Standing facilities are central bank operations at the initiative of banks, on the basis of a commitment of the central to allow such operations under certain conditions.
Three variants can be distinguished, of which the first two are liquidity-providing and the third liquidity-absorbing.
- A discount facility: banks can sell certain short-term paper to the central bank at any rate, whereby the discount rate specified by the central bank is applied to calculate the price on the basis of the securities’ cash-flows.
- An overnight borrowing facility: banks can borrow at any time against the provision of eligible collateral at some rate specified by the central bank.
- A deposit facility: banks can deposit at any time funds with the central bank on a specific account where it gets remunerated at a specific rate.
Typically, central banks offer standing facilities at preannounced rates. The joint implementation of standing facilities and money market instruments allows central banks to make the monetary policy stance explicit.
For instance, the plans for Stage III of EMU Opens in new window envisage the use of standing facilities to keep interest rates within a set range, or “corridor.” Central bank refinance is the most common standing facility.
Bernard J. Laurens reviews the use of refinance instruments in a sample of industrial countries and discusses how central banks use them to influence short-term interest rates and do manage banks’ reserves.
Although the quantitative importance of refinance instruments has diminished in recent years, they play an important role as an instrument of emergency funding to finance end-of-day imbalances.
The design of refinance instruments must take into consideration the exchange rate regime, the need to foster the development of the interbank market, and the need to minimize central bank credit risk in refinance operations.
While standing facilities can allow monetary authorities to keep short-term interest rates within a specific range in the short term, central banks need market-based instruments that they can operate at their own discretion.
Using these instruments, they can attain their monetary targets — a short-term interest rate, such as the overnight interest rate—or a monetary aggregate, such as bank reserves. Three such market-based instruments are credit auctions Opens in new window, foreign exchange swaps Opens in new window, and open market operations Opens in new window.