Band 1 dealing rates
Following discussion papers and consultation with relevant parties, the Bank's operating techniques in the money market were changed in stages, beginning in October 1980. The formal arrangements were set out in the Bank's paper "Monetary Control Provisions"; these began to take effect on 20 August 1981 when MLR was suspended. The Bank was able, however, at its discretion, to announce in advance the minimum rate which it would apply in any lending to the market. MLR has been invoked on numerous subsequent occasions for one day only. The reserve ratio requirements were discontinued and the cash ratio scheme introduced. The special deposit scheme remained available.
The Bank's initial aim was to keep very short-term interest rates within an unpublished band, set by the authorities, to establish a specific level of interest rates. Any lending would normally be at a rate above comparable market rates, but within the band. There were 4 dealing bands ranging from Band 1 to Band 4 with maturities of 1-14 days, 15-33 days, 34-63 days and 64-91 days. Most typically the Bank dealt in Band 1. Operating in such maturity ranges was necessary for outright purchases because if the Bank had specified a single maturity date, the market may have had difficulty mobilising sufficient paper maturing on that specific date at short notice.
The Bank's intervention in the money markets placed greater emphasis on open-market operations (as opposed to direct lending) in the bill markets, principally through members of the London Discount Market Association (LDMA). The Bank operated with the broad intention of offsetting daily cash flows, in either direction, between the Bank and the money market.
There was an extension of the list of eligible banks that were required to hold a minimum proportion of their eligible liabilities in secured deposits with members of the LDMA. This ensured that during periods of extreme money market shortages, the Discount Houses could effectively perform their role as intermediaries.
In supplying liquidity to the market, the Bank operated primarily through the discount houses, buying Treasury bills and eligible local government and bank bills either outright or on 'repo' (sale and repurchase agreements) to meet anticipated surpluses/shortages. The Bank aimed to supply on a daily basis whatever liquidity was necessary. Depending on the size of the day's shortage, the Bank operated up to three times a day, offering to buy bills. If this was insufficient to deal with the shortage, the Bank lent on a secured basis to the discount houses at the end of the day (up to an amount linked to their capital).
With the end of pre-determined dealing rates, the discount houses competed to sell paper to the Bank, including repo, (or buy from it when in surplus), through their choice of rates at which they could afford to do business. The Bank influenced interest rates by its reactions to these offers. If the Bank was content with these offers, it would accept sufficient amounts to ensure the market was in balance. However, if these offers conflicted with the Bank's higher interest rate objective, all or part of the offers were rejected. The Bank then declined to deal in the bill markets or limited its dealings so forcing those houses that were short of cash to borrow. The Bank then set a lending rate consistent with the level it was seeking to establish.
After 1991, there was at times a sizeable increase in the amount of liquidity the Bank has had to supply day-by-day to relieve the banking system's shortage. This largely arose from movements in Government financing and because the discount houses had generally shrunk in size. To overcome this problem, the Bank introduced a twice-monthly repo operation in 1994 which built on the temporary arrangements introduced in September 1992 when sterling left the ERM. This repo facility was offered to a wide range of counterparties (including banks, discount houses, building societies and gilt-edged market-makers) and used different assets. These were primarily gilt repo, in which the Bank buys gilts from its counterparties and agrees to sell them back at a future date at a price set in advance. The liquidity provided through the repo facility reduced the liquidity the Bank needed to support its daily operations to a more easily manageable amount.