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UK base rates and Fed funds rates

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TheMotorcycleBoy
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UK base rates and Fed funds rates

#303614

Postby TheMotorcycleBoy » April 27th, 2020, 3:05 pm

Hi,

Just lately I've been trying to research the subject of yield curves and periodically hit upon the concept of "base rates". What I can't quite figure out is what does the Bank of England's base rate (currently at 0.1%) really mean?

Does it mean this is the rate which the BoE will lend to our commercial banks (and similarly the rate it gives to savings held there) or is it just the minimum (and enforced by law) rate which *any* lender in the economy is permitted to lend at?

Secondly, would I be correct in saying that "Fed funds rate" is actually different:

https://www.global-rates.com/interest-r ... -rate.aspx

The description from the above link actually seems a bit vague:

Federal funds rate
When reference is made to the US interest rate this often refers to the Federal Funds Rate. The Federal Funds Rate is the interest rate which banks charge one another for 1 day (overnight) lending. This American base rate is set by the market and is not explicitly laid down by the FED. By withdrawing or adding funds to the money supply the FED tries to bring the effective federal funds rate into line with the interest rate that it is striving for. If the FED’s monetary policy alters the base rate, that usually affects the interest rate on various products such as mortgages, loans and savings.

It seems like the description is stating that the FFR is 1) a mandated rate which it attempts to force it's banking community to lend to each other for 1 day lending and 2) something almost immeasurable, i.e. a short term rate (presumably set live by market trading of TBs?), which the FED *attempt* to set by open market operations.

EDIT: I've just reread the italicised paragraph above, perhaps what the link very poorly explains, is actually two separate, but related rates - i.e. the FFR (which is the interbank 1 day lending rates window) and secondly the "base rate" - that due to the money markets.

Can anyone help me out here, re. the BoE and US situations?

thanks Matt

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Re: UK base rates and Fed funds rates

#303626

Postby tjh290633 » April 27th, 2020, 4:33 pm

As I understand it, Bank Base Rate is the rate at which the BofE will lend to Banks. What Banks will lend to each other used to be LIBOR (London Inter Bank Overnight Rate), which you may recall has been the subject of investigation recently.

I fancy that the Fed has two rates, Base Rate and Repo Rate (or something similar).

TJH

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Re: UK base rates and Fed funds rates

#308348

Postby NeilW » May 13th, 2020, 5:22 pm

Oh it's fun. Get ready.

Banks that can operate in Sterling are members of the Sterling Framework. That gives them access to certain facilities at the Bank of England.

The first is the deposit facility (also known as a Reserve Account) The deposit facility is essentially a forced loan by a commercial bank to the Bank of England at a set interest Rate - the Bank Rate. In aggregate the banks cannot get rid of these loans. Some operation in the Framework has to hold them. The forced loans come about due to government spending - say crediting an account with the Retirement Pension that hasn't yet been recovered by taxation going in the opposite direction. This is essentially the famous "deficit" everybody gets unnecessarily worked up about (or at least the most liquid part of it). Note that"lending money to the government" happens automatically due to the commercial bank being part of the Sterling clearing process. Remember that the next time somebody suggests "nobody will lend to the government". The banks have no choice if they want to clear in Sterling.

In addition the Banks have access to the Operational Standing Facility which allows them to obtain funds to clear balances during the day and overnight at the central bank They pay the Bank of England 0.25% above the Bank Rate for access to this overdraft facility, which has to be collateralised with Gilts or other government bonds. Essentially it's a quick way of making Gilts liquid without having to sell them if there is a big outflow from a bank during the day that hasn't yet been balanced by an inflow. It deals with timing difference.

There's also settlement accounts which are sort of reserve-lite account used by financial operations that aren't strictly banks. This gives them direct access to the Sterling clearing system. Any positive balances on these attract 0.10% less than the Bank Rate, or nothing if the Bank Rate is less than 0.25%. The cost of funds from the Bank of England is the same as banks.

Beyond that there are collateral upgrade operations - the traditional Discount Window, and various kinds of Repo. These take standard bank loans as collateral and 'upgrade' them to either Gilts or reserve balances. Collectively they are the "Lender of Last Resort" facilities that can be used by banks if they can't get anything in the wider finance market. The facilities are "reassuringly expensive".

HTH

NeilW

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Re: UK base rates and Fed funds rates

#308352

Postby NeilW » May 13th, 2020, 5:42 pm

In US terms what we call the "Bank Rate" is known as the IOER (Interest on Excess Reserves).

The Federal Funds Rate (FFR) is more akin to our LIBOR. It's the rate at which banks lend to each other. The Fed tries to target that, whereas we just set a floor with the Bank Rate.

The Fed lending facility is just the traditional Discount Window. There's less of a stigma to using it over the pond. That's normally charged at the Federal Discount Rate.

