Category Archives: Market Infrastructure

Beyond blockchain: what are the technology requirements for a Central Bank Digital Currency?

Simon Scorer

What type of technology would you use if you wanted to create a central bank digital currency (CBDC) i.e. a national currency denominated, electronic, liability of the central bank? It is often assumed that blockchain, or distributed ledger technology (DLT), would be required; but although this could have some benefits (as well as challenges), it may not be necessary. It could be sensible to approach this issue the same way you would any IT systems development problem – starting with an analysis of requirements, before thinking about the solution that best meets these.

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Filed under Banking, Currency, Market Infrastructure

Central Bank Digital Currency: DLT, or not DLT? That is the question

Simon Scorer

The topics of central bank digital currency (CBDC) and distributed ledger technology (DLT) are often implicitly linked. The genesis of recent interest in CBDC was the emergence of private digital currencies, like Bitcoin, which often leads to certain assumptions about the way a CBDC might be implemented – i.e. that it would also need to use a form of blockchain or DLT. But would a CBDC really need to use DLT? In this post I explain that it may not be necessary to use DLT for a CBDC, but I also consider some of the reasons why it could still be desirable.

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Filed under Banking, Currency, Market Infrastructure

Big Data jigsaws for Central Banks – the impact of the Swiss franc de-pegging

Olga Cielinska, Andreas Joseph, Ujwal Shreyas, John Tanner and Michalis Vasios

The Bank of England has now access to transaction-level data in over-the-counter derivatives (OTCD) markets which have been identified to lie at the centre of the Global Financial Crisis (GFC) 2007-2009. With tens of millions of daily transactions, these data catapult central banks and regulators into the realm of big data.  In our recent Financial Stability Paper, we investigate the impact of the de-pegging in the euro-Swiss franc (EURCHF) market by the Swiss National Bank (SNB) in the morning of 15 January 2015. We reconstruct detailed trading and exposure networks between counterparties and show how these can be used to understand unprecedented intraday price movements, changing liquidity conditions and increased levels of market fragmentation over a longer period.

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Filed under Currency, Financial Stability, Market Infrastructure, New Methodologies

Of Goosebumps and CCP default funds

Fernando V. Cerezetti and Luis Antonio Barron G. Vicente 

A vestigial structure is an anatomical feature that no longer seems to have a purpose in the current form of an organism. Goosebumps, for instance, are considered to be a vestigial protection reflex in humans. Default funds, a pool of financial resources formed of clearing member (CM) contributions that can be tapped in a default event, are a ubiquitous part of central counterparty (CCP) safeguard structures. Their history is intertwined with the history of clearinghouses, dating back to a time when the financial sector resembled a Gentlemen’s Club. Here we would like to address the following – perhaps impertinent – question: are current mutualisation processes in CCPs a historical vestige, like goosebumps, or do they still hold an important risk reducing role?

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Filed under Financial Markets, Financial Stability, Market Infrastructure

Macroprudential policy beyond banking

Jon Frost and Julia Giese.

A seismic shift is occurring in the European financial system. Since 2008, the aggregate size of bank balance sheets in the EU is essentially flat, while market-based financing has nearly doubled. This shift presents challenges for macroprudential policy, which has a mandate for the stability of the financial system as a whole, but is still focused mostly on banks. As such, macroprudential policymakers are focusing increasing attention on potential systemic risks beyond the banking sector. Drawing from a European Systemic Risk Board (ESRB) strategy paper which we helped write along with five others, we take a step back and set out a policy strategy to address risks to financial stability wherever they arise in the financial system.

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Filed under Financial Stability, Insurance, Macroprudential Regulation, Market Infrastructure

How credit risk can incentivise banks to keep making payments at the height of a crisis

Marius Jurgilas, Ben Norman and Tomohiro Ota.

The final, practical determinant of whether a bank is a going concern is: does it have the liquidity to make its payments as they become due?  Thus, the ultimate crucible in which financial crises play out is the payment system.  At the height of recent crises, some banks delayed making payments for fear of paying to a bank that would fail (Norman (2015)).  This post sets out a design feature in a payment system that creates incentives, especially during financial crises, for banks to keep making payments.  This feature could address situations where banks in the system would otherwise be tempted to postpone their payments to a bank that is (rumoured to be) in trouble.

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Life below zero – the impact of negative rates on derivatives activity

James Purchase and Nick Constantine.

In 1995, Fischer Black, an economist whose ground-breaking work in financial theory helped revolutionise options trading, confidently stated that “the nominal short rate cannot be negative.”  Twenty years later this assumption looks questionable: one quarter of world GDP now comes from countries with negative central bank policy rates.  Practitioners have been forced to update their models accordingly, in many cases introducing greater complexity.  But this shift is not just academic.  Models allowing for a wider distribution of future rates require market participants to hedge against greater uncertainty.  We argue that this hedging contributed to the volatility in global rates in early 2015, but that derivatives can also play an important role in facilitating monetary policy transmission at negative rates.

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Filed under Financial Markets, Market Infrastructure, Monetary Policy, New Methodologies

Recycling is good for the liquidity environment: Why ending QE shouldn’t stop banks from being able to make CHAPS payments

Evangelos Benos & Gary Harper.

Since QE began, banks have had a lot more liquidity to make payments. But some have argued (in a nutshell) that banks are reliant on this extra liquidity to make their CHAPS payments and it would be difficult to remove it from the system. Our analysis shows that banks don’t need a great deal of liquidity to make their payments simply because they recycle such a high proportion of them. In practical terms, banks do not rely on high reserves balances to make their CHAPS payments so unwinding QE shouldn’t have any impact on banks’ ability to do just that. We also briefly go over the potential reasons for this such as the CHAPS throughput rules, the Liquidity Savings Mechanism, and the tiered structure of CHAPS.

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Filed under Banking, Financial Stability, Market Infrastructure, Monetary Policy

Saving Liquidity in a Liquidity-abundant World: Why don’t banks use less liquidity when making high-value payments?

David Seaward.

CHAPS banks have oodles of liquidity and are not afraid to use it, as quantitative easing has meant banks accumulated unprecedented quantities of reserves. And in this liquidity-abundant world, banks are less likely to be concerned with how well they use tools for liquidity saving in the Bank’s Real-Time Gross Settlement (RTGS) infrastructure. And besides, the timings of liquidity-hungry payments are stubborn. They can’t always be retimed to optimise liquidity usage, and this means that the potential for liquidity savings in RTGS from the Bank’s Liquidity Savings Mechanism (LSM) is limited.

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Filed under Banking, Financial Stability, Market Infrastructure, Microprudential Regulation

High-frequency trading and market quality: What’s the deal?

Evangelos Benos.

It’s been a while now since high-frequency-trading (HFT) made its debut in the financial market landscape. Initially, little was known about it and regulators and market participants alike were naturally concerned about its potential impact on markets. Nevertheless, over the past few years we have learned quite a bit more about HFT. So what’s the deal with HFT? This short blog post briefly describes the evolution of HFT, summarizes the current understanding of the impact of HFT on market quality and highlights some aspects of HFT activity that are still contentious. Regardless, I believe, the inescapable conclusion that so far emerges is that HFT has mostly had a positive impact on market functioning.

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Filed under Financial Markets, Market Infrastructure