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Prepared for the Steering Committee for the Fundamental Reappraisal of the
Discount Mechanism Appointed by
the Board of Governors of the Federal Reserve System

The following paper is one of a series prepared by the research staffs of the Board of Governors
of the Federal Reserve System and of the Federal Reserve Banks and by academic economists
in connection with the Fundamental Reappraisal of the Discount Mechanism.
The analyses and conclusions set forth are those of the author and do not necessarily indicate
concurrence by other members of the research staffs, by the Board of Governors, or by the Federal
Reserve Banks.

George Garvy
Federal Reserve Bank of New York
Part I

The Discount mechanism as a tool of monetary control.



Provision of central bank credit at the
initiative of the banks • . . ,




Advances . ,


Widening of the range of objectives and
tools of monetary policy


General contrasts with the United States


Rate policy


Quantitative controls


Selective controls through the discount
Indirect access to the discount window
Uniformity of administration
Concluding remarks
Part II The discount mechanism in individual countries.
Austria . . . f
Federal Republic of Germany
United Kingdom



The original objective of this study was to acquaint the Steering
Committee with discount policies and techniques used by the central
banks of the most important advanced industrial countries, in particular
since World War II. Given this objective, there was a need for pulling
together from the individual country studies which constitute Part II,
and for organizing along comprehensive lines, endeavors to modify and
refine the traditional discount mechanism.

Since interest was focused

on the role of discounting as a tool of monetary policy in relation to
other tools, and on techniques rather than results, no attempt was made
to appraise the efficiency of discount policy in each country. Moreover, such an endeavor would have required review and evaluation of a
wide range of factors which far exceed the resources and time available
for this study.
Given the considerable differences in the framework in which the
discount mechanism operates here and in the countries covered, the first
part of the study attempts to bring out at legist the main differences in
institutional and policy environments that must be kept in mind when
analyzing the potential of the discount mechanism in the U.S. against the
background of foreign experience.

In view of the general objective of

this study, the review is not limited to policies and techniques in use
* The author has benefited from comments and suggestions by Ralph A.
Young a } Robert F. Gemmill, members of the Secretariat, who had special
responsibilities for this Project. Robert C. Holland made substantial
contributions to the analysis embodied in several chapters of Part II.
The initial drafts of the country studies which constitute Part II were
written by Ruth Lpgue of the Board's staff (France, Netherlands, and
Switzerland), and Dorothy B. Christelow.(Belgium and Sweden),
Rachel Floersheim (Austria and Federal Republic of Germany), Leon Korobow
(United Kingdom), Isaac Menashe (Canada and Italy), and Joachim 0. Ronall
(Japan), of the Federal Reserve Bank of New York. Mr. Stephen V.Q. Clarke
of the New York Bank also participated in preparing Part II, I am also
indebted to officials of the central banks of the individual countries
whose discount mechanisms are described in Part II for their invaluable

now, since in some cases discarded or radically modified arrangements
represent interesting variants, and the reasons for dropping or
changing the original techniques cast light on the problems encountered,


Generalizations concerning the role played since World War II by
the discount mechanism in the monetary policy of eleven leading industrial countries surveyed in this study-*- are difficult to make.

In each

case, discount policy has been shaped by the specific characteristics
of the country, its financial structure, the evolution of its economic
philosophy, and its actual postwar experience. Generalizations must be
distilled largely by rationalizing the reasons for observed differences
in policies and their evolution over time.

The specific role played by

the discount mechanism has depended in each given case on the policy
objectives of the central bank;s, and in particular on the way in which
these banks have supported government economic policies other than those
designed to defend the internal and external value of the domestic currency and to insulate it, to the extent possible, from disruptive influences from abroad.

Concern with the widening and proper functioning

of capital markets, including assisting in the financing of the public
sector, has grown in importance since the end of World War II, along
with an older concern with stirjiulation of exports.

1. Austria, Belgium, Canada, France, the Federal Republic of Germany
(West Germany), Italy, Japan, Netherlands, Sweden, Switzerland, and United
Kingdom. In this Reportt completed in 1967 "foreign central banks11 or
"other banks" always refers to these eleven countries. Parenthetical
references in Part I are not intended to be exhaustive, but merely to
refer the reader to one or two specific examples that can be found in the
country chapters in Part II.

The way in which discounting is used in each country at a given
time generally depends less on theoretical considerations and preferences, than on policy objectives, institutional realities, possibilities,
and constraints.

In particular, it depends on the variability of foreign

exchange surpluses or deficits, availability of alternative control
mechanisms (such as cash reserve requirements, liquidity ratios, and
open market operations); the ability of banks to make short-run adjustments through their investment portfolios, and the smoothness with which
excess reserves are distributed through the interbank market• The choice
of instruments to implement policy goals normally depends on the tradeoffs in terms of positive and negative side effects, and most importantly,
the degree of precision that may be expected from relying on any one of
them, singly or in combination, to achieve the desired effect.


in each of the countries surveyed, the role currently played by the discount mechanism reflects not only the policies of t]ie central bank with
regard to the means it chooses (or has at its disposal) to influence the
cash position of banks, but also the willingness of banks to make full
use of the discount facilities available.
Against the background of foreign experience our discount mechanism,
no less than our entire monetary and banking system, appears as a unique
case rather than merely a variant among many quite similar systems.

1. The authority for monetary controls is in some countries quite
diffused. Different agencies may have the authority to set the discount
rate, liquid assets ratios or credit and reserve ceilings and to determine eligibility requirements (or give final approval to such actions).
Their actions are not always perfectly coordinated, even when elaborate
coordinating agencies or arrangements exist.

Discounting is the oldest instrument of central bank policy.


a long period it was practically the only such instrument; together with
advances, it is still the most important avenue for changing the reserve
base at the initiative of commercial banks.

The flexibility inherent in

discounting has preserved its usefulness even where the range of tools
available to the central bank has been expanded considerably.

Our re-

view of foreign experience encompasses both discounts and advances, even
though in none of the countries surveyed are the two methods of obtaining
reserves strictly equivalent in terms of cost, as in the United States.
Basically, central bank policy becomes effective by affecting the
liquidity of commercial banks, through it the liquidity of the entire
economy and, in the last analysis, the level of real activity and the
country1s international payments position.

Changes in bank liquidity

are normally reflected in market rates, which are usually closely related
to the volume of borrowing from the central bank, and in the volume of
money and credit.
Central bank policy may aim primarily to influence either market
rates or the volume of money and credit.

The choice between basic

approaches to monetary controls depends in each country on specific conditions, including institutional arrangements and linkage processes, as
well as on prevailing monetary views.

Foreign experience provides il-

lustrations for both basic approaches and a number of variants.
An example of the first basic approach is found in countries where
the authorities aim at a level of short-term rates consistent with
domestic and external objectives.

The discount rate is then used as an

anchor for the entire structure of interest rates.

It is left to the

market to determine how much it wants to borrow at the discount rate.
The alternative approach is to place primary reliance on the regulation of the volume of reserves rather than on their price. Access to
reserves may be governed by quantitative controls in addition to restrictive eligibility requirements. Such controls are tantamount to
nonprice rationing and they may be designed to achieve multiple objectives-

Countries relying on quantitative controls to influence

the cash position of banks may nevertheless assign to the discount
rate an important role in regulating international capital movements
or otherwise use changes in the rate to support quantitative and related control techniques; but, basically, administrative discipline
rather than price becomes the main tool of monetary management.
Whenever alternative means for injecting and absorbing reserves
are available to the central bank, it can combine the use of these
tools in various ways in order to achieve the desired effects. The
central bank can pursue its rate or reserve base aims by absorbing
or supplying bank cash and/or by varying mandatory (or negotiated)
reserve requirements. More specifically, it can either (l) control
(and vary) conditions under which banks may obtain additional reserves at the discount window (through rate, qualitative or quantitative controls> or through some combination of these three means) but
refrain, from modifying the resulting volume of borrowing; or (2) adjust the quantity of reserves obtained at.the initiative of the banks

lo A variant is to consider the discount rate as the upper limit
of the proper range of short rates, and to make" it effective by open
market or,foreign exchange operations when market rates tend to fall
away from it. Another variant is the tying of the discount rate to a
market rate which becomes the focus of central bank control.

to its own targets by undertaking offsetting (or supporting, as the
case may be) operations through other channels. The desire of commercial banks to adjust their cash position through the discount
window thus always depends on the volume of reserves made available
to the market by other means by the central bank.

One of the sig-

nificant aspects of the closer integration of monetary management
with overall public economic policy since World War II has been an
effort in several countries to shift the initiative for injecting
(and withdrawing) reserves from commercial banks to the central
Operations at the discount window can influence the supply of
money (by affecting the reserve base or through the rate effect, or
both) only if the banking system is forced to borrow.

Central banks

use various ways to force banks to seek additional cash from it in
order to make the rates on discounts and advances effective. Specific techniques include operations in exchange markets, open market
sales of securities (United Kingdom), increases in reserve requirements (Austria) and reductions in discount quotas to force banks to
seek accommodations at the higher rate on advances (West Germany).
To achieve sufficiently tight control over bank cash, the central
bank must be able to calculate with a good deal of precision the
timing and amount of open market or foreign exchange operations required to achieve the desired rate effects. By denying the full
amount of reserves required to support seasonal, cyclical, or secular expansion of bank credit (for instance, by abstaining from purchasing securities in the open market) the central bank will force
the banking system into the discount window (the classical case being


the United Kingdom, where, however, the borrowing is undertaken
indirectly, through discount houses).

The volume of discounts, in-

terpreted in relation to changes in the central bank's securities
portfolio and to changes in relevant cash and liquidity ratios, will
be a direct indication of the state of monetary stringency.
Reference to "refinancing11 at the central bank, commonly encountered in some countries when referring to all forms of central
bank credit created at the initiative of commercial banks, realistically depicts a state of affairs in which a considerable part of
credit in use by the private economy is, in the final instance, provided through the discount window, and cash positions of banks are
sufficiently tight so that banks must go to the central banks
for refinancing during periods of seasonal or cyclical pressures.
In countries where rediscounting is insignificant (either in relation
to bank cash, or as a means of making seasonal adjustments in it), the
reason is usually traceable either to the prevalence of conditions of
excessive liquidity due to foreign exchange inflows or postwar monetary overhangs (Austria, Switzerland, and for part of the past decade, in
Sweden) or other circumstances that have reduced the importance of
the discount policy role•
Indeed, the ability of a central bank to use rediscounting as the
main tool of monetary control depends on the commercial banks not
having a large volume of assets giving
access to central bank credit.




In the immediate postwar years, there

was everywhere an overhang of war-generated liquidity.

In subsequent

years, and in varying degree, the individual countries covered by this
study benefited from balance-of-payments surpluses--in large part the


counterpart of our deficits—and at times from speculative inflows of
foreign capital.

Thus, over long periods, many central banks were con-

fronted with the problem of controlling excess liquidity in their
banking systems, and, in particular, neutralizing the effects of foreign
exchange surpluses.

In such circumstances, the need for the commercial

banking systems of most of the countries covered,;and in particular
those of continental Europe, to obtain liquidity at the discount window
was much reduced.

Indeed, in many countries the size of balance-of-

payments surpluses was during extended periods much too large to be
neutralized through adjustments in discount operations or, for that
matter, by the use of the entire range of available instruments of
monetary policy.

In several countries the central problem of monetary

policy since World War II has been to limit the monetization of the
inflow of foreign exchange.