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Re: UK base rates and Fed funds rates

#309439

Postby TheMotorcycleBoy » May 17th, 2020, 5:24 pm

Hi Neil,

I finally got round to doing your reply justice. I'm only very slowly picking this area, so I'll probably end asking you a few more questions.

NeilW wrote:Banks that can operate in Sterling are members of the Sterling Framework. That gives them access to certain facilities at the Bank of England.

Google has happened me find this https://www.bankofengland.co.uk/-/media ... procedures which I'm guessing is a layman's guide to this framework.

The first is the deposit facility (also known as a Reserve Account)

Let me get this first bit clear are Reserve Accounts, at a very simple level, just the commercial banks equivalent to the kind of "regular" current/cheque accounts that individuals hold at CmBanks? e.g. just like Ann and Bob may both have accounts at Barclays; Barclays and HSBC both hold accounts at the BoE?

Note that"lending money to the government" happens automatically due to the commercial bank being part of the Sterling clearing process. Remember that the next time somebody suggests "nobody will lend to the government". The banks have no choice if they want to clear in Sterling.

Ok. I'll take a guess at trying to understand this. Ok using my above example (Ann, Bob, Barclays, HSBC), I'll assume another person, Fred, doesn't bank with Barclays but instead he has a HSBC account. Bob owes Fred £10, and writes him a cheque for that amount which Fred pays in. So, as you mentioned earlier are both those two banks now required "clear Sterling". I'm guessing that (very crudely) Barclays subtracts £10 from Bob's account with them, HSBC credits Fred's with £10, while the corresponding reserve accounts held by the banks at BoE then exchange this tenner. Is that what is meant?

The forced loans come about due to government spending - say crediting an account with the Retirement Pension that hasn't yet been recovered by taxation going in the opposite direction. This is essentially the famous "deficit" everybody gets unnecessarily worked up about (or at least the most liquid part of it).

Now I'm on somewhat shakier ground. Again continuing my example above. Bob is a State pensioner. In order to that Govt. can pay him £175 this week (I'm really shaky!), by following on from your's directly above, somehow Barclays reserve account is credited with this amount, which (if the overall account Barclays have w/ BoE is in credit) means Barclays now have more lolly for which the BoE must pay 0.1% on? At this point I'm the dark about how the Govt's "debt" with Barclays is now recorded (does the "Treasury" itself hold an account at the BoE?).

In addition the Banks have access to the Operational Standing Facility which allows them to obtain funds to clear balances during the day and overnight at the central bank They pay the Bank of England 0.25% above the Bank Rate for access to this overdraft facility, which has to be collateralised with Gilts or other government bonds. Essentially it's a quick way of making Gilts liquid without having to sell them if there is a big outflow from a bank during the day that hasn't yet been balanced by an inflow. It deals with timing difference.

So (another guess) this would happen if at any time the total withdrawals on Barclays in the UK exceed it's Sterling reserve. I guess that Northern Rock event of 2007 would be very extreme example of this? I'm not sure about the reference to Gilts, presumably the Debt which the Bank now holds with BoE must be repaid in Gilts instead of Sterling.

The PDF I linked above has this to say on the subject:
The Operational Standing Facilities (OSFs) providea means for Participants to manage unexpected ‘frictional’ payments shocks which may arise due to technical problems in Participants’ own systems or in the market-wide payments and settlements infrastructure.

The operational standing lending facility is provided via collateralised overnight lending against the Bank’s Level A collateral set. The operational standing deposit facility is provided as an unsecured overnight deposit.

Beyond that there are collateral upgrade operations - the traditional Discount Window, and various kinds of Repo. These take standard bank loans as collateral and 'upgrade' them to either Gilts or reserve balances. Collectively they are the "Lender of Last Resort" facilities that can be used by banks if they can't get anything in the wider finance market. The facilities are "reassuringly expensive".

I'll delay this until I've understood the above better.

Thanks Matt

(Yes the financial operation of the Banking System is very murky!)

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Re: UK base rates and Fed funds rates

#309489

Postby GoSeigen » May 17th, 2020, 9:55 pm

TheMotorcycleBoy wrote:Hi Neil,

I finally got round to doing your reply justice. I'm only very slowly picking this area, so I'll probably end asking you a few more questions.


Good summary by Neil above.

Note that"lending money to the government" happens automatically due to the commercial bank being part of the Sterling clearing process. Remember that the next time somebody suggests "nobody will lend to the government". The banks have no choice if they want to clear in Sterling.

Ok. I'll take a guess at trying to understand this. Ok using my above example (Ann, Bob, Barclays, HSBC), I'll assume another person, Fred, doesn't bank with Barclays but instead he has a HSBC account. Bob owes Fred £10, and writes him a cheque for that amount which Fred pays in. So, as you mentioned earlier are both those two banks now required "clear Sterling". I'm guessing that (very crudely) Barclays subtracts £10 from Bob's account with them, HSBC credits Fred's with £10, while the corresponding reserve accounts held by the banks at BoE then exchange this tenner. Is that what is meant?

