CBI market activity and policy instruments
The main purposes of the Central Bank of Iceland’s market activities are to support monetary policy transmission, thereby supporting price stability, and to preserve financial stability.
Market transactions in support of monetary policy
The objective of transactions undertaken in support of monetary policy is to steer the supply of liquidity in circulation at any given time, affect interbank market interest rates, and thereby promote the transmission of monetary policy across the yield curve in order to achieve the Bank’s price stability objective.
Decisions on applying the Central Bank's monetary policy instruments are taken by the Monetary Policy Committee; cf. Article 9 of the Act on the Central Bank of Iceland.
Market transactions in support of financial stability
The objective of market transactions undertaken in support of financial stability lies in providing counterparties access to liquidity in response to an unexpected and temporary liquidity shortage that could affect market efficiency or payment intermediation, or could otherwise cause instability.
Decisions on the application of the Central Bank’s financial stability policy instruments are taken by the Financial Stability Committee; cf. Article 12 of the same Act.
Rules on Central Bank of Iceland Facilities for Financial Undertakings
The Central Bank sets rules on transactions between financial institutions and the Bank. The rules currently in effect are the Rules on Central Bank of Iceland Facilities for Financial Undertakings, no. 1200/2019, with subsequent amendments. The rules stipulate, among other things, who may be counterparties in transactions with the Central Bank, what types of transactions may take place, and what type of collateral the Bank deems eligible for loan facilities. The rules are reviewed and amended as needed.
Counterparties in transactions with the Central Bank
Counterparties in transactions with the Central Bank are commercial banks and savings banks. Icelandic branches of foreign financial institutions may also conduct transactions with the Central Bank. Although financial institutions are authorised to conduct transactions with the Bank, they are free to choose whether or not to do so.
Overnight loans and current accounts
Overnight loans are loans that mature on the following business day. Their purpose is to ensure that interbank payment system participants always have a positive end-of-day balance. Overnight loans are granted against collateral deemed eligible by the Central Bank.
They bear higher interest rates than other loan facilities. Overnight lending rates form the ceiling of the Central Bank interest rate corridor and the ceiling for overnight rates in the interbank market. Commercial banks and savings banks may hold deposits with the Central Bank, which bear interest at the current account rate. The Bank pays interest on the entire balance, irrespective of the amount. Current accounts are subject to the Rules on Current Accounts in the Central Bank of Iceland, no. 18/2022.
Part A Government-owned institutions may hold current accounts with the Central Bank.
It is prohibited to overdraw accounts with the Central Bank.
Weekly market transactions
On Wednesdays, the Central Bank invites counterparties to participate in its market transactions.
For monetary policy transmission, market conditions determine whether the Bank offers loans or term deposits to financial institutions. The Bank adheres to the general rule of not offering loans and term deposits at the same time; however, in January 2022 the Bank opened a special liquidity window through which counterparties may take fourteen-day collateralised loans so as to preserve financial stability. In exceptional cases, the Bank may deviate from the general rule of not offering loans and term deposits simultaneously if it deems such deviation necessary.
Financial institutions’ liquidity position can change markedly from day to day, owing in part to activity on Treasury accounts. Monthly wage payments increase the amount of krónur in circulation, for instance, and payments of taxes and levies to the Treasury reduce it.
The Bank may conduct transactions with counterparties via Central Bank facilities or in the markets. Differing circumstances can call for different types of facilities and policy instruments. Sometimes, facilities are not used for several years, yet they remain available if needed.
Seven-day term deposits
The Central Bank offers seven-day term deposits on Wednesdays. The interest rate on the deposits is 0.25 percentage points above the current account rate. The deposits may be withdrawn before the end of the seven-day commitment period, subject to a redemption fee. After the market close on Tuesdays, the Central Bank announces the amount on offer the following day. Counterparties wishing to participate in the auction submit bids, subject to a maximum of 60% of the total amount available. If the combined amount of bids submitted exceeds the total amount on offer, the total amount is divided among the counterparties in equal proportions. Seven-day term deposits have been offered on a weekly basis since May 2014.
