How Central Bank Lending Supports the Economy

Central banks play a crucial role in supporting the economy through lending. By providing loans to banks and other financial institutions, central banks increase the money supply and stimulate economic growth.

Central banks can also implement monetary policies to control inflation and stabilize the economy. For example, they can raise interest rates to reduce borrowing and spending.

Lending from central banks helps to ensure that credit is available to those who need it, such as small businesses and individuals. This can be particularly important during times of economic uncertainty.

By supporting the economy through lending, central banks help to promote economic stability and growth.

Central banks use various types of lending to manage the economy and stabilize the financial system. One common type is outright lending, where the central bank lends a fixed amount of money to a borrower for a specified period.

Outright lending is often used to provide liquidity to the financial system during times of stress. Central banks can lend money to commercial banks, which can then use it to make loans to households and businesses.

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Another type of lending is repo lending, where the central bank lends money to a borrower in exchange for collateral, typically government securities. This type of lending is commonly used to provide liquidity to the financial system during times of stress.

Repo lending allows central banks to lend money quickly and easily, as it doesn't require a lengthy application process. The borrower repays the loan with interest, and the central bank returns the collateral.

Central banks have various funding and loan facilities to support the financial system during times of need. The Bank of Korea may extend special loans to financial institutions and for-profit enterprises in emergency situations.

In the case of financial institutions, emergency credit may be extended with the concurrence of at least four members of the Monetary Policy Board, against the collateral of any assets temporarily defined as acceptable securities. This can occur when financial institutions' liquidity deteriorates due to imbalances between financing and use of funds, or when they experience pronounced difficulty in carrying out their operations due to temporary shortages of funds.

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The Federal Reserve has also established several facilities to support the flow of credit, including the Term Asset-Backed Securities Loan Facility (TALF) and the Temporary Foreign and International Monetary Authorities (FIMA) Repo Facility. These facilities aim to maintain the supply of credit to U.S. households and businesses.

Here are some of the key facilities established by central banks to support the financial system:

The Federal Reserve has established several funding and loan facilities to support the flow of credit to households and businesses during times of strain. The Commercial Paper Funding Facility (CPFF) was established on March 17, 2020, to support the flow of credit to households and businesses by ensuring the smooth functioning of the commercial paper market.

The CPFF provided credit that supported families, businesses, and jobs across the economy. The Primary Dealer Credit Facility (PDCF) was also established on March 17, 2020, to support the credit needs of American households and businesses. Primary dealers were able to use the PDCF to support smooth market functioning and facilitate the availability of credit to businesses and households.

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The Temporary Foreign and International Monetary Authorities (FIMA) Repo Facility was established to help support the smooth functioning of financial markets, including the U.S. Treasury market. This facility allowed FIMA account holders to enter into repurchase agreements with the Federal Reserve.

The Primary Market Corporate Credit Facility (PMCCF) was established on March 23, 2020, to support credit to employers through bond and loan issuances. The PMCCF provided companies access to credit so that they were better able to maintain business operations and capacity during the period of dislocations related to the pandemic.

The Term Asset-Backed Securities Loan Facility (TALF) was also established on March 23, 2020, to support the flow of credit to consumers and businesses. The TALF enabled the issuance of asset-backed securities backed by student loans, auto loans, credit card loans, loans guaranteed by the Small Business Administration (SBA), and certain other assets.

Here are some of the key facilities established by the Federal Reserve to support funding and lending:

Deposit Facilities play a crucial role in maintaining the stability of financial markets. They allow financial institutions to borrow or deposit funds with the central bank, such as the Bank of Korea or the Federal Reserve.

Liquidity adjustment loans and deposits, introduced by the Bank of Korea in March 2008, enable financial institutions to borrow from the central bank to make up for fund shortages or deposit surplus funds. These loans and deposits have maturities of one business day.

The interest rates on liquidity adjustment loans and deposits are set 50 basis points above and below the central bank's Base Rate, respectively. This helps prevent the call rate from deviating significantly from the Base Rate in the call market.