Yes, that's about it, but we could add an intermediate stage where Fred gets paid £10 by his bank (HSBC) but HSBC hasn't yet received the £10 from Barclays. This might leave HSBC short of liquidity at the end of the day so they might borrow on the overnight market from another commercial bank. This borrowing would be done at close to the base rate, and might contribute to the calculation of LIBOR for that day.

The forced loans come about due to government spending - say crediting an account with the Retirement Pension that hasn't yet been recovered by taxation going in the opposite direction. This is essentially the famous "deficit" everybody gets unnecessarily worked up about (or at least the most liquid part of it).

Now I'm on somewhat shakier ground. Again continuing my example above. Bob is a State pensioner. In order to that Govt. can pay him £175 this week (I'm really shaky!), by following on from your's directly above, somehow Barclays reserve account is credited with this amount, which (if the overall account Barclays have w/ BoE is in credit) means Barclays now have more lolly for which the BoE must pay 0.1% on? At this point I'm the dark about how the Govt's "debt" with Barclays is now recorded (does the "Treasury" itself hold an account at the BoE?).


Yes, the BoE is the government's banker, among its other roles.

Will leave the remainder to NeilW as I'm heading to bed now!

GS

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Re: UK base rates and Fed funds rates

#309579

Postby dealtn » May 18th, 2020, 10:29 am

GoSeigen wrote:
Yes, that's about it, but we could add an intermediate stage where Fred gets paid £10 by his bank (HSBC) but HSBC hasn't yet received the £10 from Barclays. This might leave HSBC short of liquidity at the end of the day so they might borrow on the overnight market from another commercial bank. This borrowing would be done at close to the base rate, and might contribute to the calculation of LIBOR for that day.



It is possible for a bank to pay uncleared funds into an individual's account pending the arrival of cleared funds. Depending on the institution you can see a difference between a "balance" and an "available balance" that reflects this.

Any net "overdrawn" balances an individual bank has will be funded through the money markets over the course of the afternoon, often on an overnight basis, but this is distinct from the LIBOR calculation process. This takes place at 11, could only possibly have an impact on the o/n LIBOR rate anyway, and post Financial Crisis the team that determines the input into any particular Commercial Bank's LIBOR submission is now distinctly separate, even to the tune of its managerial reporting line, to the operational money markets team. (Unless that has changed in the last 3 years since I left such an institution, which I doubt.)

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Re: UK base rates and Fed funds rates

#309827

Postby NeilW » May 19th, 2020, 7:20 am

TheMotorcycleBoy wrote:
(Yes the financial operation of the Banking System is very murky!)


They are because you have to strip away layers of stuff that actually has no operational function other than tradition at best and obfuscation at worst.

And since a picture is worth a thousand words, here's a video that should show you how the flow works more clearly.

https://youtu.be/KYpTyD7CLvk

Hope that answers a few things.

NeilW

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Re: UK base rates and Fed funds rates

#309829

Postby NeilW » May 19th, 2020, 7:30 am

TheMotorcycleBoy wrote: (does the "Treasury" itself hold an account at the BoE?).


Yes. That's essentially what makes a central bank a sovereign central bank. It is the bank where the government holds its main accounts. In the UK the set of accounts are known as the Exchequer Pyramid. The main account is called the Consolidated Fund.

Remember that HM Treasury owns and controls the Bank of England. If you owned and controlled a bank entirely where would you hold your accounts?

Once you get to the bottom of this you'll realise that HM Treasury is essentially a type of bank.

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Re: UK base rates and Fed funds rates

#309831

Postby NeilW » May 19th, 2020, 7:38 am

So, as you mentioned earlier are both those two banks now required "clear Sterling"


This is where it gets interesting.

It's always best to understand this by drawing up the T accounts and running the accounting through the system.

If Bob at Barclays wants to pay Fred £10 at HSBC, then HSBC has to take Bob's places as depositor in Barclays. Otherwise the balance sheets won't balance. When HSBC does that it will then mark up Fred's account at HSBC by £10 and Barclays will move the £10 it owed Bob to the credit of HSBC.

That's "inter bank lending" in a nutshell. It's how money is moved between banks.

What reserve accounts do is centralise that so that banks can net off multiple movements with each other and do it all in one place rather than with every other banks. But at the end of the day the banks have to adopt the relative positions of lending to each other that the flow of money has dictated during the day. That is 'clearing' - where the central bank tries to stop being the middleman.

The lender of last resort stuff kicks in when some bank says "you know what I don't fancy taking the overnight risk on that Northern rock lot, no matter how much interest they promise to pay me, I'll leave it on deposit at the BoE'.

