Board of Governors of the Federal Reserve System

Monetary Policy Tools

The Federal Reserve currently uses several tools to implement monetary policy in support of its statutory mandate to foster maximum employment and stable prices.

The Federal Reserve conducts OMOs in domestic markets. OMOs can be permanent, including the outright purchase and sale of Treasury securities, government-sponsored enterprise (GSE) debt securities, and federal agency and GSE MBS; or temporary, including the purchase of these securities under agreements to resell, and the sale of these securities under agreements to repurchase. The authority to conduct OMOs is granted under section 14 of the Federal Reserve Act, and the range of securities that the Federal Reserve is authorized to purchase and sell is relatively limited. OMOs are conducted by the FRBNY's Trading Desk, which acts as agent for the FOMC. The FRBNY's traditional counterparties for OMOs are the primary dealers with which the FRBNY trades U.S. government and select other securities.³ Since 2009, the FRBNY has designated other counterparties for certain OMO programs.

OMOs have been used historically to adjust the supply of reserve balances so as to keep the federal funds rate around the target federal funds rate established by the FOMC. In recent years, the Federal Reserve has also developed other tools to strengthen its control of short-term interest rates and to reduce the large quantity of reserves held by the banking system.

The Federal Reserve provides short-term liquidity to domestic banks and other depository institutions through the discount window. In addition, because of the global nature of bank funding markets, the Federal Reserve has established liquidity arrangements with foreign central banks (FCBs) as part of coordinated international efforts.

Permanent Open Market Operations

Recent Developments

• Between October 23, 2019, and February 26, 2020, the Federal Reserve's holdings of Treasury securities in the System Open Market Account (SOMA) rose as a result of the FOMC's policy of reinvesting some principal payments of agency MBS into Treasury securities and of reserves management purchases of Treasury bills. Owing to the reinvestment policy, SOMA holdings of agency MBS declined.

Background

Permanent OMOs are outright purchases or sales of securities for the SOMA, the Federal Reserve's portfolio. Traditionally, permanent OMOs are used to manage the supply of bank reserves by accommodating the longer-term factors driving the expansion of the Federal Reserve's balance sheet, principally the trend growth of currency in circulation. From 2009 to 2014, permanent OMOs were also used to expand SOMA securities holdings through a series of large-scale asset purchase programs (LSAPs) and to extend the average maturity of securities held in the SOMA.⁴ From 2017 to 2019, the FOMC conducted a balance sheet normalization program (described in more detail below) that gradually reduced the size of SOMA securities holdings.

Currently, permanent OMOs are used in a traditional role, purchases of securities to manage the supply of reserves in light of expected increases in the Federal Reserve's non-reserves liabilities. In October 2019 the Federal Reserve announced that it would purchase Treasury bills, initially at a pace of approximately $60 billion per month, at least into the second quarter of 2020 in order to maintain over time ample reserve balances at or above the level that prevailed in early September 2019. Without these purchases, the level of reserves would decline significantly because of previous and expected growth in non-reserve liabilities such as currency in circulation. This action is a purely technical measure to support the effective implementation of the FOMC's monetary policy, and does not represent a change in the stance of monetary policy. Additional information is available at https://www.federalreserve.gov/newsevents/pressreleases/files/monetary20191011a2.pdf and https://www.newyorkfed.org/markets/treasury-reinvestments-purchases-faq.html. Permanent OMOs are also used to implement the FOMC's policies of reinvesting principal payments from its holdings of agency debt and MBS and of rolling over maturing Treasury securities at auction. In addition, as a matter of prudent planning the FRBNY Trading Desk occasionally conducts small-value exercises, including outright purchases and sales of Treasury securities, outright purchases and sales of MBS, and MBS coupon swaps, for the purpose of testing operational readiness.

The composition of the SOMA is presented in table 2. The Federal Reserve's outright holdings of securities are reported weekly in tables 1, 2, 3, 4, and 5 of the H.4.1 statistical release.

Table 2. Domestic SOMA securities holdings

On September 28, 2012, the Federal Reserve began the regular publication of transaction-level information on individual open market transactions. In accordance with the Dodd-Frank Act, this information will be made available on a quarterly basis and with an approximately two-year lag. The transaction-level detail supplements the extensive aggregate information the Federal Reserve has previously provided in weekly, monthly, and quarterly reports, and is available at https://www.newyorkfed.org/markets/OMO_transaction_data.html.

