Settlement accounts
Banks and other financial institutions hold settlement cash accounts with the RBNZ (within the Exchange Settlement Account System (ESAS)) and use these accounts to settle payments between each other.
The interest rate earned on settlement cash balances flows through the financial system via wholesale interest rates to retail banking interest rates, which impact borrowing and saving rates for New Zealanders.
Market participants who do not have an ESAS account can still access our facilities and operations. This allows a broader range of market participants to access interest rates near the OCR.
Exchange Settlement Account System
About the monetary policy implementation framework
We operate a floor system of monetary policy implementation, which means we remunerate all settlement cash balances at the OCR. This ensures that short-term market interest rates are anchored at the OCR and means that there is no incentive for banks to lend settlement cash below this rate in the market. This creates a ‘floor’, which acts to keep short-term interest rates from coming under downward pressure.
Under the floor system we can implement monetary policy via the OCR, but also any use of additional monetary policy tools. This is because the floor system is robust and able to manage large changes to the settlement cash level; what is important is the price (the OCR), not the quantity.
This system also keeps operations simple, for both us and the wider banking system, because the focus is on maintaining settlement cash above a sufficient level rather than tightly managing changes in settlement cash. The current floor system best ensures our monetary policy implementation and payment system objectives are met.
New Zealand’s Monetary Policy Implementation Framework
Our balance sheet
Under the floor system, we need to supply enough settlement cash to keep short-term interest rates near the OCR and to provide for payment and settlement needs. Settlement cash is a liability on our balance sheet and has a corresponding asset that also sits on our balance sheet.
During the COVID period, our balance sheet increased due to the use of Alternative Monetary Policy (AMP) tools. The Large Scale Asset Purchase (LSAP) programme increased the size of our balance sheet: on the asset side, we hold the bonds we purchased; on the liability side, the level of settlement cash held by settlement accountholders increased. The Funding for Lending (FLP) also increased the size of our balance sheet: on the asset side, we hold the collateral transaction with the banks to secure the lending; on the liability side the level of settlement cash held by settlement accountholders increased.
As AMP tools wind down, this level of settlement cash will also wind down. The commercial banks will not be able to keep their settlement cash balances high as this wind down occurs.
We expect to return to a lower level of settlement cash that is sufficient for payment and settlement needs and that anchors short-term interest rates near the OCR. This level will likely be higher than the pre-COVID level, but lower than the high levels after the use of AMP tools. It will be prudent to maintain a buffer above this sufficient level to avoid unnecessary volatility in short-term interest rates or the need for excessive cash management operations.
As this AMP tool wind-down occurs, we will reach a point at which we may need to inject settlement cash via other tools, to maintain a sufficient level. At this point, the liability – settlement cash – on our balance sheet will be maintained, but the composition of the assets that correspond to this liability will change. These assets will change from being those corresponding with AMP tools, to those corresponding with the appropriate mix of liquidity providing tools or operations.