Navigating liquidity stress: operational readiness for central bank support

The 2023 banking turmoil demonstrated once again the potentially systemic consequences of liquidity stresses and the need for effective central bank lending operations to contain financial instability. For such operations to be a reliable source of contingency funding, banks need to be ready and able to access them. And while central bank liquidity cannot, and should not, prevent a non-viable bank from failing, access to central bank lending operations can give authorities time to prepare a resolution and may help limit broader system-wide stress.

Access to central bank liquidity facilities requires a range of steps. First, banks and central banks need to have the necessary operational capacity. Second, as central banks only lend on a collateralised basis, central banks need to value the collateral and set haircuts. An appropriate legal and operational due diligence process is also required to ensure that all risks can be managed. This process can be complex and lengthy for non-traded assets. Operational readiness involves sufficient preparation so that lending can be accessed quickly when needed.

Authorities can take actions to improve banks' operational readiness. Supervisory guidance can encourage banks to incorporate central bank lending in their contingency funding arrangements. Central banks may also improve operational readiness through regulatory requirements for testing and simulations across all eligible asset classes. Central banks may also encourage or even require banks to preposition assets at the central bank. Finally, as fear of stigma may impede banks from using central bank lending, actions to promote operational readiness are more effective if complemented by initiatives to reduce stigma.

JEL classification: E58, F33

Keywords: bank runs, central bank lending, collateral prepositioning, emergency liquidity assistance, lender of last resort, liquidity, operational readiness, operational preparedness, operational capacity, collateral due diligence, testing, stigma