Thus, since World War II in most of the

countries covered by the present study rediscounting and advances have
provided only a small, and in many cases, an insignificant part of the
funds serving to offset seasonal and cyclical fluctuations in the cash
base and to meet growth requirements.

Although excess liquidity and

opportunities for obtaining funds abroad tended to reduce sharply the
need for obtaining them from the central bank, a complete atrophy of the
discount function(similar to the U.S. experience in the period after
the Great Depression and well into the postwar years ) did not develop.
This was due to the wider seasonal swings in foreign exchange surpluses and in circulating currency, a less developed interbank money
market and a lesser use of open market operations.

The following

1. Development of an impersonal national market for reserves reduces the need for borrowing from the central bank, as does concentration of banking and the growth of branch-banking systems.

table indicates that, in contrast to the United States, in most of the
countries covered, changes in foreign assets have been since the return
to convertibility a very important, or even predominant source of
changes in central bank assets; in some countries this was true even in
the earlier period.
Changes in Central Bank Assets
(in billions of national currency units)
















Germany, Repub, of
























United Kingdom









I.M.F., International Financial Statistics.

Central banks of the countries surveyed (and elsewhere) have retained traditional forms and practices by giving preferential treatment
to credit extended by means of discounting promissory notes. The continuing prominence of rediscounting abroad reflects in part the

continuing, although perhaps diminishing, survival of the trade "bill
as an instrument for short-term credit accommodation. This fact is,
in turn, traceable in some countries to the more significant role
played by foreign trade.
Regulation of access to the discount window is traditionally
based on eligibility requirements with regard to purpose, maturity
and credit standing of drawee and endorser.

Terms and conditions,

including eligibility requirements and maturity, are usually specified
in broad terms by legislation and administered by the monetary authorities, which set policy objectives and promulgate various operating rules.
In most countries, the applicable discount rate depends on the nature
of the paper offered (in some cases this applies to advances as well).
While the stress is on the self-liquidating character of the paper
discounted, there is no tendency to question the ultimate use made of
the funds supplied or to consider lending for productive purposes more
appropriate than other uses.

However, eligibility rules by themselves

are of limited significance in controlling the aggregate volume of
discounts so long as commercial banks dispose of a more-than-adequate
volume of paper to replace any specific items judged substandard.
Similarly, the prior-authorization procedure (in France and Belgium)
is by itself an insufficient means of controlling discounts, so long
as credit demands are strong enough to produce alternative requests
to replace rejected applications.
The ability to rediscount a particular credit is usually an important factor in determining bank attitudes toward loan applications.
In particular, the status of the trade bill at the discount window has
been an important factor in preserving its role. In a few countries,

changes in eligibility requirements haye been used as a tool of
monetary control (Japan).

Varying eligibility requirements in

accordance with policy objectives gives the central bank additional
flexibility but--as in other instances—policy requirements may not
be consistent with other considerations, such as safety.
While the "real bills11 doctrine is the common origin of the discount function in all countries, the degree to which it has weathered
the changes in credit needs and financial structure that have occurred
since the Great Depression varies from country to country (Belgium
being perhaps an extreme case of survival). The actual administration of the discount window is now everywhere sufficiently subordinated
to overall objectives of monetary policy so that access to the window
does not provide an escape from monetary restraint. Indeed, the
applicable legislation.of several countries ^Lves the central bank wide
discretionary powers to regulate access to discount facilities and to
vary conditions under which it will make discounts. These powers
generally permit the central bank to refuse (usually without having to
give any reason) accommodation even when the commercial bank can submit
stipulated adequate paper.,.This discretionary power may lend considerable effectiveness to the central bank's overall ability to influence
commercial bank behavior.

In effect, discounting assumes the role of

an enforcement mechanism, as some, central banks make it clear that
access to the discount window depends on compliance with overall
objectives of monetary polipy and such compliance is frequently the
price for extending th,e discount privilege to nonbanks. In some countries, however, access tothe window within ceilings and quotas is considered by the commercial banks as a right.


Review of paper offered for rediscdunting gives central "banks a
view of the credit policies followed by commercial banks. This is
important because in mpst countries with large numbers of commercial
banks central banks have few or no direct and current contacts with
these banks, except at the discount window.

In countries where cen-

tral banks provide at all times a large proportion of bank reserves
through the window, the need to renew the discounted portfolio affords
the central bank a means for continued surveillance of the commercial
banksf lending.
In many cases, compliance by commercial banks with the wishes of
the central bank is also reinforced by its various supervisory powers
and the threat of requesting additional powers if voluntary cooperation is not forthcoming.

Institutional arrangements to obtain com-

pliance may involve a "gentlemen1 s agreement11, periodic' conferences
between the head of the central bank and heads of the large commercial
banks, or formal "window guidance" as in the case of Japan.
While rediscdunting of trad£ bills remains in many of the countries
covered an important channel for supplying central bank credit to the
private sector of the economy (and disregarding direct lending to a
shrinking inherited clientele of merchants and other nonbank borrowers),
foreign central banks have found it necessary to broaden discounting
techniques and to introduce additional ways to provide credit for reserve adjustment purposes. Advances against collateral originally
played the role of a safety valve, but more recently they have become
in some countries the normal way for obtaining short-term accommodations
at the central bank.

Other more recent techniques include repurchase

agreements-*- and direct purchase of acceptances., Such credit may be
extended either at the initiative of the central bank, or at the
initiative of borrowers (as in the case of money market dealers in
Canada, within"'- credit lines established for them).

While Federal

Reserve Banks have not made discounts for decades, the distinction
between discbiihts and advances is .still maintained in most foreign
countries and In some serves to differentiate.between access to the
discount window as a right and as a privilege.
Advances ("Lombard:" credit") are often made on collateral not
eligible' for rediscounting, such as long-dated government, debt.
The required collateral may be limited to government securities (as
in West Germany and Belgium) or to a limited list of specified securities-

There is little uniformity in, the ease of resorting to ad-

vknces as an alternative to rediscount; ing and to the relative cost
of these two modes of central

In some cases the rate

structure and othersterms and procedures are designed to make central
bank advances available at - penalty rate. to. banks when they have
reached their discount ceilings'(West. Germany) or have run out of paper
eligible for discounting.

In line with, traditional "real bills"

thinking, advances are made usually for very short periods only.
Sometimes it is more advantageous to borrow for a shorter time at
the (typically higher) rate on advances when such.lQafts can be .paid
off without restriction (West Germany).

Even when the applicable

1. The need for repurchase agreements arises primarily when conditions applicable to regular discounting are excessively restrictive
(when paper offered must have a specific minimum maturity, or discounts are made for the remaining life of the instruments only) or when
the borrower cannot be expected to dispose of an adequate volume of
eligible paper (as in the case of Canadian money market dealers)..

rates for discounts and advances are identical, other terms may favor
one of the two, as in the case of the United Kingdom where the fact
that advances can " e obtained foi" shorter maturities than discounts
makes them a less expensive source of funds (to the discount houses,
in the given case) / provided, in accordance with its policy (rate)
objectives, the Bank of England is willing to make advances at the
given time (the opposite is true in Canada where advances are jnade
for a minimum of 7 days only).
In most of the countries surveyed advances are regarded as a less
normal, or less desirable, way of providing reserves and such accommodations are extended at a higher rate (as in West Germany and Austria,
for instance) and/or for a limited time only. Advances at the bank
rate may be made up to a ceiling (which may be confidential, as in
Canada) set for each bank; advances for additional amounts may be made
at a penalty rat? (as in Canada, where this rate is subject to caseby-case negotiation)-

The rate on advances (or its equivalent which

represents the highest rate at which banks actually borrow from the
central bank) tends to set an effective ceiling on money market rates.
Some countries have gone to considerable lengths to maintain the
conceptual and operational distinctions between discounts and advances.
In others (as in Italy and the Netherlands) advances rather than discounts have become the more common technique for extension of central
bank credit, in particular where the use of advances is encouraged by
making them available on essentially the same terms as discounts.
Greater reliance on advances reflects, by and large, changes in the

1. In West Germany, discounted bills, but not advances, qualify
as cover against note issues.

structure and techniques of bank lending as well as the shifting away
from the "real bills" doctrine. On the whole, advances may be regarded as the method

likely to grow in relative importance over the

years ahead.
In all of the countries surveyed, the scope of official economic
policies has broadened since World War II to include objectives similar to those defined in, or implied by, our Employment Act of 1946;
in several countries the use of the discount mechanism has been
adapted in various ways to the new policy objectives. Indeed, for
this and other reasons, some of which are discussed below, in most of
the countries surveyed, the discount mechanism has undergone considerable change over the last quarter of a century and no country currently relies on it as the sole tool of monetary policy. Adaptation
of the traditional discount mechanism (including the shift from rediscounts to advances) to new needs and conditions has been accompanied
by the development of new tools of monetary management, many of which
were pioneered by the Federal Reserve System*
In considering the evolution of the discount mechanism since
World War II one must keep in mind that the countries covered by this
study, with the exception of Canada, Sweden and Switzerland, have gone
through a difficult period of postwar reconstruction in which various
types of direct controls were used, some of which have been continued
beyond that period. Because of the urgency of reconstruction,financial aspects tended to be pushed into the background; monetary policy
was expected to make a contribution by facilitating and implementing
attainment of targets set in capacity, output and technological terms.

Such implementation frequently involved subsidy-level interest rates,
"direction" of credit, and use of rediscounting as a mea'ns of
financing specific activities in preference to budget' financing.or
as a substitute for private capital formation.

Indeed, the evolving

condition and new challenges which emerged after World. War II caused
several of the central banks surveyed to seek "broader powers and to
develop new tools of monetary management rather than to try to meet
them by relying on the adaptability of the discount mechanism.


most countries, the discount mechanism has been increasingly supplemented b y other tools of monetary management; in particular, con;
straints on the use of rate changes led 'to the further development of
.old and the introduction of new policy tools and techniques *
The need to supplement the discount window by other control
mechanisms can be traced in part to changes in the structuring of
commercial bank portfolios (with a declining proportion of discountable paper), to various constraints which tended to1 limit the lati- •
tude for using the discount rate as a rationing device and the
tendency of commercial banks to make excessive use of the discount
window in view of fbe willingness of their customers to borrow at
rates considerably higher than the discount rate.

In several coun-

tries, the discount window was inadequate to deal with the consequence
of huge and fairly persistent balance-of-payments surpluses.

The need

for new tools was felt keenly in cases where external and internal
considerations" were flashing conflicting signals with regard to the
discount rate.

As a result, the discount mechanism has undergone con-

siderable change, of which resort to quantitative limitations, and thus
diminished use of the rate, is the motet significant.

It became clear

after World War II that the politically acceptable range within which
the discount rate could be varied had narrowed and that a number of
developments tended to inhibit free and sufficiently frequent use of
discount rate changes.

These reasons may be summarized as follows:


Fear that the signal would be overinterpreted.


Fear that large rate fluctuations would produce disruptive effects on the market for government securities and, more generally, on capital markets.


Fear that automatic linkage between the discount rate
and bank lending and/or deposit rates would tend to
produce levels of interest rates that would be
politically unacceptable.


Fear of inducing undesirable international capital
flows that would offset intended domestic effects of
rate changes.

Because of these restraints on a flexible use of the discount
rate, nonrate rationing of reserves and manipulation of reserves
acquired through balance-of-payments surpluses became supplementary
and, in some cases, an alternative tool of monetary control.


cash reserve requirements, liquidity ratios, and open market operations have been introduced since the war in a number of countries as
additional monetary tools, but they remain of limited significance
(particularly for day-to-day control of reserve availability).


of the countries surveyed (the United Kingdom and Canada being, of
course, the conspicuous exceptions) have not succeeded In developing
a broad and active market for short-dated government debt that would
provide a main avenue for supplying and absorbing bank reserves, and
their Treasury bill markets (where they exist) are extremely narrow.
Liquidity adjustments fas well as Treasury debt operations) frequently
involve direct dealings between the central bank and commercial banks,
rath-.r than Impersonal transactions through the market.

