The banking system’s liquidity surplus and interest rate formation

Date 01/12/2014

The background to this is that the Swedish banking system has in recent years moved from a liquidity deficit to a liquidity surplus in relation to the Riksbank. This means that the Riksbank now takes in liquidity from the banking system instead of supplying liquidity, as before. The surplus in the banking system has moreover grown over time, for several reasons. This is because the Riksbank's annual payment of profits to the Treasury and its interest and administration fees are not deducted from the return on its assets, but instead affect the size of the monetary policy transactions. Moreover, the surplus has grown as a result of a decline in the general public's demand for banknotes and coins.

The authors find, with the support of econometric analysis, that the increased liquidity surplus in the Swedish banking system since 2007 has been linked to downward pressure on short-term interbank rates. However, this effect is minor, as most of the surplus is invested in Riksbank Certificates. Another result is that the larger the surplus is, the less the turnover will be among the monetary policy counterparties on the overnight market. This effect is also minor, however, as most of the surplus is invested in Riksbank Certificates. Similar patterns are also visible in other countries that have had a liquidity surplus in the banking system over a long period of time.

The article is included in this year's third issue of the Sveriges Riksbank Economic Review.

By Virginia Queijo von Heideken and Peter Sellin
Virginia Queijo von Heideken is Senior Specialist at the Inter-American Development Bank and Peter Sellin is Advisor at the Riksbank's Markets Department.