Balance Sheet Normalization

From 2009 to 2014, the FOMC undertook a large expansion of SOMA securities holdings through a series of LSAPs that were conducted in order to support the housing market, improve conditions in private credit markets, and promote a stronger pace of economic recovery.⁵

In October 2017, the FOMC initiated a balance sheet normalization program that gradually reduced the size of these holdings by decreasing the reinvestment of the principal payments received from securities held in the SOMA.⁶ Such principal payments were reinvested only to the extent that they exceeded caps. These caps, which limited monthly net redemptions of maturing securities, remained in place while the FOMC reduced its aggregate securities holdings so that these holdings declined in a gradual and predictable manner. Initially, for October 2017 to December 2017, the decline in SOMA securities holdings was capped at $6 billion per month for Treasury securities and $4 billion per month for agency debt and agency MBS. During 2018, these caps gradually rose to maximums of $30 billion per month for Treasury securities and $20 billion per month for agency debt and agency MBS. In March 2019, the FOMC announced that it intended to slow the reduction of its holdings of Treasury securities by reducing the cap on monthly redemptions to $15 billion from $30 billion beginning in May 2019, and intended to conclude the reduction of its aggregate securities holdings in the SOMA at the end of September 2019. In July 2019, the FOMC announced that it would conclude this reduction of its securities holdings two months earlier than previously indicated. In addition, the FOMC intends to continue to allow its holdings of agency debt and agency MBS to decline, consistent with the aim of holding primarily Treasury securities in the longer run. Beginning in August 2019, principal payments received from agency debt and agency MBS are reinvested in Treasury securities subject to a maximum amount of $20 billion per month; any principal payments in excess of that maximum will continue to be reinvested in agency MBS. Additional information on the balance sheet normalization program is available at https://www.federalreserve.gov/monetarypolicy/policy-normalization.htm.

By reducing the Federal Reserve's securities holdings, the FOMC has reduced the quantity of reserve balances to a level appreciably below that seen in recent years but larger than before the financial crisis. The FOMC intends to continue implementing monetary policy in a regime in which an ample supply of reserves ensures that control over the level of the federal funds rate and other short-term interest rates is exercised primarily through the setting of the Federal Reserve's administered rates, and in which active management of the supply of reserves is not required.

Temporary Open Market Operations and Other Reserve Management Tools

Recent Developments

• To implement its monetary policy stance announced on October 30, 2019, the FOMC directed the FRBNY to conduct OMOs as necessary to maintain the federal funds rate in a target range of 1-1/2 to 1-3/4 percent.
• To implement its monetary policy stance announced on March 3, 2020, the FOMC directed the FRBNY to conduct OMOs as necessary to maintain the federal funds rate in a target range of 1 to 1-1/4 percent.
• As of February 26, 2020, outstanding repurchase agreements (RPs or repos) conducted under OMOs totaled $143.4 billion. Outstanding RPs from these operations ranged from $136.0 billion to $260.0 billion during the period from October 24, 2019, to February 26, 2020. The results of the operations are available at https://www.newyorkfed.org/markets/omo/dmm/temp.cfm.
• As of February 26, 2020, outstanding reverse repurchase agreements (RRPs or reverse repos) conducted under OMOs totaled $2.3 billion. This amount is shown in table 1 as reverse repurchase agreements with others. Outstanding RRPs from these operations ranged from $0 to $64.1 billion during the period from October 24, 2019, to February 26, 2020. Additional information is available at https://www.newyorkfed.org/markets/rrp_op_policies.html and https://www.newyorkfed.org/markets/rrp_faq.html, and the results of the operations are available at https://www.newyorkfed.org/markets/omo/dmm/temp.cfm.

Repos and Reverse Repos

Temporary OMOs are typically used to address reserve needs that are deemed to be transitory in nature. These operations are either repos or reverse repos. Under a repo, the FRBNY Trading Desk buys a security under an agreement to resell that security in the future. A repo is the economic equivalent of a collateralized loan from the Federal Reserve to a primary dealer (the Federal Reserve counterparty in repo operations) and increases bank reserves while the trade is outstanding. The difference between the purchase and sale prices reflects the interest on the loan.