In several

countries, special Treasury instruments (usually a special series of
Treasury bills, not available to the general public) are issued to
commercial banks, at rates deemed appropriate by the authorities,
rather than set by market bidding (and are repurchased at posted
rather than market rates, as in West Germany).
Because of the unavailability or limitations of new monetary
tools, means were sought in most of the countries covered to achieve
greater monetary restraint through nonprice rationing at the discount
window and, in some countries, to shield certain sectors (e.g. export
financing, municipal borrowing, home mortgages, etc.)
effects that would have resulted from price rationing.

from the
Regulation of

access through quantitative limitations on borrowing (rather than
tightening eligibility requirements) became a policy tool, making
availability of eligible paper a necessary, but not sufficient, condition for access to central bank credit, thus moving away from the
automatism of the "real bills" doctrine.
Eligibility and collateral requirements for discounts and advances have always tended to influence the assets composition of commercial banks' portfolios (and, presumably to a lesser extent, of
other financial institutions having direct or indirect access to the
discount window).

In several countries, restrictive features have

been added to the discount mechanism with a view to restraining excessive use of central bank credit and to channelling bank credit into
priority uses (France, Japan).

Excessive credit demands and insuf-

ficiency of internal funds to support high rates of capital formation
characterized the economies of the countries studied during much of
the post-World War II period.

In general, post-World War II monetary

policies of these countries (with the exception of,the United Kingdom
and Canada) have endeavored to limit and regulate access to the discount window " y specific rules, including quantitative provisions
(allowing in some case$ for procedures which amounted to little less
than direct extension of credit for purposes haying.national priority),
in particular in countries wheire, reluctance on the part of banks to " e
in debt to the central bank was small or nonexistent. This led to the
* establishment in several countries of. discount ceiling quotas for individual banks. Some countries have gone, even further by establishing
direct ceilings for bank credit expansion; other* ^countries, have, endeavored to keep growth of bank credit in line with official objectives
through informal directives.
In some countries the "discount window ha-s been used as a (tool of
credit allocation, usually by corapartraentalizing discount procedures and
by establishing a whole hierarchy of rentes from preferential to penalty.
Central bank credit has been .also quite widely used as a supplement or
even- as an alternative to budgetary financing in implementing a variety
of officially-sponsored programs, including implementation of national
investment plans. In such ca^es, institutional arrangements have been
made for formally meeting the' requirement that discountable paper be of

Such use of the discount mechanism for stimulating invest-

ment, including provision of central bank credit on a semipermanent
basis, has been due to shortcomings in capital market structure and
processes, and npt to the inherent superiority of discounting as a
means of achieving policy objectives in this field.

Other examples of

use of discounting as a means of financing governmental programs are

found ip Switzerland (financing of defense stocks of raw materials)
and Italy (agricultural price-subsidy programs),
The discount mechanism thus has grown in complexity in part because in many countries it is now impressed into the service of other
objectives for which the use of the mechanism of discounting offered
certain advantages, both technical and budgetary * The need to resort
to a variety of artifices to fit the letter of the. requirements of
the discount window arose, in part, from the inflexibility of banking
legislation of various countries and the unwillingness or inability
of governments to introduce desirable changes.
New techniques h ^ to be introduced, to sterilize the inflow of
foreign exchange and to adjust monetization of domestic assets to
variations in balance-of-payments surpluses. Central banks have endeavored (paralleling similar efforts with regard to meeting domestic
challenges) to develop alternative policy tools that would diminish
reliance on the discount rate to prevent or correct imbalances- in international accounts and, in particular, to cope with wide swings in
foreign exchange flows. Since foreign commercial banks usually keep
part of their liquid assets abroad, mainly in the form of interbank
balances and money market assets (subject to applicable foreign exchange control regulations), in several-countries regulation of
foreign exchange holdings of commercial' banks has become one of the
most important tools of monetary policy. Since the re-establishment
of convertibility in 1958* closer integration of financial markets of
the Western World and the growing importance of banKs and other
financial institutions operating across national borders, borrowing
from foreign branches and in foreign money markets, including in more

recent years, the Eurodollar market, have1 provided commercial banks
with additional access to liquidity in periods of temporary strain
and thus further reduced the need to seek accommodation at the central
A common objective of measures adopted in individual countries
has been to control commercial bank access to liquidity resulting from
foreign exchange inflows, and, more generally, to develop a foreign
exchange policy that would support other tools of monetary controls.
Among the control tools used, forward-exchange operations aiming at
keeping funds from flowing in or out through a forward premium or
discount (Italy), and manipulation of reserve requirements against
foreign deposits (West Germany, Switzerland) have proven to be of
considerable effectiveness. A variety of techniques has-been applied
in several countries to cope specifically with international capital
movements, including prohibiting payment of interest on foreign deposits (Italy, Switzerland). Furthermore, some central banks have
been able to control commercial banks' access to foreign borrowing,
including limits on the amount of foreign currency claims or liabilities that banks (and nonbanks) can take, and to regulate net positions
in foreign currencies,
On the whole, in the countries covered the discount mechanism has
been relied upon more heavily since World War II than in the United
States to achieve domestic and external monetary policy goals by influencing the supply of credit, the cost of money, and the market pattern of rates. In the absence of significant alternatives, in most of
the countries surveyed discounts and advances'are a normal means for

adjusting bank liquidity positions. In some countries, discounting
is considered a normal source of a considerable part of the banking
system1s cash reserves rather than merely a safety valve, available
normally only for a very short period, pending adjustment of bank
assets and liabilities. Still other central banks insist that funds
should be sought,at the discount window only to meet seasonal and
other specific temporary apd reversible needs.
Before revieying in more detail the various technical details of
the discount mechanism in the countries covered by this study, it
might be useful to comment on some of the more important differences
in the setting in which monetary policy operates in these countries.
They range from forces wfrich cause fluctuations in the reserve base
to institutional factory in the financial area and beyond.

But quite

generally, aqcess to central bank credit is embedded in each case in
a somewhat different set of policy considerations, institutional
arrangements, and procedures than in the United States.
In all of the countries surveyed, foreign trade accounts for a
much larger proportion of gross national product than in the United
States • International considerations are traditionally a main focus
of monetary policy, and day-to-day management of foreign exchange reserves requires considerable official attention. Since, in the other
countries, commercial banks keep part of their ^Liquidity abroad,
mainly in the form of interbank balances and money market assets (and
subject to applicable foreign exchange control regulations), in
several countries regulation of foreign exchange holdings of commercial
banks of the most important expressions of monetary policy.
Extension of foreign currency loans (by the central bank or by the

separate foreign exchange institution typically managed by the central
bank), swap arrangements and forward exchange transactions are among
the techniques used to influence the liquidity position of domestic
banks. Management of foreign exchange reserves supplies some of the
day-to-day flexibility that otherwise would be lacKirtg. because of the
limited scope:(or absence) of open market operations and a variety of
factors reducing the flexibility of other policy tools.
Bank credit accounts for a much larger share of domestic credit
flows in the countries surveyed th^n in the United States; it would
lead us too far afield to examine the underlying reasons. . Among
them/ the relative narrowness of capital markets, the larger part of
capital formation that bypasses them, the pre-emption of a considerable part of savings by the national government and ^emigovernmental
institutions, the lesser importance of financial intermediaries (in
some cases a direct effect of earlier disastrous inflations) would
apply to a different degree for each given country. But in all of
the countries surveyed, the predominant role of commercial banks in
credit markets, especially ip serving credit needs of private business, usually results in more direct transmission to the central
bank of'fluctuations in credit demands,
Another significant difference is that in many of the countries
studied, an important segment of.the commercial banking system is
nationalized (as in France and Italy) and that public or quasi-public
credit institutions have access to the discount window. . While nationalized commercial banks are usually operated in ipuch the same way as
those privately owned arid do not enjoy any preferential treatment at
the discount window, subtleties may be involved that are difficult to

detect. The specialised quasi-public credit institutions usually
combine several activities, including centralizing temporarily redundant resources for national networks of similarly specialized
financing institutions and providing rediscount facilities for them,
as well as "attracting certain types of savings and channeling
government funds into long-term investment. Giving such institutions
direct access to the discount window broadens the original function
of the discount window by using central bank credit to implement certain priorities set by national economic policies. This widening of
the discount function has no direct counterpart in the United States,
but neither has the underlying involvement of the national government
in influencing the direction of investment flows and using the central
bank to implement or support a broad range of specific economic policies, including'the diversion bf central bank resources to nonbudgetary
A related structural difference is reflected ^n the origin of the
paper reaching the discount window.-1- In several of the countries surveyed, large segments of industry are nationalized, while other important units involve some degree of government participation or
sponsorship. Municipal ownership of public utilities is widespread,
and communications as well as important railroads, airlines, and
shipping lines are usually government-owned, directly or indirectly.
Contractors and other suppliers of government-owned enterprises (such

1. It may also be worth: noting that while almost since its inception the Federal Reserve System has been engaged in developing the
acceptance market, it has chosen to monetize acceptances through open
market purchases rather than through discounting, while in the other
countries paper arising from foreign trade is not only typically an
important part of discounts but in some cases also enjoys preferential

as shipyards) enjoy official support which may extend to special
facilities at the discount window. In many countries yith a significant public sector (and in particular in France and Italy, but also
in Japan where government tutelage, rather than outright ownership is
involved), the us-e of the discount mechanism as a means of directing
credit has becbme a significant and integral part af central bank
policy. Thus, a considerable proportion of assets owned by commercial
banks (whether privately or publicly owned) consists of loans (and
other credits) to public enterprises, even though the form of the
accommodatidns extended (and the eligible paper which they generate)
may be indistinguishable, on the surface at least, from that used to
accommodate private.borrowers, In effect they represent credits extended to official entities, or those guaranteed by government institutions or instrumentalities frequently set up for the purpose of
implementing specific government policies.
Also in contrast to the United States, most of the central banks
of Western Europe (having evolved from commercial bank?) continue to
haVfc some private clientele which has access to central bank resources through direct discounting (but in some cases also through
advances, as in West Germany, Italy, and Switzerland). Direct lending
to private borrowers (even to individuals, rather than to business
borrowers, as in Italy) is in most cases a carryover from the time
when the central banks were privately owned. The newer central banks
(Canada), have never engaged in such activities and the other banks
are., trying to close them out.
By and large, the relative volume of direct lending through discounts or advances is negligible and is not done with any policy

purpose in mind/ except in the United Kingdom where the Bank of
England*continuously acquires a certain volume of bills "to be in
touch with the market" and to ascertain the quality and composition
of bills being offered in the market. Since this Report is concerned with the use of the discount window by foreign central banks
as a tool of monetary policy, we shall not discuss techniques for
discounting paper of private customers.•*Foreign central banks do not administer the discount window on
the basis of rigid rules on the public record (and, hopefully, uniformally interpreted and understood by all), comparable to
Regulation A, as issued in 1955- The notion of "appropriate borrowing" is not encountered in foreign experience. While the stress
on the self-liquidating character of the discounted paper is quite
general, there is no

attempt to question in this context the actual

use made of the funds supplied or to consider lending for productive
purposes more appropriate than other uses.
Only a few of the central banks surveyed the administration of the discount window on the assumption that commercial banks
are reluctant torborrow (and to stay in debt), even though, in fact,
banks prefer to obtain liquidity elsewhere and, come to the central
bank only as a'last resort. In most countries surveyed, commercial