The Bank of Korea also offers the Bank Intermediated Lending Support Facility, which has maturities of one month and interest rates generally lower than the Base Rate. This facility aims to strengthen incentives for banks to lend to SMEs and other enterprises.

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Here's a summary of the deposit facilities mentioned:

These deposit facilities demonstrate the central banks' efforts to maintain financial stability and support the smooth functioning of financial markets.

Intraday overdrafts were introduced in September 2000 to provide temporary financial support to banks experiencing shortages of settlement funds.

Financial institutions subject to reserve requirements and participating in BOK-Wire are eligible for intraday overdrafts.

These overdrafts serve to stimulate fund transactions among financial institutions and corporations using those institutions.

In the event of a bank failing to redeem its borrowings by the close of the business day, the non-redeemed amount is converted into a liquidity adjustment loan.

Liquidity adjustment loans are provided on an interest-free basis, but a certain level of interest is applied on loans exceeding 25% of a financial institution's equity capital.

The interest rate applied to these loans is equivalent to the spread between yields on three-year Treasury bonds and the uncollateralized overnight call rate during the last month of the immediately preceding quarter.

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The Federal Reserve established several emergency lending programs to support the economy during the pandemic. The Money Market Mutual Fund Liquidity Facility (MMLF) provided loans to eligible financial institutions secured by high-quality assets purchased from money market mutual funds.

The MMLF helped money market funds meet demands for redemptions, enhancing overall market functioning and credit provision to the broader economy. This was crucial for households and businesses that relied on these funds as investment tools.

The Federal Reserve also established the Primary Market Corporate Credit Facility (PMCCF) and the Secondary Market Corporate Credit Facility (SMCCF) to support credit to employers. The PMCCF provided companies access to credit, while the SMCCF purchased corporate bonds in the secondary market.

Here are the emergency lending programs established by the Federal Reserve:

The Main Street Program was established by the Federal Reserve to support lending to small and medium-sized businesses and nonprofit organizations in sound financial condition before the pandemic.

The program operated through five facilities, each designed to provide a specific type of loan to eligible businesses. These facilities included the Main Street New Loan Facility, the Main Street Priority Loan Facility, and the Main Street Expanded Loan Facility.

The Main Street Program aimed to provide much-needed support to businesses struggling to stay afloat during the pandemic. The facilities operated by the program offered a range of loan options to help businesses access the capital they needed to survive.

Here are the five facilities that made up the Main Street Program:

The Secondary Market Corporate Credit Program was established by the Federal Reserve on March 23, 2020, to provide liquidity to the market for outstanding corporate bonds.

The program purchased corporate bonds issued by investment grade U.S. companies or certain U.S. companies that were investment grade as of March 22, 2020.

The Treasury made an equity investment in a Special Purpose Vehicle (SPV) established by the Federal Reserve for the Secondary Market Corporate Credit Facility and the Primary Market Corporate Credit Facility.

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This program supported credit to employers by providing liquidity to the market for outstanding corporate bonds.

The Secondary Market Corporate Credit Facility purchased U.S.-listed exchange-traded funds whose investment objective is to provide broad exposure to the market for U.S. corporate bonds.

The Treasury used funds appropriated to the Exchange Stabilization Fund (ESF) through the CARES Act for the equity investment.

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The Paycheck Protection Program Liquidity Facility (PPPLF) is a program designed to help small businesses keep their employees on the payroll. The Federal Reserve is providing liquidity to participating financial institutions through term financing backed by PPP loans.

The PPPLF will extend credit to eligible financial institutions that originate PPP loans, taking the loans as collateral at face value. This means that the financial institutions can borrow money to fund their PPP loans.

The Paycheck Protection Program (PPP) provides loans to small businesses so they can keep their workers on the payroll. The PPPLF is a way to support the effectiveness of the PPP.

Here's a quick summary of the PPPLF:

Liquidity swaps and facilities are an important tool for central banks to provide liquidity to financial institutions and support the flow of credit to households and businesses. They can be used to address shortages of funds and provide stability to the financial system.

