Criteria for Central Bank Assets: Lessons from Pre-ECB Germany
Nelson, William R., New England Economic Review
The Deutsche Bundesbank was formed in July 1957, when the two-tier central bank system set up following World War II was consolidated. (1) That previous system had been established by the Allies in imitation of the Federal Reserve System and consisted of independent regional banks (the Land Central Banks) and a governing body. Under the new system, the Land Central Banks became offices of the Bundesbank. As was true under the previous system, the Bundesbank was made independent of the federal cabinet by law and was particularly proscribed from lending to the public sector except for short terms. Acquisitions of public debt occurred exclusively in the open market. (2)
Before the establishment of the European Central Bank, the operating procedures of the Bundesbank included two lending facilities: the rediscount facility, which provided loans at the discount rate, and Lombard loans, at the Lombard rate, which generally was about 1.5 percentage points above the discount rate. The discount rate was maintained below market rates and discount credit was limited to a "rediscount quota." The discount rate acted as an approximate floor on market interest rates, because banks could reduce their use of the discount facility when market interest rates fell below the discount rate; however, the extent of substitution was limited by the amount of rediscounted bills coming due. The Lombard rate, which was generally above market rates, acted as a ceiling on market rates.
Beginning in 1979-81, and with a marked increase in 1985, the Bundesbank also engaged in repurchase agreements to adjust the level of bank reserves. The frequency with which these repurchase agreements were offered rose over the years, while the maturity of the agreements fell; by the late 1990s, they were offered once a week with a two-week maturity. (3) The Bundesbank engaged in both variable-rate and fixed-rate repos. The variable-rate tender allowed for a market-determined interest rate outcome, while the fixed-rate tender allowed the Bundesbank to provide a clearer signal of its policy stance. (4)
Instruments Eligible for Rediscount (5)
The Bundesbank was allowed to rediscount two sorts of instruments: Treasury bills issued by the federal government; and trade bills employed on the basis of deliveries of goods or services, falling due within three months and backed by three parties known to be solvent, or two parties if the bill was insured in some other way. In practice, the Bundesbank did not generally rediscount the Treasury bills of depository institutions; instead, it either discounted the bills directly with the Treasury or it bought them in the open market. Foreign bills were purchased only if they had been drawn on foreign trade transactions of a domestic enterprise.
The rediscount quotas were based on a credit institution's capital, with adjustments for the extent to which the institution held bills available for discount. (6) In addition, the quotas were adjusted up or down by a standard multiplier to achieve the aggregate level of potential rediscounts desired by the Bundesbank. Quotas were reduced if the credit institution was not fully in compliance with supervisory standards for capital and liquidity or for other misconduct. At least historically, the ability to restrict rediscount quotas was an important regulatory tool of the Bundesbank, perhaps explaining why the formulas for the quotas remained opaque and judgmental. (7) Quotas were generally fixed for one year.
Collateral for Lombard Loans (8)
Lombard loans were made against instruments eligible for rediscount (Treasury bills and trade bills), federal Treasury discount securities, other federal debt securities, other debt securities deemed acceptable by the Bundesbank, and equalization claims (claims on the federal government that were granted to banks and enterprises that experienced losses as a result of the currency reform of 1948 and the monetary union with the former Democratic Republic of Germany in 1990). …