Under a reverse repo, the Trading Desk sells a security from the SOMA under an agreement to repurchase that security in the future. A reverse repo is the economic equivalent of collateralized borrowing by the Federal Reserve from a reverse repo counterparty and reduces bank reserves while the trade is outstanding. The securities temporarily sold under the agreement continue to be shown as assets held by the SOMA in accordance with generally accepted accounting principles. Reverse repos are a tool that is used to manage money market interest rates and provide the Federal Reserve with greater control over short-term rates.

In December 2009, the FRBNY began conducting small-scale reverse repo test operations with primary dealers as a matter of prudent advance planning. Reverse repo test operations were gradually expanded to include a larger group of counterparties (which is described in more detail below), and terms varying from overnight up to about four weeks. From September 2013 to December 2015, the FRBNY conducted a series of overnight reverse repos as a technical exercise for the purpose of further assessing the appropriate structure of such operations in supporting the implementation of monetary policy during normalization. Since the commencement of the monetary policy normalization process in December 2015, the FOMC has authorized the FRBNY to conduct OMOs, including reverse repos, as necessary to maintain the federal funds rate in its target range. Additional information is available at https://www.newyorkfed.org/markets/rrp_op_policies.html and https://www.newyorkfed.org/markets/rrp_faq.html.

In September 2019, the Federal Reserve began conducting overnight repurchase agreement operations, initially in amounts of at least $75 billion, in order to maintain the federal funds rate within the FOMC's target range, and later began conducting term repurchase operations for terms of up to 14 days.⁷ Subsequently, the FOMC announced that overnight and term repurchase agreement operations will continue at least through April 2020 to ensure that the supply of reserves remains ample even during periods of sharp increases in non-reserve liabilities, and to mitigate the risk of money market pressures that could adversely affect monetary policy implementation. These actions are purely technical measures to support the effective implementation of the FOMC's monetary policy, and do not represent a change in the stance of monetary policy. Additional information on repos is available at https://www.newyorkfed.org/markets/rrp_op_policies.html and https://www.newyorkfed.org/markets/repo-agreement-ops-faq.

Repo and reverse repo operations are conducted as competitive auctions or as full-allotment operations in which participants' bids are awarded in full up to a maximum amount at a fixed rate. The results of repo and reverse repo operations are available at https://www.newyorkfed.org/markets/omo/dmm/temp.cfm. Amounts outstanding under repos and reverse repos are reported weekly in tables 1, 2, 4, and 5 of the H.4.1 statistical release.

Expanded Counterparties for Reverse Repos

The FRBNY conducts reverse repos with an expanded set of counterparties that includes entities other than primary dealers. This enhances the Federal Reserve's capacity to conduct large-scale reverse repo operations to drain reserves. The additional counterparties are not eligible to participate in transactions conducted by the FRBNY other than reverse repos. The set of expanded counterparties includes domestic money market funds, GSEs, and banks, and is expected to remain around 150 in number. The FRBNY may amend the list of counterparties at its discretion.

Acceptance as a counterparty is not an endorsement of the firm by the FRBNY and should not be used as a substitute for independent analysis and due diligence by other parties considering a business relationship with the firm. Further information on reverse repo counterparties is available on the FRBNY's website at https://www.newyorkfed.org/markets/rrp_announcements.html, https://www.newyorkfed.org/markets/rrp_counterparties.html, and https://www.newyorkfed.org/markets/counterparties/policy-on-counterparties-for-market-operations.

Reverse Repos with Foreign Official and International Accounts

The Federal Reserve has long operated an overnight reverse repo facility as a service for FCBs and international account holders that choose to hold a portion of their dollar assets at the FRBNY.⁸ Facility participants invest their cash balances with the FRBNY using securities in the SOMA as collateral, at an interest rate that is derived from comparable market-based rates. While reverse repos conducted under this facility are separate from monetary policy operations, such as the overnight and term reverse repo operations described above, they also result in a corresponding decrease in reserves. Amounts outstanding under reverse repos to foreign official and international accounts are shown in table 1. Additional information is available at https://www.newyorkfed.org/aboutthefed/fedpoint/fed20.