IV We shall also pay only passing attention to discounting of,
or lending on, government securities undertaken either to accommodate
the Treasury in-periods when, its expenditures exceed receipts, or to
cover budget deficits, since such activities dp not fall under the
heading of credit policy (although monetary policy must, of course,
cope with the resulting reserve creation). In some countries, central
government borrowing takes the form of advances from the central bank
rather than of marketable paper. In most countries, legislative safeguards exist tq protect the central bank against abusive use of its
facilities to cover budgetary deficits directly or indirectly.

banks tend to regard access to the discount window as a right rather
than a privilege (within applicable limitations, such as quotas) even
though the central bank normally has discretionary authority. This
attitude, confirmed by their actual experience, is traceable in some
cases to the availability in their portfolios of specific types of
paper which the central bank must discount automatically, and more
generally to the inherent function of the central bank

as the 'Mender

of last resort."1 All central banks recognize their role as lender of
last resort to be crucial, and discounting continues to be widely used
to implement this role. Even in countries which use discounting
ceilings or where alternative means for injecting liquidity on a massive scale (for instance, through open market operations) are available, central banks do not see how they can refuse to lend at some
price as long as the formal requirements with regard to collateral or
eligibility are meto
In countries where cash reserve requirements exist, quasipermanent borrowing by individual banks is tantamount to an offset to
such requirements .2 in countries where they do not exist, but where banksl
endeavor (or are expected) to maintain conventional liquidity ratios,
resort to the discount window reduces, in effect, the borrowing bank's
primary liquidity position. Thus, frequency of borrowing by individual

1. In some countries at least (Italy being perhaps the most conspicuous example), access to the discount window was, originally, considered to be a quid pro quo for the note privilege of the central
2. Borrowing in excess of applicable reserve requirements has
severely affected the usefulness of this monetary tool in several
Latin American countries.

banks, and the aggregate amount of discounts and advances outstanding,
are in all countries an important element in interpreting (and influencing) the central bank's policy posture.
The United States is almost unique (Canada and Switzerland being
other important examples) in limiting direct access to the discount
window to commercial banks (provided they are members of the System)
and in denying it to other money market participants (except for nonbank dealers in Government securities).

Foreign central banks in-

terpret their role as lender of last resort more broadly;

as a

result, a variety of financial institutions other than commercial
banks usually have direct access to central bank credit.

Some of the

central banks surveyed extend (depending on historical and institutional factors) discount privileges or advances to most or all of the
following groups:

public and quasi-public credit institutions, cen-

tral bodies of such sectoral credit institutions as national groupings
of savings banks, farm credit associations and credit unions (Italy),
municipal savings banks (Italy, Japan), credit cooperatives
(Netherlands), and stock brokers who act as dealers in government
securities (Canada, Netherlands), and private borrowers.

Such access

may be available at all times (although, in fact, rarely resorted to)
or under specific conditions.
Access to the discount window is determined by law and/or administrative decisions; in none of the countries surveyed can banks
elect-to escape regulation by the central bank through a



status and thus not to have direct access to the discount window.


and large, applicable reserve (and liquidity) requirements abroad are
administered more flexibly than in the U.S.

Greater flexibility in

meeting legal reserve requirements and/or liquidity ratios frees
commercial banks (as well as central banks) abroad from some of the
problems of day-by-day reserve management which are rooted in our
system of administering member bank reserve requirements.,
Because of the prevalence of nationwide branch-banking systems,
and the virtual absence of secondary financial centers,-*- some of the
problems of reserve management inherent in our fragmentized commercial banking system do not exist to the same extent in the countries studied *

While important regional, and even local, banks

exist in most countries studied, there is nowhere a counterpart of
the reserve management problems typical for thousands of our banks.
This does not necessarily mean that offsetting of a much larger part
of the local and regional day-to-day fluctuations in the demand for,
and supply of, banking funds within the nationwide branch system
significantly diminishes overall seasonal variations in the demand
for cash.

Other forces operating in the opposite direction may be

equally significant.

For instance, bank cash positions in the coun-

tries surveyed are more exposed to fluctuations in the public's demand
for cash since a much larger portion of the money supply than in the
U.S. consists of currency.

Fluctuations in currency in circulation

affect bank reserves one-for-one, but fluctuations in deposits only

. 1. With some exceptions, however; but even Canada and the
Netherlands each has no more than one additional money market of real
2. While there are some parallels (the United Kingdom comes first
to mind) to the limitation of the impact of our policy actions on member banks, the problem of "non-membership11 is not duplicated abroad.
3- Currently, between one third and one half of the money supply
of Italy, France, Germany still consists of currency, and there is
little reason to believe that the composition of the marginal demand
for cash is different from its average composition.

The main objective of day-by-day discount operations is to
neutralize the effects of seasonal and cyclical factors on the money
market (in other words, to provide normal seasonal reserves and to
accommodate, within broad policy considerations, cyclical swings in
reserve use), and in some to provide for secular growth.

There does

not seem to be in the countries surveyed any specific philosophy or
policy with regard to the way in which the cash base of the banking
system should be enlarged to provide for secular growth.

In part,

this may be an overhang from the real bills doctrine which, at least
implicitly, assumed that growth of "commerce" would generate an enlarged flow of bills to the central bank.

More importantly, in most

of the countries studied inflows of foreign exchange and-intermittently—government deficits focused attention on the means
for controlling excess liquidity rather than the need to provide banks
with reserves to assure adequate monetary growth.

On the whole, how-

ever, it is proper to conclude that discounting is generally considered
the residual mechanism through which overall availability of reserves
is adjusted to longer-run growth requirements„
Most central banks use the discount mechanism to minimize day-today and week-to-week fluctuations in money market rates and gyrations
due to tax payments, end-of-month and similar recurrent periods of

Usually, offsetting other recurrent influences on the money

market, such as fluctuations in the Treasury balance with the central
bank, equally belongs in the category of routine activities.

The ex-

tent to which the discount window is used to regulate bank reserve
positions on a day-by-day 'basis depends on institutional factors and
on the availability of alternative mechanisms in each given country.

Specific situations are discussed in several country reports; the broad
generalization is that there is no general preference to use discounting
when other channels, such as intervention in foreign exchange markets or
open market operations, are available.
Indeed, in most of the countries surveyed, day-by-day adjustments
in reserves take place mainly by manipulating foreign assets and through
the domestic interbank money markets.

However, nowhere is the interbank

money market as developed and so actively used as in the United States,
and only a limited amount of interbank lending takes place in an impersonal money market.

There is no close counterpart of our corre-

spondent banking system which involves some interbank borrowing on the
basis of credit lines.

Except for the United Kingdom and Canada^ non-

bank participation in the money market is in most countries either
nonexistent (by tradition or formal arrangements) or of marginal importance (as in the Netherlands).

Even open market operations are in

most countries conducted only between the central bank, commercial
banks, and a limited number of other private financial institutions,
including dealers in government securities and government and quasipublic institutions active in the capital market.
The development and routine use of open market operations has
been thwarted in many countries by the narrowness of the market for
government securities.

The activity of a market for government debt

depends a good deal on the size, structure, distribution, and origin
of the public debt; considerable differences in this respect exist
among the countries surveyed.

In none of these countries is the

(central) government debt so widely held and actively traded as in
the United States.

Most of these countries (exceptions:


Kingdom and Canada) have not succeeded in developing a broad and
active market for short-dated government debt that would provide a
main avenue for supplying and absorbing bank reserves.
Where open market operations for adjustment purposes are not
feasible, and various means of regulating the impact of.flows of
foreign exchange are insufficient, central bank intervention for
balancing out end-of-period positions and for fine tuning of the
money market (where this is an objective) has been attempted through
other means, including, typically, outright transactions and repurchase agreements with the call-money market.

In some cases, such

adjustments take the form of special arrangements at the discount
window at the initiative of the central bank (see France) and which
perform a function similar to repurchase agreements in the United

Even in those countries in which open market operations

have become part of the range of policy instruments used by the
central bank, such operations are in some countries not a continuous
process, and are not necessarily undertaken "at the market;" indeed,
transactions may be consummated at rates posted by the central bank
(as in West Germany), or negotiated in each case (as in Japan;, so
that both sales and purchases usually take the form of special

In some cases, prior transformation of book credits

to the government into marketable securities is necessary to open
the way for open market sales.
The traditional reliance on discounting, together with the fact
that banks as a whole are continuously "in the Bank" for considerable
amounts, has tended tc inhibit the development of open market operations even where suitable securities and appropriate market arrangements are available.

When banks acquire excess cash, they tend to

reduce their "borrowing

(or sell funds, in the interbank market,

obviating the need for banks with deficiencies to borrow), so that
the central bank does not need, to sell securities in the open market to mop them up.

Conversely, in countries where commercial banks

are almost continuously borrowers from the central bank, they have
little inducement to hold eligible securities, the yield on which is
usually lower than the discount rate.

Thus, in many countries, the

pivotal assets, for the purpose of reserve adjustment, are not the
lowest yielding government securities (such as Treasury bills), but
the lowest-yield paper which is automatically rediscountable (such
as medium-term paper in France)•
We can now1 proceed to the discussion of the changes introduced
in the traditional discount mechanism since World War II, and which,
in many cases, go back to modifications introduced during the Great
Depression of the thirties.

Discussions of rate policy will be fol-

lowed by sections on quantitative controls and on the use of the discount window as a tool of selective control...
The discount rate is first of all the cost at which cash may be
obtained from the central ba.nk.

The use of the discount window has

a time as well as a rate dimension; a widely used technique is to
require discounts to be for a certain minimum period in contrast to
the U.S., where more emphasis is placed on maximum terms. Banks normally endeavor to borrow at the cheapest cost, depending on the
availability of required collateral and on applicable terms (such as
minimum duration of a given accommodation).

Responsibility for setting the discount

and related rates (such

as the rate on advances) usually rests with the Board of Directors of
the central bank, although in some cases this responsibility is lodged
with a separate monetary authority (such as the Monetary Policy Board
in Japan).

Prior consultation with the Treasury is usual in view of

the generally close relationship between the two institutions or, less
frequently, as a result of specific legal requirements (as in the
United Kingdom).
The minimum amounts by which rates are typically changed differs
from country to country and reflects tradition and trade uses as well
as policy objectives. In general, changes are normally made by a
minimum amount of l/2 per cent, but some banks also use l/4 per cent
steps, and there is some tendency to make increases by the larger and
decreases by the smaller amount,

(in Japan, rates are changed by

O.365 per cent or multiples thereof, this figure being the equivalent
of a rate of one-thousandth of one per cent per day.) Decisive action
is usually symbolized by moves of a full percentage point in either
direction, and, in recent years, there have been examples of moves by
larger amounts (United Kingdom) to cppe with serious external disequilibria. By and large, moves undertaken for external reasons involve changes by relatively larger amounts than those for purely
domestic reasons, in particular if the central bank tends to follow
rather than lead market developments.
Borrowing from the central bank usually involves a hierarchy of
instruments carrying successively higher rates (and/or related terms
tending to raise the real cost of borrowing), so that availability
of specific categories of collateral determines the marginal cost of


This is true even when quantitative limitations are

applied at the window.

