Canadian Manufacturing

Bank of Canada mulls tools to boost market liquidity

The bank says the last financial showed the importance of maintaining liquidity, and how its absence can amplify financial distress



OTTAWA—The Bank of Canada is aiming to use lessons learned during the global financial crisis as a way to help cushion the country’s own system against future periods of stress.

The central bank announced several proposed changes it believes would help inject beneficial amounts of liquidity into the markets amid any tumult down the road.

Speaking in Montreal, senior deputy governor Carolyn Wilkins described the recommendations as a sharpening of the bank’s tools during the current stretch of relative market calm.

“And, should another major bout of liquidity turmoil arise, we will be ready,” Wilkins told the Montreal Chamber of Commerce.

Liquidity is a measure of the ease and speed at which individuals or organizations can buy and sell assets or benefit from reliable access to business financing at a reasonable rate.

For example, buying and selling a house is quite illiquid because of factors like the time and the high transaction costs involved in making a deal. On the other hand, stock market transactions are quick and relatively inexpensive.

Wilkins noted that liquidity affects all Canadians, whether they’re aware of it or not.

The bank, she said, learned during the last crisis about the importance of maintaining liquidity in the markets _ and how its absence can amplify financial distress.

“A solid economy rests on reliable funding and market liquidity,” she said.

“If we all do our part, a more robust financial system will emerge to the benefit of the people it ultimately serves: businesses and households who save and borrow.”

The bank outlined the recommendations in two consultation papers posted on its website Tuesday. It is accepting public input on the updates until July 4.

Wilkins listed several ways the bank proposes to enhance liquidity, such as limiting its emergency lending program to institutions that have a credible recovery plan in place. During a crisis, the central bank can act as a lender of last resort to boost liquidity as a way to help prevent or address financial instability.

In other proposals, the bank would reduce the number of “benchmark government bonds” it buys and it would set up a regular program for term repurchase agreements. These “repo” deals involve bonds sold on condition they will be repurchased by the seller at a later date.

CIBC economist Nick Exarhos said that amid the increased uncertainty of a crisis the central bank can also boost liquidity by offering guidance, or more transparency, to the markets about where it’s headed with regard to its trend-setting interest rate.

Analysts typically dissect every word uttered by senior Bank of Canada officials in search of rate-related hints.

“You’re increasing liquidity by creating, sort of, a predictable and stable backdrop,” Exarhos said.

On the other hand, he said surprising markets by moving the rate with little or no warning _ like the Bank of Canada did with its January cut _ erodes the confidence of those hoping to trade. Such moves can reduce liquidity, he said.

Wilkins’ speech did not offer any insight into the bank’s thinking on when it might move its key rate.

In fact, before announcing the recommended changes, Wilkins stressed that audience members avoid reading too much into what she was about to say.

“First of all, I want to underline that these proposals should not be viewed as clues about current or future monetary policy,” she said.

The Bank of Canada’s next rate announcement is scheduled for May 27.

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