Term Deposit Facility

The TDF is a program through which the Federal Reserve Banks offer interest-bearing term deposits to eligible institutions. A term deposit is a deposit at a Federal Reserve Bank with a specific maturity date. The TDF was established to facilitate the conduct of monetary policy by providing a tool that may be used to manage the aggregate quantity of reserve balances held by depository institutions and, in particular (as with reverse repos), to support a reduction in monetary accommodation at the appropriate time. An increase in term deposits outstanding drains reserve balances because funds to pay for them are removed from the accounts of participating institutions for the life of the term deposit.

Term deposits may be awarded either through (1) a competitive single-price auction with a noncompetitive bidding option (which allows institutions to place small deposits at the rate determined in the competitive portion of the operation), (2) a fixed-rate format with full allotment up to a maximum tender amount at an interest rate specified in advance, or (3) a floating-rate format with full allotment up to a maximum tender amount at an interest rate set equal to the sum of the interest rate paid on excess reserves plus a fixed spread. Since September 2014, term deposits have incorporated an early withdrawal feature that allows depositors to obtain a return of funds prior to the maturity date subject to an early withdrawal penalty.

Beginning in June 2010, the Federal Reserve has periodically conducted TDF test offerings as a matter of prudent planning. These offerings are designed to ensure the operational readiness of the TDF and to provide eligible institutions with an opportunity to gain familiarity with term deposit procedures; the operations have no implications for the near-term conduct of monetary policy. Additional information about term deposits, auction results, and future test operations is available through the TDF Resource Center at https://www.frbservices.org/central-bank/reserves-central/term-deposit-facility/index.html.

Securities Lending Program

The Federal Reserve has long operated an overnight securities lending facility as a vehicle to address market pressures for specific Treasury securities. Since July 9, 2009, this facility has also lent housing-related GSE debt securities that are particularly sought after. Amounts outstanding under this facility are reported weekly in table 1A of the H.4.1 statistical release. Additional information on the Securities Lending program is available at https://www.newyorkfed.org/markets/sec_faq.html.

Discount Window Lending

Recent Developments

• Credit provided to depository institutions through the discount window generally remained around its usual level. As presented in table 5, discount window credit outstanding on February 26, 2020, was less than $50 million, and the lendable value of collateral pledged by borrowing institutions on that date was $17.9 billion.
• Effective October 31, 2019, the Board approved a 1/4 percentage point decrease in the primary credit rate, to 2.25 percent.
• Effective March 4, 2020, the Board approved a 1/2 percentage point decrease in the primary credit rate, to 1.75 percent.

Background

The discount window helps to relieve liquidity strains for individual depository institutions and for the banking system as a whole by providing a source of funding in times of need. Much of the statutory framework that governs lending to depository institutions is contained in section 10B of the Federal Reserve Act, as amended. The general policies that govern discount window lending are set forth in the Federal Reserve Board's Regulation A.

Since 2003, depository institutions have had access to three types of discount window credit: primary credit, secondary credit, and seasonal credit. Primary credit is available to depository institutions in generally sound financial condition with few administrative requirements, at an interest rate that is 50 basis points above the FOMC's target rate for federal funds. Secondary credit may be provided to depository institutions that do not qualify for primary credit, subject to review by the lending Reserve Bank, at an interest rate that is 50 basis points above the rate on primary credit. Seasonal credit provides short-term funds to smaller depository institutions that experience regular seasonal swings in loans and deposits. The interest rate on seasonal credit is a floating rate based on market funding rates.

On September 28, 2012, the Federal Reserve began the regular publication of detailed information on individual discount window loans. In accordance with the Dodd-Frank Act, this information will be made available on a quarterly basis and with an approximately two-year lag. The disclosure includes the name and identifying details of the depository institution, the amount borrowed, the interest rate paid, and information identifying the types and amount of collateral pledged. This detailed information supplements the extensive aggregate information the Federal Reserve has previously provided in weekly, monthly, and quarterly reports, and is available on the Federal Reserve's website at https://www.federalreserve.gov/newsevents/reform_quarterly_transaction.htm.