As long as adequate collateral of a given

category is available within the banking system, the rate which it
carries (such as the "Lombard" rate in West Germany) tends to become the effective ceiling on money market'rate fluctuations.
cost of marginal borrowing


from the central bank (whether deter-

mined by eligibility requirements or quantitative restrictions)
tends to determine market rates, unless conditions are sufficiently
easy to drive market rates below the lowest applicable central bank
lending rate.

When commercial banks are uninhibited from making the

fullest possible use of credit facilities offered (the reluctance to
borrow not being a significant aspect of behavior in most foreign
countries), the restrictiveness of any given discount rate depends
on a number of circumstances, including the terras of borrowing and
the relation of the discount rate to market rates (or, more generally,
the cost of alternative sources of funds).

Because of the signal role

of the discount rate and/or its relative inflexibility, and because
certain bank deposit and lending rates are tied to it, in actual
practice in some countries discounts and advances are made at rates
below or above the official rate, as policy requires.
All countries covered by the present study have a. multiple-rate
structure for central bank credit, even though public reference is
typically made to "the" discount rate which, indeed, is the key to
the whole structure of official rates.

A multiple-rate structure is

applied either by relating rate to the characteristics of the paper
discounted (or accepted as collat^rritj),. or by establishing a progressive (stepped) rate structure <t$$igried to make more expensive

any borrowing for longer periods or for larger amounts.

In the first

cage, the discount rate-may be differentiated according to the type
and/or maturity of collateral* or by different institutional classes
of borrowers.
When a whole family of rates is used instead of a single discount
rate, subsidiary rates may be linked to the main rate in a variety of
ways, by fixed or variable differentials; alternatively, subsidiary
official rates may be linked to a significant market rate (for instance, the Treasury-bjll rate) as well as to the main discount rate.
Such multiple-base linkage offers greater,flexibility for adjusting
the cost of. borrowing to market conditions without requiring frequent
changes in the discount rate itself (as in the case of tjae doublebase system for lending to money market dealers in Canada).


generally,- under a multiple-rate structure with variable differentials,
changes in the structure of effective rates can be made more frequently
than in the basic 'discount rate.l
Progressive rate structures are used essentially to reduce administrative problems at the window.

In some cases, progressive rates

are applied without using discount quotas-, and in some countries it is
indeed believed that such rates are an alternative to quantitative

Foreign experience includes a great variety of examples

of (a) progressive rate structures as a function of size of borrowing
(related to capital, reserves, assets, or some other magnitude) and
duration of 'borrowing (Sweden, France); (b) posted or negptiated rates

1. For instance, from December 3> 1959 to April 8, 19&5> o n e o r
more of the specific rates for discounts or advances of the Bank of
France were' changed 17 times, whereas the basic discount rate was
changed only eight times.

for borrowing in excess of basic quotas (Japan, France); and
(c) preferential rates for specific types of instruments or categories
of loans (France).
When the central bank endeavors to keep its discount r$te always
above important market rates, or to make the effective cost of borrowing higher than comparable borrowing in the market, such rate is
usually referred to as a ''penalty rate."I

If a central bank has a

progressive rate structure, all rates above the basic rate are
usually considered penalty rates. The central bank may operate in the
call-money or government securities market with the specific purpose
of keeping market rates below a certain penalty rate level.
Penalty rates are also used as a sanction to support other tools
of monetary control, such as abservance of liquidity ratios (Sweden);
penalty rates may be charged to banks which fail to comply with such
ratios or to penalize relending (charging penalty rates to banks which
sell reserves).

Penalty rates are also used as a means of regulating

borrowing above quotas or as an additional restraint in the absence of

Continuous (or excessively frequent) borrowing may be reduced

by applying penalty rates after a set period or for repetitive recourse
to the window within a determined period; in the last case,, penalty
rates may apply to an individual bank (Canada) or to all banks, for
instance, as soon as one single bank's borrowing exceeds a set duration
(five days in Sweden)*

In some cases, the penalty rate is graduated in

such a way as to become practically prohibitive beyond a certain margin

1. In the context of this Report, the term "penalty rate" refers
to a level in relation to market rates, and "progressive rates" to the
structure of rates. Usually, at some point, rate progression reaches
a penalty level.

above the normal quota (currently, the "superhell" rate in France) or
so high as not to be used (currently in Japan).

The principle that

access to central bank credit should always be available--though at
penalty rates--is thus preserved, but the ultimate penalty rate is
used mainly to encourage banks to" adjust their reserve positions
through borrowing in the open market or by selling securities', A
policy to maintain the penalty rate status of discount rates may lead
to periods of excessive ease when reserves are supplied through open
market operations to prevent a rise in market rates when raising the
discount rate appears inappropriate (Canada).
In several countries, willingness to borrow at a cost higher than
the basic discount rate has been interpreted (in France and Japan, for
the second tranche of progressive rates) as prima facie evidence of
extreme tightne'ss. The central banks of these countries have made
it a policy rule in such cases to' relieve pressure by injecting reserves through open market operations or by other means in order to
avoid high marginal rates (such as the "superhell" rate in France and
the second-tier penalty rate in Japan) and to avoid pushing up money
market rates to excessively high levels. Foreign experience also
suggests that a progressive discount rate structure tends to produce
discontinuities *in the rate curve around the steps, and that the steps
may thus pose problems for monetary policy.
In many countries, deposit and/or lending rates (or important
segments of the rate structures) are automatically tied to the discount rate. Such linkages have come into existence in a variety of

as a result of the Great Depression, under wax emergencies, as

part of control measures instituted by totalitarian governments, or

as a result of pressures on the part of bankers' associations, with or
without official review and/or sanction.

When lending rates are rigidly

linked to the basic discount rate, the cost of discounting at higher
(including penalty) rates cannot be passed on readily to customers; the
resulting pressure on profit margins constitutes an additional restraint for meeting customers' loan demands.

Tying may have a certain

degree of flexibility, with margins in relation to the discount rate
being varied from time to time, or bank rates, following changes in
official rates, regularly, but not automatically, and perhaps

with a

In some countries at least, undercutting of stipulated mini-

mum rates, as well as concealed additional charges, depending on credit
conditions, are not unknown.
Rigid tying of deposit and lending rates to the discount rate is
inimical to flexible use of the discount rate for monetary policy purposes . As already mentioned, some countries have tried to resolve the
problem by lending to banks at rates which were in effect higher or
lower than the official discount rates.

In recent years there has been

a tendency to loosen or remove such traditional or institutionalized
Most of the countries surveyed have not been able to place exclusive reliance on the discount rate for controlling the total quantity
of reserves, i.e., to rely on rationing through rate alone and keeping
an "open window" at that rate.

Those who traditionally relied on

regulation through rate (like the United Kingdom) have found it necessary in recent years to make considerable use of moral suasion, aiming
at quantitative limitation (but avoiding overt, rigid control) of

commercial bank lending, and applying to a steadily widening circle of
credit institutions.

Even those central "banks which have continued to

exclusive or primary

reliance on the rate have found it neces-

sary in recent years to make accommodations at the discount window more
flexible; a recent example of the need for greater flexibility to
differentiate between the cost of discounts relevant for the international flow of funds and for regulating the domestic money market
without changing the rate was provided in the United Kingdom.
Some of the countries surveyed have gone further to limit the
growth of bank credit by a variety of quantitative restrictions.
Quantitative controls may apply to reserves (usually, to the aggregate
volume of discounts), to assets, or directly to bank liabilities.


may be geared (as in France) to credit targets specified in national
economic plans.

Various techniques to limit bank credit expansion

directly have been used at different times in various countries.
Direct control of- total rediscounts, reserves, and/or loan volume, is
usually supported and reinforced by various forms of moral suasion
(with Japan as a conspicuous example).

Controls may involve fixed

limits for loans or total assets or maximum permissible rates of increase during specified time periods.

Alternatively, the ratio of

loans to deposits, or some other total among a bank's assets or liabilities

is made subject to regulation.

Demand at the discount win-

dow may be also controlled by freezing a certain volume of eligible
assets in bank portfolios through the imposition of liquidity ratios.1'
The central bank can vary the list of assets which qualify for

1. In other countries, such as West Germany and Switzerland,
liquidity ratios are imposed for other than monetary policy reasons.

inclusion; it can furthermore stipulate minimum percentages of
specific assets (such as Treasury bills) to be held within the overall liquidity ratio.

An outstanding example was the (variable)

liquidity ratio ("coefficient de tresorerie!t) in France.
Some central banks use discount quotas (credit lines) as a means
of influencing directly the total volume of bank credit.

They are

the fulcrum against which rate policy becomes effective.


quotas are typically used in countries where alternative monetary
policy tools (such as open market operations) to control the reserve
base are not available, or cannot be used meaningfully and/or where
variable cash reserve requirements are not available to control the
credit multiplier.

In several countries, they have proven inadequate

to. achieve this goal and have had to be subsequently supplemented by
ceilings on total loan volume or other quantitative controls.


other countries have concluded that only a direct control over bank
credit would achieve their policy goals, but have retained discount
quotas as part of the control mechanism.

Indeed, a central bank

which directly controls the total volume of bank credit may downgrade
the role of discount quotas, or dispense with them altogether, and
supply reserves readily (but take into consideration reserves acquired
from, or absorbed by, other sources) as long as credit expansion remains below target limits.
Quotas to regulate the volume of discounts are set~-and modified—
on the basis of broad policy considerations.

Such quotas may be set

for total borrowing from the central bank, or separately for discounts
alone (as in West Germany after 1952); and additional

but separate

credit lines may be established for advances. 1

Additional quantitative

limitations may apply to the permissible amounts of specific types of
assets within the total discount quotas.

In fact, discount quotas may

be equivalent to credit lines with no questions asked, or conditional
on conforming with the wishes of the central bank or on the observance
of specific, stated ground rules* ~
Quantitative regulation of access to the discount window always
raises questions of equity and flexibility.

Setting of discount quotas

for institutions (and their subsequent administration) must steer between excessive generosity, which might interfere with the conduct of
monetary policy, and excessive restrictivenessj in the latter case,
the problem of above-quota accommodations becomes chronic•

Quotas may

be geared to bank capital, liabilities, past changes in selected balance sheet items, or a variety of other variables.3

Techniques used

for setting and changing discount quotas for individual institutions
range from complex formulas (as in West Germany) to informally determined across-the-board percentages^ (as in the case of advances in

1. In several countries in which dealers in government securities are an important element in the mechanism through which monetary
policy is implemented, separate lines of credit may be established
for them. A related reason for such credit lines is tne endeavor to
develop a national capital market.
2. Access to central " a i credit depends, of course, on availbrK
ability of proper collateral in an individual institution's portfolio*
3. The smaller banks may be given special consideration in
setting or administering discount or loan quotas.
4. In at least one country (France) revisions of ceilings are
negotiated with the banks involved.


Various approaches have "been developed to revise ceilings in

the light of growth requirements and, in some countries, changing
policy objectives.
Discount quotas need to be adjusted upward over time to keep in
step with the growth of the economy and its expanded credit needs
since the variables on which they are based, such as capital funds,
will not necessarily grow at the same rate as the needs which the
quotas are designed to meet.

Such adjustments may be automatic or

subject to discretionary determination,,
Quotas may be left unchanged for long periods (as in Canada) or
recalculated frequently on the basis of formulas (monthly* in West
Germany, quarterly in Japan), or administered informally, in the guise
of- approximate guidelines (as in Italy).