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Re: UK base rates and Fed funds rates

#310216

Postby NeilW » May 20th, 2020, 11:07 am

TheMotorcycleBoy wrote:I'm not sure about the reference to Gilts, presumably the Debt which the Bank now holds with BoE must be repaid in Gilts instead of Sterling.


Here's another version of the video with Gilts in it. https://youtu.be/Bh48hsslo0E

Let me know what that fails to address adequately.

NeilW

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Re: UK base rates and Fed funds rates

#310301

Postby TheMotorcycleBoy » May 20th, 2020, 3:43 pm

NeilW wrote:
TheMotorcycleBoy wrote:I'm not sure about the reference to Gilts, presumably the Debt which the Bank now holds with BoE must be repaid in Gilts instead of Sterling.


Here's another version of the video with Gilts in it. https://youtu.be/Bh48hsslo0E

Let me know what that fails to address adequately.

NeilW

Many thanks Neil,

Will reply to your last few, hopefully by Friday...or failing that, this weekend. Day job is currently a killer, leaving little inclination for much more than fiction book afterwards!

Matt

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Re: UK base rates and Fed funds rates

#311010

Postby TheMotorcycleBoy » May 22nd, 2020, 1:18 pm

NeilW wrote:
TheMotorcycleBoy wrote: (does the "Treasury" itself hold an account at the BoE?).


Yes. That's essentially what makes a central bank a sovereign central bank. It is the bank where the government holds its main accounts. In the UK the set of accounts are known as the Exchequer Pyramid. The main account is called the Consolidated Fund.

Remember that HM Treasury owns and controls the Bank of England. If you owned and controlled a bank entirely where would you hold your accounts?

Once you get to the bottom of this you'll realise that HM Treasury is essentially a type of bank.

Maybe. Though in my way of thinking it's more like the finance department of a large conglomerate, called "Great Britain Incorporated".

NeilW wrote:
TheMotorcycleBoy wrote:
(Yes the financial operation of the Banking System is very murky!)


They are because you have to strip away layers of stuff that actually has no operational function other than tradition at best and obfuscation at worst.

And since a picture is worth a thousand words, here's a video that should show you how the flow works more clearly.

https://youtu.be/KYpTyD7CLvk

Hmm..

Well the picture does certainly portray the abstraction. Maybe obfuscation as you propose. I'm not really swung on the "government debt is an asset" since that argument is only sold by virtual of the 'A' symbols in the diagram. Though of course we do have "Intangible Assets" I suppose! In the referred diagram the asset created by the BoE/TrB entity was purely electronic, and it would only be a real asset IMO, had there been a real life lender. Then the asset would be owned by them and not the British Government.

Aha, now I see you get to here, you introduced the owner of a gilt asset:
NeilW wrote:
TheMotorcycleBoy wrote:I'm not sure about the reference to Gilts, presumably the Debt which the Bank now holds with BoE must be repaid in Gilts instead of Sterling.


Here's another version of the video with Gilts in it. https://youtu.be/Bh48hsslo0E

Let me know what that fails to address adequately.

NeilW

Interesting. I just watched this once, but may watch again to reinforce any lessons. Nice references to the "consolidated fund" and "national loan fund" (all new to me) and the "DMO" (not so new but till then unlinked). Interesting to hear gilts being referred to as *another currency*.

Thanks for putting the clips together,
Matt

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Re: UK base rates and Fed funds rates

#311264

Postby NeilW » May 23rd, 2020, 6:48 am

TheMotorcycleBoy wrote:Maybe. Though in my way of thinking it's more like the finance department of a large conglomerate, called "Great Britain Incorporated".


That would be a mistake. The government sector is the yang to the business ying. It has to do almost precisely the opposite of what a business would do at any given point in time. For example at the moment it needs to expand greatly as business contracts.

It's far more helpful, in terms of understanding what can and can't be done, to see the government sector as the national bank. The more credit it issues, the more circulation there is.

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Re: UK base rates and Fed funds rates

#311265

Postby NeilW » May 23rd, 2020, 6:52 am

TheMotorcycleBoy wrote: Though of course we do have "Intangible Assets" I suppose!


To a bank loans are assets. That's the only assets they have - intangible ones. All finance businesses are like that. As are most service operations. which is 80% of the economy.

The majority of assets stopped being stuff you can kick when the economy financialised.

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Re: UK base rates and Fed funds rates

#318585

Postby TheMotorcycleBoy » June 15th, 2020, 3:19 pm

NeilW wrote:
TheMotorcycleBoy wrote:Maybe. Though in my way of thinking it's more like the finance department of a large conglomerate, called "Great Britain Incorporated".

That would be a mistake. The government sector is the yang to the business ying. It has to do almost precisely the opposite of what a business would do at any given point in time. For example at the moment it needs to expand greatly as business contracts.

Yes, I see what you mean.


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