During the financial crisis that began in 2007, the Federal Reserve modified the terms and conditions of the discount window lending programs in order to promote orderly market functioning. Information about these actions is available on the Federal Reserve's website at https://www.federalreserve.gov/monetarypolicy/bst_crisisresponse.htm and https://www.frbdiscountwindow.org/.

Table 3. Discount window credit outstanding to depository institutions

In extending credit through the discount window, the Federal Reserve closely monitors the financial condition of depository institutions using a four-step process designed to minimize the risk of loss to the Federal Reserve posed by weak or failing borrowers. The first step is monitoring, on an ongoing basis, the safety and soundness of all depository institutions that access or may access the discount window and the payment services provided by the Federal Reserve. The second step is identifying institutions whose condition, characteristics, or affiliation would present higher-than-acceptable risk to the Federal Reserve in the absence of controls on their access to Federal Reserve lending facilities and other Federal Reserve services. The third step is communicating—to staff within the Federal Reserve System and to other supervisory agencies, if and when necessary—relevant information about those institutions identified as posing higher risk. The fourth step is implementing appropriate measures to mitigate the risks posed by such entities.

Table 4. Concentration of discount window credit outstanding to depository institutions

At the heart of the condition-monitoring process is an internal rating system that provides a framework for identifying institutions that may pose undue risks to the Federal Reserve. The rating system relies mostly on information from each institution's primary supervisor, including CAMELS ratings, to identify potentially problematic institutions and classify them according to the severity of the risk they pose to the Federal Reserve.⁹ Having identified institutions that pose a higher risk, the Federal Reserve then puts in place a standard set of risk controls that become increasingly stringent as the risk posed by an institution grows; individual Reserve Banks may implement additional risk controls to further mitigate risk if they deem it necessary.

Collateral

All extensions of discount window credit by the Federal Reserve must be secured to the satisfaction of the lending Reserve Bank. Discount window loans are made with recourse to the borrower beyond the pledged collateral. Nonetheless, collateral plays an important role in mitigating the credit risk associated with these extensions of credit. The Federal Reserve generally accepts as collateral for discount window loans any assets that meet regulatory standards for sound asset quality. This category of assets includes most performing loans and most investment-grade securities, although for some types of securities (including commercial MBS, collateralized debt obligations, collateralized loan obligations, and certain non-dollar-denominated foreign securities) only very high-quality securities are accepted. An institution may not pledge as collateral any instruments that the institution or its affiliates have issued.

Assets accepted as collateral are assigned a lendable value deemed appropriate by the Reserve Bank; lendable value is determined as the market price of the asset, less a haircut. Securities are valued using market prices supplied by external vendors. Securities for which a price is not available from the Federal Reserve's pricing vendors receive zero collateral value. Loans pledged as collateral are valued using an internally modeled fair market value estimate. Haircuts reflect credit risk and, for traded assets, the historical volatility of the asset's price and the liquidity of the market in which the asset is traded; the Federal Reserve's haircuts are generally in line with typical market practice.

Table 5. Lendable value of collateral pledged by borrowing depository institutions

A borrower may be required to pledge additional collateral if its financial condition weakens. Collateral is pledged by depository institutions under the terms and conditions specified in the Federal Reserve Banks' standard lending agreement, Operating No. 10, available at https://www.frbservices.org/assets/resources/rules-regulations/071613-operating-circular-10.pdf.

To ensure that they can borrow from the Federal Reserve should the need arise, many depository institutions that do not have an outstanding discount window loan nevertheless routinely pledge collateral. As presented in table 6, depository institutions that borrow from the Federal Reserve generally maintain collateral in excess of their current borrowing levels.

Table 6. Discount window credit outstanding to borrowing depository institutions—percent of collateral used

The Federal Reserve periodically reviews its collateral margins and valuation practices. The current lending margins on discount window collateral took effect on July 1, 2019, and reflect the results from the most recent such review as well as the incorporation of updated market data. Additional information on collateral margins is available on the Discount Window and Payment System Risk website, https://www.frbdiscountwindow.org/.

Liquidity Arrangements with Foreign Central Banks

Recent Developments

• As presented in table 7, as of February 26, 2020, dollar liquidity extended under the central bank liquidity swap arrangements totaled less than $50 million. Detailed information about swap operations is available at https://apps.newyorkfed.org/markets/autorates/fxswap.