Attempts to reduce the area

of administrative judgment and/or to provide for gradual Increases of
quotas by linking them to such balance sheet items as short-term liabilities (and medium-term liabilities, if the borrowing financial institution is a savings bank) foundered on the hard fact that any
addition to reserves leads to secondary credit expansion which, in
turn, provides the justification for a further rise in the quota.
Indeed, any automatic linking of quotas to bank assets or liabilities
(or other growth variables) carries with it the danger of an automatic
inflation of quotas*

Obviously, when quotas are based on capital

accounts, some degree of manipulation by individual banks is possible
by increasing such accounts.
A certain degree of flexibility is generally provided by permitting banks to exceed overall discount quotas at a penalty rate
or under

special conditions, or by





certain categories of paper (such as medium-term paper covering
approved financing of equipment or of exports), or by establishing
additional quotas for specific categories of credit instruments.
It can also be provided by granting or negotiating temporary supplementary quotas for purposes (to meet end-of-month and similar
periods of money market pressures) and amounts specified in advance,
or by negotiating such quotas on a case-by-case basis to accommodate
specific situations (West Germany).

Such flexibility is essential

where the central bank does not possess adequate alternative tools
for meeting exceptional or unexpected situations.
Overline credit can take the form of (temporary) supplementary
quotas at regular rates granted for specific reasons and for limited
periods (West Gerraany).

Normally, however, borrowing above the quota

is available at a penalty rate only and subject to quantitative restrictions or "window guidance."

The cost of above-quota accommoda-

tion may be stepped in such a way as to become, in effect, prohibitive
beyond the first "tranche" above the basic quota (France).

Instead of

penalty rates, borrowing beyond ceilings may involve merely the obligation for proper downward adjustment in subsequent periods.
Under a system of discount quotas, tighter monetary policy usually has a pervasive effect, since banks which are close to exhausting
their leeway under quotas tend to lay off bills with banks in a more
comfortable position.

As a result, total borrowings tend to rise

toward the aggregate quota ceiling, market rates tend to rise, and
this tendency is reinforced as some banks begin to borrow at penalty

In effect, while offering additional accommodation at a

penalty rate and under restrictive conditions, as a privilege rather
than as a right, the central bank counts on the rate to inhibit credit
exp-Vision beyond the limits set by quotas.
The effectiveness of discount quotas depends on a skillful combining of quantity and rate controls0

But it also depends on the avail-

ability and cost of alternative sources of reserves and on the volume of
liquid assets the banks have at their disposal, as well as on whether or
not the balance of payments is generating a significant surplus.


the point of view of monetary policy,-*- the main advantage of a formal
quota is that it reduces problems of day-to-day discount window administration by stating to each bank unequivocally how much it can borrow
within the framework of established discount window philosophy.


fact, a discount quota becomes the amount which an individual bank
feels it can borrow as a right, as long as it adheres to clearly stipulated ground rules.

To a large extent, administrative problems are

shifted from the control of total borrowing to the control of "overline"

use of discount quotas as a tool of monetary control involves.

In addition to giving access to central bank credit outside and above
such quotas, at least two groups of problems, (a) the role of the

margin" and (b) changes in quotas to implement policy•
One of the widely recognized limitations of quotas is the

stated or implied right to their continuous and full use which, except
for the cost involved, in effect, amounts to an equivalent reduction of

1. As distinct from the use of rediscount quotas to protect the
central bank from possible losses as a result of excessive lending to
individual banks (as in VJest Germany before 1951) •

cash reserve requirements or prescribed liquidity ratios.


there are considerable differences in the actual use that various
categories of banks make of credit lines available to them.

On the

other hand, the actual effectiveness of discount quotas depends, in
part, on the willingness of banks to exhaust them quickly and to rely
on additional accommodations when needed, or on the unwillingness of the
central bank to permit their continuous use.

In some countries banks

tend normally to make only partial (but typically substantial) use of
credit lines and to shift to fuller use when official credit policy
become more restrictive.

The attitude of banks toward utilization of

quotas thus becomes an element in setting their overall level.


formulating its day-to-day operating objectives, a central bank must
take into account the willingness of banks to further reduce the leeway
under credit lines.

On the other hand, under a system of discount

quotas, the margin between the quota ceiling and current borrowings
tends to become an important consideration in determining a commercial
bank's lending policy.
The attitude of central banks toward interbank trading in excess
reserves is not uniform.

In most European countries borrowing to re-

lend is considered consistent with the normal use of lines of credit,
as relending (in fact, though an interbank money market) is recognized
as part of the adjustment process; in others (such as Sweden), it is

Borrowing in order to relend in the interbank market and/or for

buying bills from banks which have exhausted their quotas is common.

1. This is even true when, as in Italy, banks are expected to repay their advances completely from time to time and not to return to
the window immediately.
2. Italian and West German banks even include the unusued margin
in computing their liquidity positions.

Even when a penalty rate is involved, "banks with unusued margins may
still -have a strong inducement to discount for the purpose of lending
to the market (France).

Foreign central banks do not uniformly frown

or penalize relending at a profit.

Discretionary changes in credit lines are used:

to meet special situations (such as their reduction to

offset foreign borrowing in West Germany in 1964).

as a sanction against nonobservance of the rules of the

game or for noncompliance with the express wishes of the central bank.
(For instance, in West Germany; in France, in 1965* the governor in his
capacity as Vice-Chairman of the National Credit Council, in a published
letter to the Banking Association, threatened to reduce quotas of banks
which expanded credit too rapidly).

as a countercyclical measure,

The central bank can achieve greater ease or tightness by merely
changing aggregate quota ceilings (provided such action is made public
or at least is communicated separately to each bank involved; and thus
varying the amount of the


unused margin!f (Japan).

for ordinary business reasons, such as failure to meet

bank examination standards, deterioration of bank management, or because of adverse developments in the financial position of the borrower
(West Germany).
Thus, the role of discount quotas as a tool of credit control depends on prevailing bank attitudes toward them; these, in turn, will
depend in large part on whether, under what conditions, and at what
cost, a given category of credit institution

can expect to obtain

central bank credit beyond the unused portion of the quota.


about bank attitudes toward this unused margin is, indeed,one of the
basic difficulties,of operating with discount quotas. West German experience suggests that these attitudes may also not be consistent over
In countries in which discounting is used as a means of selective
credit control designed to influence the distribution of bank credit
(France, West Germany, and Japan being the most important examples)
certain types of loans may be exempt from overall quota ceilings, or
benefit from specific additional quotas.
Typically, certain types of investment and export credit
are favored, and preferential discount rates may apply to such paper
(as in France).

Conversely, low-priority activities may be discouraged

by eligibility, quantitative or cost restraints at the window.

In some

countries discount rates are structured in such a way as to encourage
specific categories of lending, or of lending on specific terms.


structure of rates at the window thus becomes an indirect means of influencing portfolio composition.
Distributive considerations (selective controls) may also be given
effect within overall discount (or credit) quotas by giving preference
to certain categories of paper, either through automatic access to the
discount window (frequently after prior approval of credit by the central bank) or through preferential rates (or a combination of such

1. As an alternative to using the discount mechanism directly as
a means of qualitative credit regulation, it may be used indirectly to
enforce compliance with selective credit policies applied through other
techniques (West Germany, Italy).


In fact, such policies amount to direct central bank

financing of favored economic activities, provided the selective
devices used to achieve this purpose prove effective; evidence on
this point is contradictory.

Sometimes a privileged status is given

to credits that private lenders would not have undertaken without
what amounts to a take-out commitment by the central bank (France);
private credit is thus, at least temporarily, substituted for central
bank credit or Treasury resources.

Such discounting has the double

aspect of selective credit controls (credit direction) and creation
of additional bank liquidity.

The favored assets become, in effect,

instruments of secondary liquidity giving their holder automatic
access to central bank credit at his option, since they can be converted into reserves without prior notice.
Extension of preferential treatment to specific types of credit
(or instruments) usually involves obtaining a preliminary authorization, usually in the form of a certification by affixing a "stamp" or
"visa" from the central bank or the proper primary discount institution (see below), which is tantamount to a commitment to discount the
particular loan on presentation, at the holder's option.


bills" (Japan) or "visaed bills" (France), kept in the portfolio of
the original lender (commercial banks), are, in effect, instruments of
secondary liquidity since they can be converted into cash without
question at any time.

After obtaining an official seal of approval,

1. More generally, in some countries commercial banks may obtain,
in the form of a "visa" or "stamp" the central bank's advance certification that a particular credit is eligible for discount. Some central
banks review in advance all bank loans, or all credits above a certain
amount to determine their eligibility at the window (Belgium). Such
review usually amounts, in effect, to screening and tends to have some
selective control aspects.

banks may be more willing to hold such paper in their own portfolios
than they otherwise would.

Indeed, the giving of advance approval has

been used in some countries (in particular, when coupled with the
availability of preferential discount rates) to induce commercial
banks to enter new fields of lending (medium-term loans) or to expand
their assets in specific areas in line with overall government economic

In effect, an unconditional agreement to discount through the

technique of formal advance agreements permits the central bank to add,
at its own direction (and under certain conditions, in a discriminatory
manner) to the liquidity of the banking system.

In some countries, dis-

counting of certain instruments outside quotas has impaired central
banks1 control over overall credit expansion.

Some central banks have

found it necessary to put an outside (global) limit on the volume of
such preferred paper which it would discount (West Germany); for a
special technique to restrict rediscounting of exempt paper

see the

chapter on France.
Pursuance of multiple policy goals by countries using quantitative
credit tools at times results in complex schemes under which the overall
effectiveness of ceilings is undermined by various exceptions.


generally, the use of the discount mechanism as a tool of selective
credit control tends to render more difficult implementation of overall
monetary policy, in particular when the discount window is used to
stimulate particular activities.
Access to the discount window does not have to be direct.


the interposition of a discount market (as in the United Kingdom), some
part of the reserve surpluses and deficits is evened out at a cost which

may be below the official discount rate, if warranted, by money market

Obtaining central bank credit through discount houses

helps to conceal the identity of the deficient bank, at least
temporarily (Canada).
In other countries, in some cases as a result of the financial
crisis of the 1930's, special primary discount institutions were
created, which, in turn, rediscount with the central bank.


in periods of stress, traditional eligibility requirements have frequently proven to be too rigid to permit effective injection of required liquidity.

The solution adopted in some countries was the

creation of separate official institutions for the purpose of rediscounting paper not eligible at the central bank's discount window.
These institutions usually also borrow in the call or short-term money
market and from the central bank, and have access to its rediscounting
On the other hand, some countries have created institutions
specializing in medium-term financing through discounting of credits
originating in specific activities considered deserving of official
support" (typically, export trade, but also public construction,
equipment financing, and others).

These institutions, which normally

are government-sponsored, also have access to rediscounting at the
central bank to the extent that they are unable to finance their activities from their own funds or by borrowing in the money market and
from special resources, such as Treasury deposits or long-term funds
raised in capital markets (Belgium).


By changing conditions under

The German Frivatdiskont A.G. is a good example•

which it makes such rediscounts, or by varying the ceiling for such
rediscounts, the central, bank has a potentially powerful means of controlling the activities of these public investment and primary rediscounting institutions; frequently, however, there is little room for
discretionary policy because the central bank is expected to implement
government policies carried out by the specialized institutions.
In fact, both types of primary discounting institutions are a conduit for central bank credit on the basis of collateral of a maturity
or quality not acceptable for regular central bank operations < The
official rediscounting institution may provide the additional endorsement ("name") required to make the instrument rediscountable at the
central bank.

It also normally examines the loan application and

issues advance discount commitments without which the original lender
would not make the loan, or would accommodate the borrower at a higher
rate only (France).