Fourteen-day collateralised loansOn Wednesdays, Central Bank counterparties are invited to apply for fourteen-day collateralised loans through the liquidity window, at an interest rate 0.5 percentage points above the Bank’s seven-day collateralised lending rate; cf. the press release of 14 January 2022. Interest rates on loans taken through the liquidity window are variable and are based on Central Bank rates at any given time. Central Bank counterparties may apply for a loan of up to 5 b.kr. versus collateral according to the Bank’s list of assets deemed eligible as collateral for Central Bank facilities. Counterparties are prohibited from taking loans if they simultaneously hold term deposits with the Bank. Fourteen-day collateralised loans have been offered each week since January 2022.
Minimum reserve requirements
The Central Bank imposes reserve requirements on entities subject to such requirements, mainly deposit-taking institutions. Reserve requirements are provided for in the Rules on Minimum Reserve Requirements, no. 585/2018, and Rules no. 1218/2019 amending the Rules on Minimum Reserve Requirements, no. 585/2018. Reserve requirements are satisfied via financial institutions’ reserve accounts with the Central Bank. The minimum reserve requirement is calculated as a percentage of the reserve base, which comprises deposits, plus bonds with a residual maturity of two years or less and issued by the financial institution concerned. The calculation is based on the average reserve base for the two months immediately preceding. The reserve amount is the requirement that an entity subject to reserve requirements must maintain on a daily basis over the reference period (reserve maintenance period), which extends from the 21st day of the month through the 20th day of the following month. The minimum reserve requirement is divided into a fixed reserve requirement and an average maintenance requirement.
Since 21 March 2020, the minimum reserve requirement has been 1% of the reserve base, and only the fixed reserve requirement has been imposed.
Secondary market purchases of Treasury bonds
Foreign exchange market transactionsThe Central Bank can conduct transactions with market makers in the interbank foreign exchange market in order to mitigate exchange rate volatility as it deems necessary, to deepen the market, or to improve market efficacy. The Bank has both intervened in the market and conducted regular, preannounced transactions. The amount of krónur owned by market makers increases if the Bank buys foreign currency, and it decreases if the Bank sells currency. The Bank’s foreign currency transactions therefore affect liquidity in circulation unless mitigating action is taken. The Central Bank publishes interbank foreign exchange market turnover data on the Statistics pages of its website.
Other policy instruments
The Central Bank has other policy instruments at its disposal in addition to those mentioned above, chiefly to include the following:
- The Bank may grant loans for both shorter and longer periods, but all loans that it grants are collateralised, as the Bank may not loan funds except against collateral that it deems acceptable. The seven-day collateralised lending rate is at the centre of the interest rate corridor.
- Repurchase (repo) transactions are contracts made between two parties who agree on the purchase or sale of securities that the Bank deems eligible for such transactions. A repo agreement has a predetermined maturity date, at which time the transaction is reversed. The Central Bank has not engaged in such transactions for a long time.
- The Bank can issue marketable securities in the form of bonds and bills and can sell them to counterparties. The securities are electronically registered at the securities depository, and their terms are set at the time of each issue.
- The Bank can offer term deposits for short or long periods. Term deposits have the same impact on liquidity as bonds and bills; i.e., the Central Bank draws liquidity out of the financial system.
The Central Bank and the Treasury
According to the Act on the Central Bank of Iceland, the Bank serves as the commercial bank for the Treasury. Both the Treasury and various Government institutions are authorised to hold current accounts with the Central Bank. Interest rates on Government institutions’ current accounts are the same as those on financial institutions’ current accounts with the Central Bank. The Treasury is prohibited from overdrawing its accounts with the Central Bank.
Terms and Conditions
Here you can find terms and conditions for term deposits between the Central Bank of Iceland and its counterparties.