The Bank of Korea's Liquidity Adjustment Loans and Deposits, introduced in March 2008, allow financial institutions to borrow from the Bank of Korea to make up for fund shortages. The interest rates on these loans are 50 basis points above the Bank of Korea Base Rate.

In times of crisis, central banks can also establish special facilities to provide liquidity to specific markets. For example, the Federal Reserve's Money Market Mutual Fund Liquidity Facility (MMLF) was established in March 2020 to support the flow of credit to households and businesses. The MMLF made loans available to eligible financial institutions secured by high-quality assets purchased by the financial institution from money market mutual funds.

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The Bank of Canada, the Bank of England, the Bank of Japan, the European Central Bank, the Federal Reserve, and the Swiss National Bank have also taken coordinated action to enhance the provision of liquidity via the standing U.S. dollar liquidity swap line arrangements. This is an example of how central banks can work together to provide stability to the global financial system.

Here's a brief overview of some of the key facilities:

Liquidity Loans and Deposits are a type of standing facility that allows financial institutions to borrow from the Bank of Korea to cover shortages of funds or deposit surplus funds. They were introduced in March 2008.

The eligible financial institutions are those subject to holding of required reserves, and these loans and deposits have a maturity of just one business day. This is a relatively short period, and it's likely that financial institutions will need to replenish their funds quickly.

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The interest rates on liquidity adjustment loans and deposits are set 50 basis points above and below the Bank of Korea Base Rate, respectively. This helps to keep the call rate in line with the Base Rate, preventing it from deviating too widely.

Individual financial institution quotas are allocated based on their performance in areas such as trade financing, loans to start-up SMEs, and other fund operating performance. This ensures that the loans and deposits are distributed fairly and efficiently.

The Bank Intermediated Lending Support Facility for regional branches of the Bank of Korea is distributed to different regions based on their economic situations and the performance of financial institutions in extending loans to regionally-based SMEs. This helps to support economic growth in different areas.

The interest rates on the Bank Intermediated Lending Support Facility are generally kept lower than the Base Rate, which strengthens the incentives for banks to lend to SMEs and other enterprises. These loans have a maturity of one month, which is a relatively short period.

Here's a summary of the key features of Liquidity Loans and Deposits:

The Municipal Liquidity Facility was established by the Federal Reserve to help state and local governments manage cash flow pressures.

The facility was designed to purchase up to $500 billion of short-term notes directly from eligible issuers, including U.S. states, counties, and cities with a population of at least 250,000 residents.

Eligible state-level issuers can use the proceeds to support additional counties and cities, helping to ensure the flow of credit and liquidity to these governments.

The Federal Reserve will closely monitor conditions in the primary and secondary markets for municipal securities, evaluating whether additional measures are needed to support the flow of credit and liquidity.

Here are the details about the Municipal Liquidity Facility:

The Money Market Mutual Fund Liquidity Facility (MMLF) was established by the Federal Reserve on March 18, 2020, to support the flow of credit to households and businesses.

The MMLF made loans available to eligible financial institutions secured by high-quality assets purchased from money market mutual funds. These funds are common investment tools for families, businesses, and companies.

The facility assisted money market funds in meeting demands for redemptions by households and other investors, enhancing overall market functioning and credit provision to the broader economy.

A standing lending facility, or SLF, is a type of lending facility that lends on a bilateral and on-demand basis, rather than in the open market through scheduled auctions.

The Fed's discount window is an example of an SLF, and it's not the only one - the ECB calls it the marginal lending facility, the BoJ calls it the complementary lending facility, and the BoE uses two SLFs: the operational SLF (OSLF) and the discount window facility (DWF).

The OSLF usually lends overnight and is used for monetary policy purposes, while the DWF lends on a longer-term basis and serves a financial stability purpose.

SLFs are normally considered financial stability tools, but they also serve a monetary policy role by limiting upward pressure on interest rates by providing loans to individual institutions that might experience urgent funding needs.

In fact, most SLFs have a financial stability purpose, providing credit to the financial sector broadly during crises.

The Fed's discount window, for example, can be used to set a ceiling in the interest rate corridor, which is a key function of SLFs.

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