Typically, short-term instruments (eligible at

the discount window) are issued against a portfolio of debt instruments
of longer maturity; this procedure is known as "liquefying" or
"mobilizing" long-term assets., An alternative technique is for these
institutions to hold medium-term paper until it moves close enough to
maturity to become eligible at the discount window.
Both types of special discount institutions have in common that

provide credit for certain government economic policies
without directly involving the central bank;


extend credit on terms that are more flexible with
regard to maturity, collateral, and quality than available from the central bank;


give additional flexibility to the conduct of credit
policy, in particular when expansion is desired;


contribute to broadening credit and capital markets
by substituting their own credit for that of their
borrowers, by borrowing short to discount mediumterm debt, and in other ways.

In some respects, these specialized central credit institutions
resemble similar government credit institutions in the United States
which also use borrowed or Treasury funds to finance certain sectoral
activities (such as housing).

In contrast, foreign specialized credit

institutions often use the discount technique for providing official
financial assistance.

They have extensive direct dealings with com-

mercial banks, and usually cooperate closely with their respective
central banks.
Credit activities of primary discount institutions require adequate and continuous coordination with overall objectives of credit

These institutions are usually subject to direct and close

supervision by the Ministry of Finance, and there is normally little
room for policy conflicts.

To meet this problem, several countries

have created special coordinating bodies, such as the National Credit
Council in France.
Uniform administration of the discount facility does not pose
significant problems abroad because of the centralized nature of central banks, even in Germany, where the


Landeszentralbankenn are the

closest counterpart of Federal Reserve Banks that can be found abroad.
Discounts are usually available at all branches of the central bank,
whether they are few (as in the United Kingdom) or relatively numerous
(as in Italy or France).

Uniform discount administration is assured by

issuing rules and regulations to regional and local offices•


necessary, quotas are assigned to each office to assure that the

aggregate amount of discounts does not exceed policy ceilings
determined by the head office.

Daily reporting of discounts and

advances made (and maturing) permits the head office to exert tight
and current control and to make quick changes in individual branch
office quotas when necessary.
Because of the prevalence of branch banking, a large proportion
of the paper originating locally is discounted at the head office of
the central bank through



office of a branch-banking

system which typically centralizes eligible instruments.

This is

not necessarily true where headquarters of some of the leading
national branch-banking systems are not located in the capital (as
in Japan) or where important regional branch systems exist (as in
France, Italy, and West Germany).
Uninhibited access to the discount window, and central bank transactions undertaken to bridge short-term swings in reserve availability,
permit banks in most countries to reduce the demand for excess reserves
to zero.
While remaining a very important tool of monetary policy, discounting has lost its central position since the banking crises of the
thirties, and even more clearly since World War II.

In almost all the

countries surveyed, central bank policy has come to rely more heavily
on tools other than discounting.

1. Also, in some countries, the reserve ratio needs to be observed
only on specified control days, such as the end of the month. The absence of the need for meeting cash reserve requirements within relatively
short periods reduces the pressure for developing detailed and up-to-date
data of the kind on which the Federal Reserve System bases its elaborate
and continuously revised projections of reserve needs and availability.

Several developments contributed to reducing, though, to a varying
degree, its original significance, including conditions of excess
liquidity and changes in the institutional environment,

These in turn,

required the forging of new monetary tools (in some cases, following
their idevelopment in the United States) and--in some countries at
least—led to closer integration of monetary management with overall
economic controls and planning.

It is, indeed, not improper to speak

of a "politization" of the discount rate,- as practicable limits
for discount rate variation, and in some

cases conflicting domestic

and-balance of payments considerations, tended to reduce the scope of
rate regulation.
In some countries in which progress toward developing flexible and effective open market operations has been slow, a tendency can
be discerned to regard variable reserve requirements as an alternative.
By and large, however, there has. bqen. some ..disenchantment, with the
potency of" flexible reserve requirements as. a tool of monetary control
and, as a result., a tendency to introduce or expand direct controls.
In the larger continental countries, in particular, but also in Japan
and in several other•countries, direct quantitative regulation of bank
liquidity and/or-bank credit has become an integral and important part
of monetary controls-.
Rediscounting with the central bank (or obtaining advances) remains the only routine means for adjusting stiort-term fluctuations in
reserve positions.

Inability to use open market operations as a main

tool of monetary policy, as well as difficulties encountered in
developing adequate new tools of monetary policy (such as variable.

reserve requirements, or even fixed reserve requirement^) have tended to
keep the discount function

as an important tool of monetary policy,

along with the management of liquidity of external origin.

Even when the average amount of reserves provided to the banking
system as a whole through the discount window is relatively small, its
marginal role may be important.

Similarly, the significance of

changes in the discount rate may be considerable, even though they
affect directly the cost of only a small fraction of reserves in use,
because bank deposit and lending rates are geared to it, and for maintaining equilibrium in international accounts• With its rationing
function much reduced, the discount rate has become in several countries mainly a peg for manipulating the structure of a variety of
commercial bank and other rates.
In some countries (Netherlands, Belgium), the rate still has an
important domestic signal function through its announcement effect,
but it has been lost in others, mainly because changes have always
been very infrequent (Italy) or because of tying (as in Canada,
1956 - 1962). With the exception of Canada and Switzerland, where
discounts and advances are of quite marginal significance, although
for different reasons, discounting continues everywhere to be an
important tool of central bank policy and, in some countries, has
become an important avenue for achieving economic objectives of
government policy outside the credit field.
the discount window was

In these countries,

broadened, not primarily because it was

judged a more powerful means for controlling money and credit, but
because it provided a convenient way for achieving certain government

policy objectives.

To some extent it appeared as a natural way of

utilizing the money-creating power of the central "bank to meet some
of the new challenges of the post-World War II era and to provide
another indirect way for government guidance of the economy--by now
an unquestioned principle in all countries surveyed.
Many countries expect to achieve greater policy flexibility by
developing open market operations and a more sophisticated management of fluctuations in foreign reserves, rather than from a rejuvenation of the discount mechanism.

But understandably, current

central bank attitudes toward the present and future role of discounting vary.
In view of the numerous modifications which the discount
mechanism has already undergone in most of the countries surveyed,
it seems safe to assume that it is likely to evolve further, as conditions change and new challenges arise.

Only history will show in

what countries, and in which way, changes in the setting and objectives of monetary policy and the gradual emergence of other tools
of monetary management will change the relative role of discounting
as a tool of monetary policy.



This part consists of eleven chapters describing the essential
aspects of the discount mechanism in the eleven countries covered by
this study.

The general aim has been to limit detail to what seemed

essential to bring out the framework in which the discount mechanism
is operating in each of the countries covered, to identify its relation to other tools of monetary control, and to describe in some
detail specific processes and techniques.

The general emphasis is on

post-World War II developments; no attempt has been made to trace in
detail the evolution of the discount mechanism in each of the eleven

In some cases, it seemed, however, useful to describe

policies or techniques supplanted in the meantime.

No attempt has

been made to keep the structure and coverage of the individual chapters uniform.
It has not proven possible to present a comparative analysis of
the role of discounting in quantitative terms without adding considerably to explanatory material. It was therefore concluded that it
was of little use, given the objective of the study, to present
limited and not always entirely comparable data.




The Banking System




Reserve Requirements

. .

IV. The Discount Mechanism and its Effectiveness
Credit policy
The central bank credit facilities




The effect of central bank rates on the
interest rate structure

Other Policy Instruments
Credit ceilings


Liquidity ratios


Open-market operations


Moral suasion


After recovering national independence Austria had little choice
but to closely integrate with the international economy and to live
with the ebb and flow of international capital.

Austria's basic

monetary control problem derives from its relative smallness in the
international economy, more particularly, from the smallness of the
cash base of the banking system in relation to possible changes in
the central bank's international assets.

Thus, to take only one

example, the $600 million equivalent increase in such international
assets in the five years ended December 1965 was equivalent to twothirds of the cash base at the beginning of the period.

To maintain

monetary control under such conditions requires powerful tools but
the Austrian authorities are not well equipped even with traditional
monetary control tools.

The discount mechanism plays only a sub-

ordinate role in monetary policy which is primarily implemented through
official ceilings on the volume of bank credit.
In rudimentary money and capital markets, the central bank's open
market powers are virtually useless as a means by which to handle the
effects on the cash base of changes in the central bank's holdings of
international assets.

Likewise, the central bank's authority to vary

reserve requirements is narrow in scope, certainly too narrow to freeze
the commercial banks into the reserve balances that they can and have
acquired as the result of surpluses in the country's balance of
Realizing their predicament, the authorities have not employed the
discount rate for domestic monetary control purposes.

Discount rate

changes have become rare; thus the last time the discount rate was

changed was in 1963-

However, borrowing at the central bank is

controlled to some extent, both discounts and advances being regarded
not as rights, but as privileges.

In recent years, changes in cash

reserve ratios have been made more frequently than those in central
bank rates, while open market operations have been initiated only
recently, and on a small scale.
Having little influence over the cash base, the authorities implement their monetary policy primarily through direct controls over
bank credit.

These controls include both compulsory liquid asset

ratios and, more important, the so-called voluntary credit ceiling
agreements between the Ministry of Finance and the banks.


ceilings apply to all types of credit both to the government and to
the private sector, exceptions being made only for special categories
such as export credit.

The ceilings are set in terms of percentages

of the banks' total liabilities and net worth.

Since the agreements

are voluntary, there are presumably no formal limits on the extent
to which the percentages can be changed.

No penalty is imposed for

violation of the ceilings, but the latter have not been exceeded by
the banks, taken altogether.

When total bank credit did, in fact,

approach'the ceiling during 1966, the ceiling was raised.


The Austrian National Bank is half government-owned, the other
half of the stock being held by bodies representing the interests of
business and employees and partly by credit institutions and insurance companies.

Its Board of Directors is appointed by the govern-

ment and the President of the Republic appoints its chairman.


Board of Directors appoints the General Manager, his deputy and four

managers, to conduct the day-to-day affairs of the Bank and to
imr.lement its monetary policy decisions.

A Commissioner appointed

by the Ministry of Finance attends the Board's meeting for the purpose of assuring that policy actions taken are in conformity with
the law.

The formulation and implementation of monetary policy has,

in recent years, involved close cooperation between the central bank
and the Ministry of Finance which is vested with certain important
monetary control powers.

The authorities deal with a banking system

that is highly centralized.

Two large commercial, banks operate a

nationwide system of branches; several commercial banks serve various
regions of the country, in addition to a variety of specialized credit


Reserve requirements (which cannot exceed 15 per cent of total
deposit liabilities) apply to a broad range of credit institutions


are to be fulfilled in the form of direct or indirect deposits with the
central bank or with the Postal Savings Bank.

Reserve deficiencies

which individual credit institutions have occasionally incurred, carry
with them a penalty or fine that amounts up to 3 per cent above the
discount rate.

These deposits are counted as part of the liquid assets

held under credit-control agreements with the Ministry of Finance.
At the beginning of 1968 the reserve requirements were for larger
banks, 10 per cent against demand deposits, 8 per cent against time and
savings deposits with maturities of less than twelve months, and 7 per

1. These institutions are: commercial banks, savings banks,
mortgage banks, urban and rural cooperative credit societies, and the
Postal Savings Bank.

cent against time and savings deposits with maturities of twelve months
or more; for other "banks the corresponding ratios are 6, 5 1/2 and 5 per
Savings banks or urban and rural credit cooperative societies
which are affiliated with a central credit institution may hold their
required deposits with that institution, which in turn is required to
hold equivalent deposits with the Austrian National Bank*


commercial banks and other credit institutions, such as mortgage banks,
may deposit their reserve balances with the Postal Savings Bank which
in turn is required to make an equivalent deposit with the National Bank.
The reserve ratio has been moved in both directions.

