Questions and answers on monetary policy implementation
How does the SNB implement its monetary policy?
The SNB implements its monetary policy by fixing a target range for the reference interest rate, the Libor (London Interbank Offered Rate) for three-month interbank loans in Swiss francs. The target range is the third element of the SNB's monetary policy strategy besides the definition of price stability and the conditional inflation forecast (Questions and answers on monetary policy strategy). The SNB steers the Libor into the defined target range by means of its monetary policy operations. The target range normally has a bandwidth of 100 basis points (1 percentage point) and, as a rule, the SNB holds the Libor in the middle of the defined range. An overview of the target range figures since the beginning of 2000 can be found at Monetary statistics. As interest rates increasingly approached zero in the wake of the financial crisis, the Libor target range was narrowed. From 6 September 2011 to 15 January 2015, the main focus of implementation was on the minimum exchange rate of CHF 1.20 per euro, which the SNB enforced during this period. On 18 December 2014, the SNB decided to impose an interest rate of -0.25% on sight deposit account balances. With the announcement of a negative interest rate, the target range for the Libor was taken into negative territory for the first time, and extended to its usual width of 1 percentage point. On 15 January 2015, the SNB lowered the interest rate on sight deposits to -0.75% and moved the target range downwards to between -1.25% and -0.25%. Negative interest has applied since 22 January 2015.
What is the three-month Libor for Swiss franc investments?
The three-month Libor for Swiss franc investments, which is published daily in London, corresponds to the trimmed mean of the interest rates reported by leading banks for unsecured Swiss franc interbank loans with a three-month maturity. The three-month Libor is an important benchmark for credit relationships in Switzerland and abroad. Thus it plays a key role in the monetary policy transmission mechanism in Switzerland.
Why does the SNB use a target range instead of a target interest rate?
The SNB is unable to steer the three-month Libor for Swiss franc investments directly, since it is ultimately determined by the conditions on the interbank market. By providing the Swiss franc money market with liquidity or withdrawing liquidity from it, the SNB can only approximately steer the level of the three-month Libor. This is why it fixes a target range marking the upper and lower bounds for the three-month Libor.
The interbank market for unsecured loans has become distinctly less relevant since 2008, and the Libor has lost a lot of its credibility due to instances of manipulation. Why does the SNB continue to use the Libor as a reference rate?
Although few unsecured credit transactions are concluded on the interbank market and the credibility of the Libor has suffered as a result of the manipulation uncovered during the financial crisis, the Libor remains an important reference rate for credit relationships in Switzerland and abroad for the time being. It therefore continues to play a key role in the monetary policy transmission mechanism. With its monetary policy operations, the SNB can only approximately steer the level of the Libor. It therefore fixes a target range, normally with a bandwidth of 100 basis points, for the three-month Libor for Swiss franc investments. The reported distortions of the Libor did not go beyond a single-digit basis point figure. Moreover, since 2013 a number of initiatives to strengthen the Libor have been launched, which has reduced the potential for manipulation. It does not, therefore, pose a threat to the SNB's monetary policy strategy.
However, as a result of the low level of underlying transaction activity, in July 2017 the UK Financial Markets Authority concluded that the Libor benchmarks were no longer sustainable and announced that it would no longer compel banks to take part in the Libor panel after end-2021. Consequently, there are doubts about the future of the Libor. In Switzerland, therefore, the national working group on Swiss franc reference rates, which is the body responsible for drawing up reform proposals for Switzerland and monitoring developments abroad, has recommended SARON (Swiss Average Rate Overnight) as an alternative to the Swiss franc Libor. SARON is based on transactions concluded and tradable quotes on the Swiss franc interbank repo market. The SNB will provide information on any adjustments that may be necessary for its monetary policy strategy in good time. These adjustments will have no impact on the monetary policy stance.
What are monetary policy instruments?
Monetary policy instruments are transactions through which the SNB implements its monetary policy. Art. 9 of the Federal Act on the Swiss National Bank (NBA) defines the transactions that the SNB may conduct in the financial market. The SNB distinguishes between open market operations and standing facilities. In the case of open market operations, the SNB takes the initiative in the transaction, while for the standing facilities it merely specifies the conditions at which counterparties can obtain liquidity. Regular open market operations include repo transactions and the issuance of SNB Bills. The interest rate (currently negative) on sight deposits, which was introduced on 18 December 2014, is a monetary policy instrument, too (Questions and answers on repo transactions and other monetary policy instruments). Further instruments, such as foreign exchange swaps (Questions and answers on foreign exchange swaps) and foreign exchange transactions, are available if necessary. Standing facilities include the liquidity-shortage financing facility and the intraday facility. Details can be found in the Guidelines of the Swiss National Bank on Monetary Policy Instruments.
How can the SNB implement its monetary policy by means of monetary policy instruments?
The SNB implements its monetary policy by managing liquidity on the Swiss franc money market and thereby influencing the interest rate level. The three-month Libor for Swiss franc investments serves as its reference interest rate. The SNB steers the three-month Libor indirectly through liquidity-providing and liquidity-absorbing money market transactions. It can influence the three-month Libor by means of the volume and conditions of these operations. The SNB also influences the level of interest rates on the money market by setting the interest rate on sight deposits. The choice of liquidity management regime depends on monetary policy requirements and the liquidity structure in the banking system. If the banking system shows signs of being undersupplied with liquidity, the SNB provides liquidity through short-term money market transactions and thereby increases the banks' sight deposits held at the SNB. Conversely, the SNB absorbs liquidity via short-term money market transactions and thereby reduces the banks' sight deposits at the SNB.
