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OP 2005/34. Szilárd Erhart: Driving factors behind O/N interbank interest rates – the Hungarian experiences

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Abstract

This study examines overnight (O/N) interest rates which constitute the short end of the yield curve and the factors which have an impact on such rates. The MNB, unlike several other central banks, does not have a direct overnight interest rate target; it does, however, limit the divergence of O/N interest rates from its policy rate with the settings of its operational framework. First, the MNB’s regulations on compulsory reserves allow banks to apply averaging in the reserve maintenance period, which reduces overnight interest rate volatility. Second, the interest rate corridor – determined by MNB’s collateralised loan and deposit – limits the maximum fluctuation band of overnight interbank interest rates. The study finds that the role of reserve averaging to reduce yield fluctuations is imperfect, as a clear seasonal pattern is observed in the intra-maintenance period evolution of overnight rates. The frequency of cumulative front-loading and excess reserves is significantly higher than the frequency of reserve deficit. Therefore, the level of overnight interest rates tends to remain below the policy rate and drop towards the interest rates of overnight central bank deposits at the end of the maintenance period. Moreover, statistical analysis finds evidence that the impact of liquidity withdrawing shocks are typically greater – approximately twice as much – as of those injecting liquidity.

This phenomenon could be explained by the volatility of autonomous liquidity factors, especially that of the government accounts, which is particularly high on VAT payment days. Institutional settings (credit limits, limitation of maximum deviation from reserve requirements, high interbank concentration) curtail the potential of the interbank market to efficiently distribute liquidity over the entire system, which may also explain the asymmetric liquidity management characteristics of Hungarian banks.

JEL: G14,E42,E52

Keywords: overnight rate, central bank instruments, operational framework, averaging, reserve requirements