Table 7. Amounts outstanding under U.S. dollar liquidity swaps

Background

Because of the global character of bank funding markets, the Federal Reserve has at times coordinated with other central banks to provide liquidity. Starting in December 2007, the Federal Reserve entered into agreements to establish temporary currency arrangements (central bank liquidity swap lines) with several FCBs in order to provide liquidity in U.S. dollars. Later, foreign currency liquidity swap lines were established with a few FCBs. These temporary arrangements expired on February 1, 2010.

In May 2010, temporary U.S. dollar liquidity swap lines were reestablished with the Bank of Canada, the Bank of England, the Bank of Japan, the European Central Bank, and the Swiss National Bank in order to address the reemergence of strains in global U.S. dollar short-term funding markets. The FOMC authorized extensions of these temporary arrangements in December 2010 and June 2011. On November 30, 2011, as a contingency measure, the FOMC agreed to establish temporary foreign currency liquidity swap arrangements that would allow for the Federal Reserve to access liquidity, if necessary, in any of these FCBs' respective currencies. In December 2012, the FOMC and these five FCBs authorized an extension of the temporary U.S. dollar and foreign currency liquidity swap arrangements through February 1, 2014.

The temporary swap arrangements helped to ease strains in financial markets and mitigate their effects on economic conditions. In October 2013 the Federal Reserve and FCBs announced the conversion of these temporary swap lines to standing arrangements that will remain in place until further notice and will continue to serve as a prudent liquidity backstop. The standing arrangements constitute a network of bilateral swap lines among the six central banks that allow provision of liquidity in each jurisdiction in any of the five currencies foreign to that jurisdiction. Additional information is available at https://www.federalreserve.gov/newsevents/press/monetary/20131031a.htm.

Since the establishment of the central bank liquidity swap lines in 2007, the Federal Reserve has at times provided U.S. dollar liquidity to FCBs but, except for pre-arranged small-value test operations, has not drawn on any foreign currency liquidity swap lines. The FRBNY operates the swap lines under the authority granted under section 14 of the Federal Reserve Act and in compliance with authorizations, policies, and procedures established by the FOMC. Additional information is available at https://www.newyorkfed.org/markets/international-market-operations/central-bank-swap-arrangements and https://www.federalreserve.gov/monetarypolicy/bst_swapfaqs.htm.

U.S. dollar liquidity swaps consist of two transactions. When an FCB draws on its swap line with the FRBNY, the FCB transfers a specified amount of its currency to the FRBNY in exchange for dollars at the prevailing market exchange rate. The FRBNY holds the foreign currency in an account at the FCB. The dollars that the FRBNY provides are then deposited in an account that the FCB maintains at the FRBNY. At the same time, the FRBNY and the FCB enter into a binding agreement for a second transaction that obligates the FCB to return the U.S. dollars and the FRBNY to return the foreign currency on a specified future date at the same exchange rate as the initial transaction. Because the swap transactions will be unwound at the same exchange rate used in the initial transaction, the recorded value of the foreign currency amounts is not affected by changes in the market exchange rate. At the conclusion of the second transaction, the FCB compensates the FRBNY at a market-based interest rate.

When the FCB lends the dollars it obtained by drawing on its swap line to institutions in its jurisdiction, the dollars are transferred from the FCB account at the FRBNY to the account of the bank that the borrowing institution uses to clear its dollar transactions. The FCB is obligated to return the dollars to the FRBNY under the terms of the agreement. Neither the FRBNY nor the Federal Reserve is counterparty to the loan extended by the FCB. The FCB bears the credit risk associated with the loans it makes to institutions in its jurisdiction.

The foreign currency that the Federal Reserve acquires in these transactions is recorded as an asset on the Federal Reserve's balance sheet and is shown in tables 1, 4, and 5 of the weekly H.4.1 statistical release in the line entitled "Central bank liquidity swaps." U.S. dollar liquidity swaps have maturities ranging from overnight to three months. Table 2 of the H.4.1 statistical release reports the maturity distribution of the outstanding U.S. dollar liquidity swaps. Detailed information about drawings on the swap lines by the participating FCBs is presented on the FRBNY's website at https://apps.newyorkfed.org/markets/autorates/fxswap.

References