator, the Grid Baseline Time behavior Next steps Conclusions 3

4 Background Real-time information from payment system data Utilising data on TARGET2 transactions Oversight to be more quantitative Support for financial stability analysis Aim: easy-to-use tool for every day oversight work 4

5 Idea Two independent sources of information Liquidity usage Central bank sees from TARGET2 data Interest rates paid for overnight loans Banks price overnight loans to other banks Central bank can trace back these transactions from TARGET2 data How to combine these two pieces of information? Inspired by the ideas presented by DnB in simulator seminar

6 Liquidity usage by TARGET2-Suomen Pankki participants 6

7 Algorithm to trace back overnight loans from TARGET2-Suomen Pankki data Furfine (1999) Assumptions in this study: Only overnight loans Borrowing on day t and refunding (principal and interest rate in the same transaction) on day t+1 Transactions over EUR (10 000, , etc.) Result: FEONIA very close to EONIA 7

8 Interest rates on overnight loans EONIA = blue FEONIA = red 8

9 Spread between minimum and maximum of the difference curves (EONIA - interest rate paid by each participant for overnight credit) 50% of observations are concentrated in the dark area 9

10 Indicator Need to combine information on liquidity usage and interest rates paid for overnight loans Firstly, we analysed average figures over five years the baseline Secondly, we selected the two most interesting participants Thirdly, we analysed the behavior of these two participants over time Next two slides show these steps 10

11 Indicator: The Grid 11

12 Behavior of two banks over time A=normal B=pre-crisis C=acute crisis D=post-acute crisis 12

13 Next steps How to calibrate the Grid? How to identify all significant behavior changes? How to do this in real time? support for financial stability analysis 13

14 Conclusions The Grid combines liquidity usage and interest rates on overnight loans The Grid reveals differences between participants during abnormal times = lack of confidence between banks Banks paid lower interest rates for overnight loans in Finland The Grid is found to be a useful tool for overseers to support financial stability analysis 14

15 15

16 Borrowing and refunding volumes of overnight loans over the business day 16

of Payment Systems Case: Bank of Finland 8th Payment and Settlement System Simulation Seminar and Workshop 26-27 August, 2010

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