What is the operational framework and what does it do?

13 September 2024

The operational framework is the set of tools, procedures and market operations through which the monetary policy stance of the ECB’s Governing Council is implemented. The purpose of the operational framework is to steer short-term money market rates closely in line with the policy rates set by the Governing Council.

An effective transmission of policy rates to money markets ultimately affects the cost of borrowing for people and businesses.

How is the operational framework linked with the Governing Council’s monetary policy decisions?

The operational framework implements the desired monetary policy stance, but it must not interfere with it. Thus, any changes to the framework are independent of the decisions the Governing Council takes at its regular monetary policy meetings. The March 2024 changes to the operational framework affect how central bank liquidity will be provided as excess liquidity in the banking system, while remaining significant over the coming years, gradually declines.

There is a clear separation in place between decisions on the monetary policy stance, primarily determined by the level of the key ECB interest rates except when those rates are at or close to the effective lower bound, and how the Eurosystem implements those decisions. Decisions on the stance in turn are guided by the ECB’s monetary policy strategy.

Why did we review the operational framework?

Before the Great Financial Crisis, the ECB implemented monetary policy by aiming to provide banks with just enough liquidity to meet their needs, mainly those arising from the public’s demand for banknotes and other autonomous factors (which are related to liquidity factors beyond the direct control of ECB monetary policy, such as government deposits) as well as those needed to cover their minimum reserve requirements.

Major shifts in the economy as well as the recognition of the effective lower bound on the ECB key policy rates have resulted in the Eurosystem deploying a range of new tools to meet its price stability objective since the onset of the Great Financial Crisis. This has resulted in liquidity levels well beyond banks’ structural needs. In addition, banks’ preference to hold reserves increased as they opted to maintain liquidity buffers beyond their traditional minimum needs, also to address regulatory requirements. But as the amount of liquidity in the system was so large anyway, the question of how banks would cover their liquidity needs lost prominence.

Following the start of the process of Eurosystem balance sheet normalisation in December 2021, the level of liquidity or reserves in the financial system has, with some lag, started to fall. As excess liquidity declines further, banks will increasingly need to be more active in ensuring that their liquidity needs are covered. The Governing Council therefore reviewed the operational framework to address the question of how banks will access liquidity in the future. The review aimed to ensure that the framework remains appropriate as the Eurosystem balance sheet normalises and to tailor it to the new environment. This will ensure that the implementation of monetary policy decisions will continue to be effective in the future. 

What was the outcome of the review?

On 13 March 2024, the ECB communicated the outcome of the review. Some of the key features are listed below:

• The Governing Council will continue to steer the monetary policy stance through the deposit facility rate (DFR). Short-term money market interest rates are expected to evolve in the vicinity of the DFR with tolerance for some volatility as long as it does not blur the signal about the intended monetary policy stance.
• The Eurosystem will provide liquidity through a broad mix of instruments, including short-term credit operations (i.e. main refinancing operations, MROs) and three-month longer-term refinancing operations (LTROs) as well as – at a later stage – structural longer-term credit operations and a structural portfolio of securities. For further information on the structural operations see below.
• MROs, as well as three-month LTROs, will continue to be conducted through fixed-rate tender procedures with full allotment. This means that banks’ demand for borrowing in these operations will be met elastically, provided they have adequate eligible collateral, which will remain broad.
• MROs, together with the three-month LTROs, are intended to play a central role in meeting banks’ liquidity needs and their use by counterparties is an integral part of a smooth implementation of monetary policy.
• As of 18 September 2024, the spread between the rate on the MROs and the DFR was reduced to 15 basis points from the previous spread of 50 basis points. This narrower spread incentivises bidding in the weekly operations, so that short-term money market rates are likely to evolve in the vicinity of the DFR, and it limits the potential scope for volatility in short-term money market rates. At the same time, it leaves room for money market activity and provides incentives for banks to seek market-based funding solutions. The rate on the marginal lending facility (MLF) has also been adjusted such that the spread between the rate on the MLF and the rate on the MROs remained unchanged at 25 basis points.

New structural operations

The Eurosystem intends to provide central bank reserves through a broad mix of instruments to offer an effective, flexible and stable source of liquidity to banks, thereby also supporting financial stability. These instruments will include short-term credit operations, namely MROs, and three-month LTROs. At a later stage, once the Eurosystem balance sheet begins to grow durably again taking into account legacy bond holdings, new structural longer-term refinancing operations and a structural portfolio of euro area securities will also be introduced.

The structural refinancing operations and the structural portfolio of securities will be calibrated in accordance with the principles as announced in March 2024 and to avoid interference with the monetary policy stance. These operations will make a substantial contribution to covering the banking sector’s structural liquidity needs arising from autonomous factors and minimum reserve requirements. Autonomous factors and minimum reserve requirements create a structural liquidity deficit in the banking sector. This deficit is currently filled by the Eurosystem’s legacy bond portfolios, so there is no need for such structural operations at this stage. But as the legacy bond portfolios acquired under the asset purchase programmes continue to be run off in line with the Governing Council’s monetary policy decisions, banks’ reserves will be increasingly absorbed by the demand for banknotes and other autonomous factors. At some point, the Eurosystem monetary policy operations will need to grow durably again to match the expected growth in structural liquidity needs. And it is around that time that the new structural operations will be launched to provide a stable source of liquidity. 

How is the structural portfolio different from the current portfolios of bond holdings?

A structural portfolio is different from a monetary policy portfolio and serves different purposes. The monetary policy portfolios under the asset purchase programme (APP) and pandemic emergency purchase programme (PEPP) served the purpose of easing the monetary policy stance at a time when interest rates were constrained by the effective lower bound. The PEPP served a dual purpose, also supporting monetary policy transmission. The purpose of a structural portfolio is to provide liquidity on a durable basis to satisfy the structural demand for reserves from banks. The structural operations are, therefore, intended to implement, not to steer, the monetary policy stance. Thus, the composition of the structural portfolio may also be different from that of monetary policy portfolios. The ECB will conduct an in-depth analysis on the design of the new structural operations, including structural longer-term refinancing operations and a structural securities portfolio.

How will you incorporate climate change-related considerations into the design of your structural operations?

Without prejudice to the ECB’s primary mandate, the design of the operational framework will aim to incorporate climate change-related considerations in the structural monetary policy operations. To the extent that different configurations of the operational framework are equally conducive to ensuring an effective implementation of the monetary policy stance, the operational framework shall facilitate the ECB’s pursuit of its secondary objective of supporting the general economic policies in the European Union, in particular the transition to a green economy, without prejudice to the primary objective of price stability.

This is also in line with the ECB’s intention to step up work focused on the green transition and on climate and nature-related risks, as announced in a press release of 30 January 2024. The three areas of focus for 2024 and 2025 are the implications of the green transition, the physical impact of climate change and role of nature-related risks for the economy and the financial system. In this respect, the ECB will explore, within its mandate, the case for further changes to its monetary policy instruments and portfolios in view of this transition.

These climate considerations will be part of the ECB’s in-depth analysis on the design of the new longer-term refinancing operations and the new structural portfolio.