Collateral for loans from Norges Bank--consequences of changes in the rules.

Norges Bank requires collateral for all lending to banks. Collateral is provided in the form of securities which are pledged to Norges Bank. The list of eligible securities was changed in 2005. The aim of the changes has been to reduce Norges Bank's risk while ensuring that the borrowing facilities available to banks remain sufficient for payments to be settled and monetary policy to be implemented effectively. This article presents the changes that have been made and analyses the effects on Norges Bank's risk and banks' borrowing facilities. We conclude that the changes in the rules have indeed reduced Norges Bank's risk, and that the rules still provide for adequate borrowing facilities.

1 Introduction

Banks can raise loans from Norges Bank against collateral in the form of securities. These loans are to help ensure that banks have sufficient liquidity for payments to be settled and monetary policy to be implemented effectively (see Box 1). Norges Bank seeks to avoid losses on its loans to banks and therefore requires that they are collateralised. (2) The collateral must meet various requirements. The collateral may be realised if a bank defaults on its obligations to Norges Bank or is placed under public administration. A bank's borrowing facilities correspond to the market value of the securities pledged less haircuts for various types of risk.

When the requirement of full collateralisation of loans from Norges Bank was introduced in 1999, Norges Bank accepted a wider range of securities than is usual for a central bank. This was due, in part, to few government bonds being issued in Norway. Internationally, government bonds are the most common form of collateral for loans from central banks. Relatively liberal rules on eligible collateral were necessary to ensure that banks had sufficient borrowing facilities. Parts of this eligible collateral entailed a degree of risk for Norges Bank.

In 2005, Norges Bank found that conditions were right for the rules to be amended so that this risk could be reduced. There were several reasons for this. First, banks" borrowing facilities had grown relative to their borrowing requirements. Second, the Financial Collateral Act of 2004 provided for immediate realisation of collateral, allowing banks' borrowing facilities to be calculated on the basis of market value rather than nominal value. The use of market value to calculate borrowing facilities reduced Norges Bank's risk and paved the way for lower haircut rates. For a given volume of pledged securities, reduced haircuts mean increased borrowing facilities. Third, there was reason to believe that banks would gradually begin to use new covered bonds as collateral at Norges Bank.

 
Box 1. Norges Bank's lending 
facilities 
 
Norges Bank's lending facilities are important 
instruments in the implementation of its liquidity 
policy. First, they are to help adjust the supply 
of liquidity so that Norges Bank's interest 
rate decisions influence market interest rates. 
Through auctions of fixed-rate loans (F-loans), 
Norges Bank ensures that banks have sufficient 
liquidity to maintain suitably large deposits in the 
central bank. This means that short-term money 
market rates remain just above the key policy 
rate (the sight deposit rate), which is the interest 
on banks' deposits at Norges Bank. Second, the 
lending facilities are to help ensure that banks 
have sufficient liquidity for smooth settlement of 
payments. Banks settle their dues by transferring 
funds between their accounts at Norges Bank. If 
a bank has insufficient deposits in its account to 
settle a payment, it can use Norges Bank's D-loan 
facility. (1) This serves as an overdraft facility. 
Intraday loans are interest-free, while overnight 
loans attract a rate of interest which is 1 percentage 
point higher than the key policy rate. As a 
result, banks normally make sure that they repay 
D-loans before the end of the day, often with funds 
borrowed from other banks. 
 
F-loans and D-loans are Norges Bank's ordinary 
lending facilities. The central bank can also issue 
loans on special terms (S-loans) to a bank running 
into acute liquidity problems. No such loans have 
been issued since the banking crisis of the early 
1990s. (2) 
 
(1) For further information on F-loans and D-loans, see Fidjestol, A.: 
"The central bank's liquidity policy in an oil economy", Economic 
Bulletin 4/07, Norges Bank, and "Norske finansmarkeder--pengepolitikk 
og finansiell stabilitet" [Norwegian financial markets--monetary 
policy and financial stability], Occasional Papers 34, Norges Bank, 
2004. 
 
(2) For further information on S-loans, see pp. 36-37 of Financial 
Stability 2/04, Norges Bank. 

Some of the changes adopted in 2005 did not enter into force until 1 November 2007. We now have a basis for analysing the consequences of the changes in the rules for banks' borrowing facilities and Norges Bank's risk.