The SNB can also provide liquidity in Swiss francs to the banking system, or withdraw liquidity from it, by purchasing or selling foreign currency. Foreign exchange market transactions are conducted with a wide range of domestic and foreign counterparties.
What roles do sight deposits and the money market play?
In order for a bank to maintain its solvency, it must have sufficient liquidity at all times. A bank's most liquid assets are sight deposits held at the SNB, since they can be used immediately to effect payments and are deemed to be legal tender. Domestic banks hold sight deposits to satisfy minimum reserve requirements. Banks also need them for payment transactions and as liquidity reserves. The SNB influences sight deposits through the use of its monetary policy instruments. Liquidity adjustments between the individual financial market participants are effected on the money market. Banks seeking to place funds on a short-term basis provide liquidity in the form of a loan to other banks that require short-term refinancing. These loans can be granted on a secured or unsecured basis. The level of sight deposits influences activity on the money market. A disruption in the money market impairs the liquidity adjustment process between the market participants and can threaten the solvency of the banks.
Why do banks have an interest in carrying out money market transactions with the SNB?
In the past, the banking system was faced with a liquidity deficit; in other words, it needed liquidity. The SNB implemented its monetary policy by providing the banking system with temporary liquidity, which meant that banks had to request further liquidity on an ongoing basis. This is how, through the amount of liquidity provided and the interest rate, the SNB steered the money market and the reference interest rate, the three-month Libor for Swiss franc investments. Since 2010, however, the banking system has been characterised by excess liquidity. The exceptionally high level of liquidity is due to the SNB's foreign exchange transactions against Swiss francs.
There has been excess liquidity in the banking system since 2010. How can the SNB steer the three-month Libor in such an environment?
Following the discontinuation of the minimum exchange rate of CHF 1.20 per euro on 15 January 2015, the target range for the three-month Libor for Swiss franc investments is set at between -1.25% and -0.25%. Banks continue to hold high levels of surplus liquidity. The three-month Libor is within the range aimed at by the SNB. The SNB is able to react swiftly and effectively to monetary policy requirements. An example of this is the decision of 18 December 2014 to introduce a (negative) interest rate on sight deposits. Between mid-2010 and mid-2011, the market was also characterised by excess liquidity. In that environment too, the SNB was always in a position to steer interest rates by means of liquidity-absorbing open market operations, i.e. the issuance of SNB Bills (for large amounts and terms of up to one year) and repo transactions. From 6 September 2011 to 15 January 2015, the main focus of monetary policy implementation was on the minimum exchange rate. Since then, SNB monetary policy has been based on two key elements: the negative interest rate, and the willingness to intervene in the foreign exchange market as necessary.
Is the high level of sight deposits at the SNB a sign that banks are hoarding their money at the SNB instead of putting it into circulation?
The total level of sight deposits (sight deposit account balances of domestic banks and other sight deposits) at the SNB can only be changed through SNB monetary policy operations or through exchange against cash. If a bank reduces its sight deposits at the SNB, the amount is either transferred to another sight deposit account with the SNB or is put into circulation. This is why the monetary base, which by definition is made up of the sight deposit account balances of domestic banks and banknotes in circulation, can only be changed by the SNB. The growth rates of loans and monetary aggregates reflect the extent to which the available liquidity has entered the economic cycle.
What counterparties are admitted to the SNB's monetary policy operations?
In principle, all banks domiciled in Switzerland and the Principality of Liechtenstein with sight deposits at the SNB are admitted as counterparties for SNB monetary policy operations. Other domestic financial market participants such as insurance companies as well as banks domiciled abroad, may be admitted as counterparties in monetary policy operations, provided this is in the SNB's monetary policy interest and the said institutions contribute to liquidity on the secured Swiss franc money market.
Why does the SNB also provide liquidity for banks abroad - does it not conduct its monetary policy on behalf of Switzerland?
The Swiss franc money market is not limited by geographical boundaries. The Swiss franc is one of the most important currencies on the international financial market and is therefore also actively traded abroad. It is thus also in the interests of Switzerland if banks domiciled abroad can participate in the SNB's liquidity-absorbing and liquidity-providing money market operations too.
How does the SNB conduct its open market operations?
The SNB may conduct its open market operations in the form of auctions or bilateral transactions. Transactions on the money market are usually conducted via an electronic trading platform. Auctions are conducted either by volume tender or by variable rate tender. In the case of volume tenders, the interest rate is fixed and amounts are allocated in relation to demand. If, for example, demand is twice as high as supply, each bank receives 50% of the amount it bid for. In the case of variable rate tenders, banks bid for variable amounts at given interest rates. The most favourable bids are considered until the desired overall amount has been reached. Variable rate tenders are conducted to provide or absorb liquidity either according to the American method (bids considered are satisfied at the interest rate offered) or the Dutch method (participants making the bids considered pay or receive the interest rate called by the last bidder considered).
What procedures does the SNB apply for its open market operations?
Repo auctions are, as a rule, conducted by volume tender, whereas auctions of SNB Bills in the form of a variable rate tender with allocation according to the American system. The SNB does not use variable rate tenders according to the Dutch allotment system for its monetary policy-related open market operations. It does, however, auction Swiss Confederation bonds and money market debt register claims in this manner on behalf of the Confederation. Further information can be found at Primary market for Swiss Confederation bonds.