16 May 2007

Amendments to Rules on Transactions by Financial Companies with the Central Bank of Iceland

Rules on Transactions by Financial Companies with the Central Bank of Iceland have been under review in recent weeks. The new rules are planned to enter into force in coming weeks. The amendments are largely of a technical nature and do not warrant detailed discussion. However, the review also involves changes that need to be explained, in particular in two respects.

The first is the decision to rename the Central Bank’s lending facility for financial companies to which the policy rate applies. This facility has been known as repurchase agreements (repos). Strictly speaking, however, this facility has not involved a repurchase agreement, but a loan against collateral. Henceforth the facility will be referred to by its technically correct name and the policy rate will continue to apply to the Central Bank’s main facility for financial companies, i.e. collateral loans.

The second change relates to the numerical presentation of the policy interest rate. Until now, the policy rate that the Central Bank has published in its interest rate announcements has strictly speaking been the annual rate of return and not the nominal interest rate. It has now been decided that all Central Bank interest rates will in future be stated and announced as nominal rates. When interest rates are calculated more than once a year, this means that the nominal interest rate will be lower than the yield. Since December 2006, the yield on Central Bank loan facilities for financial companies has been 14.25% p.a. The Central Bank’s policy rate has generally been referred to as 14.25%. Most central banks adopt a different approach and state their policy rates in nominal terms. One consequence has been to produce misleading comparisons between the policy rate of the Central Bank of Iceland and other central banks. For example, the nominal rate corresponding to an annual return of 14.25% on Central Bank loans against collateral is 13.31%. Thus in comparing the Central Bank of Iceland’s policy rate with that of other central banks, the logical figure to use would currently be 13.31% and not 14.25%.

When the new Rules on Transactions by Financial Companies with the Central Bank of Iceland enter into force, it is planned to change the presentation of the policy rate at the same time. This will not involve any change in the policy rate itself.


No. 9/2007

May 16, 2007