The following is an edited
copy of "A Primer
on the Implementation of Monetary Policy in the LVTS Environment"
by D. Howard, December 2001 on the website of the Bank of Canada:
The Bank of Canada’s method for
policy is closely linked to the system through which payments clear and
settle daily. With the introduction of the Canadian Payments
electronic system for the transfer of payments (the Large Value
System or LVTS), a new approach to the implementation of monetary
was adopted on 4 February 1999.
The Bank of Canada establishes a
target rate for
the overnight interest rate within an operating band in order to
other short-term interest rates and the exchange rate. The
to influence other short-term rates partly reflects the fact that
of money market securities are generally financed with overnight
However other factors such as changing market expectations and exchange
rate developments also affect how other interest rates, including those
with relatively short terms to maturity, respond to changes in the
Key features of the operating
The Bank of Canada’s primary
influence on the
overnight rate is through its 50 basis-point operating band for the
• The interest rate charged for
to LVTS participants at final settlement is the upper limit of the
band. This interest rate is the Bank Rate.
• The interest rate paid by the
Bank of Canada
on positive balances after settlement of the LVTS is set at the lower
of the band.
• Changes in the operating band,
and hence in
the Bank Rate, are announced by 9 a.m. via a press release on the
The overnight rate typically stays
band since participants are aware that they will earn at least Bank
less 50 basis-points on positive balances and need not pay more than
Rate to cover negative balances given the standing facilities at the
The Bank has a target interest
rate at the midpoint
of the operating band for the overnight interest rate.
• To reinforce the target rate if
Bank of Canada will intervene in the overnight market with open market
buyback operations at the target rate at 11:45 a.m. The
is at midday to encourage market participants to trade with each other
during the morning when a large proportion of daily funding activity
• If the overnight rate is
generally trading above
the target rate, the Bank will intervene with Special Purchase and
Agreements (SPRAs), commonly referred to as “repos”.
• If the overnight rate is
generally trading below
the target rate, the Bank will intervene with Sale and Repurchase
(SRAs), commonly referred to as “reverses”.
• If the overnight rate is
generally trading around
the target rate, there will be no intervention.
• The counterparties to these
be primary dealers.
• Each counterparty will have a
limit for offerings of either SPRAs or SRAs.
Settlement Balance Management
During the initial stages of
operating under this
framework, the Bank of Canada typically set the level of settlement
in the financial system at zero. Therefore any participant in the LVTS
with a surplus funds position would be aware that there was at least
participant in the LVTS with an offsetting deficit position who was a
counterparty for transactions at market rates. However, the
rate typically traded above the target rate indicating that there was
demand for excess settlement balances.
Since November 1999 on a daily
basis, the Bank
has generally provided some positive level of settlement balances, most
recently around $50 million, but somewhat higher when technical
Transfer of government deposits
to affect the
level of settlement balances
• To maintain the level of
at its desired level, the Bank must neutralize the net impact of any
sector flows between the Bank of Canada’s balance sheet and that of the
financial system. Public sector flows include government receipts
and disbursements, the Bank of Canada’s own transactions, and those of
• This neutralization and any
in the level of excess settlement balances is effected through the
of government deposits from/to the government’s account at the Bank of
Canada to/from its accounts with participants in the LVTS.
• The transfer is made through the
auction of Receiver General (federal government) balances -- the first
at 9:15 a.m. and the second at 4:15 p.m.
• The difference between the total
and the total amount maturing equals the amount of the neutralization
the change in the level of excess in the system.
For example, if the government
were to receive
$100 million net in taxes into its account at the Bank of Canada (the
banker), in the absence of any neutralizing action, settlement balances
in the system would decline by this amount. The Bank would
arrange a net increase of $100 million in the government deposits
to leave the system unchanged (or a net increase of $200 million to
the level of balances in the system by $100 million). On the
hand, if the Bank transacted $100 million in SPRAs, there would be a
reduction of $100 million in that day’s government deposit auction (or
there were no change in the amount to be auctioned, this would
a net increase in settlement balances of $100 million).
After the close of client business
in the LVTS
at 6 p.m., LVTS participants have a period of one-half hour in which to
enter into transactions with each other. This will allow
to reduce their LVTS positions -- positions that resulted from their
and their clients’ transactions -- at interest rates typically
by the limits of the operating band. In fact, trades should occur
at rates within the band since it is typically more advantageous for
the lending and borrowing parties to trade at a rate within the band
to resort to the Bank of Canada facilities at the limits of the
Paper-based payment items
Paper-based payment items, such as
to be cleared through the Automated Clearing Settlement System
Some consideration was given to moving to a next-day settlement for the
net amounts due to or due from the ACSS, but the financial institutions
concerned preferred to maintain the existing system of retroactive
These institutions also chose the
option of eliminating
the calculation (averaging) period and having the Bank charge for
and remunerate positive balances at a given spread around the operating
band for operational simplicity. The rate spread for ACSS
was originally 250 basis points and is now 150 basis points above and
the operating band. The midpoint of this wider band is same as
midpoint of the operating band for the overnight rate.
Although the ACSS continues to
all of the value of public sector flows and most market-related
transactions move through the LVTS. Therefore, the LVTS is the sole
of monetary policy operations.
In the LVTS environment, the Bank
of Canada affects
financial markets through its influence on the overnight interest rate
by setting a target rate at the mid-point of a 50 basis point operating
band for this rate and through a framework that is designed to hold the
rate within this band.