In the

period 1962-1965, reserve requirements were raised four times.

This was

done more to absorb some of the liquidity generated by International
reserve gains than to force the credit institutions to the discount
window, and during the three-year period 1962-1964 rediscounts and advances actually declined.

Since June 1965 the minimum reserve require-

ments were lowered twice (apart from a temporary reduction by
2 percentage points for November and December 1966 only).


since 19^5^ the credit institutions have increased their borrowings
because the balance of payments has been in deficit.


Credit policy in Austria
In its current state of evolution, monetary policy is more concerned with controlling the volume of credit by direct means rather
than by indirect means, such as variations in the cost of borrowing
from the National Bank.

Austria has an open economy and, with a con-

vertible currency, there are few outright restrictions on capital

movements. As a result, the domestic credit situation can be heavily
influenced by the state of the international accounts.

In time of

surplus, the monetary authorities are faced with the task of immobilizing a liquidity inflow, which, considering the limited size of
financial markets, can readily take on massive proportions. This was
the problem during the years 1961-1964 and the monetary authorities
used practically every tool at their command in an effort to absorb
the liquidity.

The discount rate was lowered at one point, with the

hope that funds would jnove out of Austria in search of higher interest
rates elsewhere. But, lowering interest rates at a ti$e of considerable
inflationary potential is tricky business, and the monetary authorities
tended to rely more heavily on other instruments--such as credit
ceilings and liquidity ratios--which more directly affect the volume of
credit. Even in the 1966 turnaround, when credit institutions borrowed
heavily from the central bank, there yas only one minor move to raise
the; cost of central bank credit. This was a l/2 percentage point
increase in rates charged on advances (effective July 1, 1966) which,
however, was taken in conjunction with an increase in the credit
ceiling (by two percentage points of liabilities).

Otherwise, the

National Bank seems to have discounted quite freely, allowing the
credit ceilings to provide the basis for restraint.

Since I960, the

relation of discounts and advances to total reserves and other cash held
with the National Bank has fluctuated widely, mostly as a function of
fluctuations in foreign reserve holdings, ranging from over ^0 per cent
in i960 to less than 3 per cent four years later.
The central bank credit facilities
Legally, all credit institutions which are subject to mininw
reserve requirements have access to National Bank facilities and.

for historical reasons, some private firms or individuals also may
discount and obtain advances. The restraint on the credit institutions' ability to discount and borrow depends mainly on the volume
at their disposal of paper eligible for rediscounting or as collateral
against advances. Eligibility requirements are drawn very broadly.
The paper eligible for rediscounting includes schilling-denominated
commercial bills and promissory notes signed by two parties known to
be solvent, and payable within three months, and all securities and
assets that are accepted as collateral against advances. Such assets
are gold coins or bullion, bonds listed on the Vienna Stock Exchange, promissory notes and bills denominated in Austrian or specified foreign cur^
rencies that mature within six months from date of granting the credit,
or rediscounting and warehouse receipts issued by officially authorized

Other assets eligible for central bank discount are bills

and promissory* notes of enterprises owned by the federal, state and
local governments (in Austria the publicly-owned sector is quite substantial); and the federal, state and local governments can obtain
advances using as collateral Treasury certificates—up to a legal
limit of SI billion.

Bills arising from export transactions that are

induced by the export promotion program are rediscountable at a preferential (lower) rate.
In order to determine whether bills offered are rediscountable, the
Bank's Board of Directors appoints an outside Committee of Scrutiny, the
members of which are expected to be familiar with conditions in trade,
industry, handicraft or agriculture. The Scrutineers advice, however,
is not binding.

The only quantitative restraints and ceilings apply to government
borrowing (including state and municipal governments) and to export
promotion bills (currently S2.5 billion), which are not subject to bank
credit ceilings and which are discountable at a perferential rate;
otherwise there are no explicit limits to rediscounting or granting
loans at the stated rates for discounts and advances.

The National

Bank nevertheless maintains informal quotas on discounting, watching
the volume of discounts by each credit institution.

When an institu-

tion's discounting is considered as bordering on the excessive, further
borrowing by that institution is required to be in the form of advances
(at a higher cost).

The legal basis for this informal control is the

provision by which the National Bank can refuse rediscounting without
statement of reason.
The effect of central bank rates on the interest
rate structure
During the twelve-year period since the National Bank was organized
in its present form, the discount rate has been changed only six times,
beuv^een a range


3 3/4


5 per


Yet, despite



use of central bank rate changes, the National Bank considers them
important because they can serve as a widely recognized signal of the
authorities' view of the direction in which monetary and credit conditions should move and because of their possible effects on the domestic
interest structure.

Changes in the central bank discount rates are

usually accompanied by changes in the rates on advances granted by the
Bank and are sometimes instrumental in affecting credit institutions'
lending rates.

Rates on advances depend on the type of collateral; tjie

differential between the discount rate and the rate on advances is

smaller if the collateral is a federal government obligation. This
differential is currently 1/2 and 1 percentage point, respectively.
There is, however, no rigid link between the discount rate and
credit institutions' lending rates, which may move in response to
other influences as well.

Nevertheless, following the reduction in

the discount rate to 4 l/2 per cent in June 1963, the monetary
authorities negotiated an agreement with the credit institutions to
reduce the cost of credit by 1/2 to 1 percentage point and this
relationship apparently still holds.


Credit ceilings
Under the Credit Control Agreement (originally made in 1957,
last revised in July 1966), the authorities have set ceilings on
the credit institutions' loans and advances; these ceilings are
stated as fixed proportions of a credit institution's net worth and

Credit is defined as all-schilling loans on current

account, acceptances, advances to the public authorities, advances
against mortgages, and loans to credit institutions which are
excluded from a similar agreement.

Discounted and rediscounted

bills are included in this definition of credit, but export promotion bills, ERP bills, and certain other types of financing are

Net worth is defined to include not only paid-in capital

and reserves, but also pension reserves (which usually expand more
rapidly than capital and regular reserves).

Liabilities consist of

schilling deposits of Austrian and nonresident depositors and
1. MERP bills" arise from loans made for industrial and other
development purposes by the National Bank out of a revolving fund
consisting of the schilling counterpart of Marshall Aid to Austria.

promissory notes. Deposits belonging to Austrian credit institutions
which participate in this or similar agreements are not considered
liabilities for the purpose of extension of credit. The maximum level
of schilling deposits of foreign credit institutions to be included in
liabilities for this purpose was limited to their level of December 31>

This means that additional schilling deposits by foreign credit

institutions cannot be added into the base used to determine the credit
Since July 1966 the ceiling for commercial banks is equal to 70 per
cent of liabilities plus 75 per cent of net worth.

While the net worth

ratio has been unchanged since April 1957> the liability ratio was
reduced between 1962 and 1964 at three successive times, and has only
recently (July 1966) been raised again. Thus this tool was frequently
used in response to changes in monetary conditions.

Individual banks an#

other credit institutions have from time to time exceeded their credit
ceilings, but credit expansion of all credit institutions has remained
below aggregate ceilings, and only recently has the margin for expansion been reduced substantially.
Liquidity ratios
Liquidity ratios, originally established for the protection of
depositors, have in recent years been employed on occasion for monetary
policy purposes. The ratios, established by the Ministry of Finance,
prescribe the form in which a certain proportion of assets have to be
held and is set in terms of the credit institutions1 liabilities. The
latter are defined as all-schilling deposits of Austrian and foreign

1. Net worth is defined to include paid-in capital and reserves
(also pension reserves) reduced by the value of certain assets, as there
are real estate, buildings and permanent investment in other enterprises.

depositors (including credit institutions), promissory notes and

Currently, "primary" liquid assets are defined as vault

cash and deposits with the National Bank and the Postal Savings Bank,
and their ratio to liabilities is presently 10 per cent.


liquid assets are defined as securities acceptable by the National
Ban'K as collateral for advances and bills eligible for rediscount, as
well as net foreign assets; the liquidity ratio on "secondary" assets
is currently 30 per cent.

Any deficiency in primary liquid assets

incurs a penalty charge equal to the discount rate, but the penalty
for a deficiency in secondary liquidity is only 1 per cent.
Open-market operations
Article 54 of the National Bank Law empowered the central bank to
undertake open-market operations for the purpose of regulating the
money market.

Nevertheless, in view of almost continuous balance-of-

payments surpluses, the National Bank actually did not use this
authority until 1965; except for two special transactions in 1962.


1965} the parliament adopted a law which provided for the conversion
of the central bank's claims on the government--up to an amount of
3 billion schillings — into 2 per cent Treasury certificates (with
maturities from three months to two years) for use in open-market
operations, and this authority has been used.
payments situation

A favorable balance-of-

and the lack of money market facilities so far has

restricted the scope of open-market operations, but since October 1966
the Austrian National Bank has operated as a buyer in the open market.
Fixed interest-bearing securities which fall due within one year from
the purchase date are eligible for such purchases.

Moral suasion
Moral suasion has been used by the authorities from time to time.
Examples are the agreement with most categories of credit institutions
to reduce the cost of credit to the nonbank public, and the agreement
with selected banks in 1964 not to repatriate foreign assets. A recent
example (August 1966) was a letter to the credit institutions from the
Ministry of Finance reminding them that according to the Credit Control
Agreement, credit could be granted only for economically justified purposes, and that consumer credit at that time was not economically
justified unless all credit demands for investment purposes had been




. .

Institutional Framework. • • • • • • • « • « » • • • •


The Discount Mechanism


IV. Relation of the Discount Mechanism
to Other Monetary Control Tools. * • • • • • , . . .





In Belgium, monetary policy is ^administered by the National Bank,
under the direction of the Minister of Finance; open market operations
are executed by the Fonds des Rentes, which is administered jointly by
the Minister of Finance and the Bank, and which, when other means of
financing prove insufficient, can obtain advances from the National
At. the end of World War II, bank liquidity was very high, as the
banks had accumulated a very large portfolio of short-term Treasury

In order that the authorities might control credit

expansion, the banks were required to maintain liquidity ratios that
had to be satisfied by holding Treasury certificates, thus preventing
massive liquidation to meet loan demands;
For a number of years after the war, credit demand pressures on
the part of business and industry never was long-lasting, and could be
regulated quite easily by variations in the cost of credit achieved
through changes in official rates. On the other hand, the liquidity
ratios had the indirect effect of supplying funds to the Treasury when
inflationary pressures resulted in an increase in bank deposits, and
the opposite effect in the case of deflationary trends; they thus
defeated their purpose. For that reason, towards the end of the fifties
and at the beginning of the sixties, they were successively modified
and ultimately abolished.
In recent years, credit demand on the part of business and industry has been extremely active during certain periods and it has not been
possible to control this credit expansion exclusively by "Che manipulation
of the National Bank's rates. Moreover, the monetary authorities could

not expect to influence significantly the volume of bank credit to the
private sector by acting upon bank liquidity.

The' banks have, in

effect, many possibilities for obtaining resources for such lending,
including redeeming their short-term government securities and rediscount ing loans.
Indeed, a large proportion of trade bills is rediscounted.
Domestic trade bills that meet the eligibility conditions of the
National Bank can be rediscounted with that institution.


the Institut de Reescompte et de Guarantie (IRG) operates as a primary
discounting institution.

Foreign trade acceptances, previously cer-

tified by the National Bank, (see below) can be discounted at the IRG
or, when their remaining term is less than 120 days, at the Bank.
Moreover, the banks can negotiate on the market any bills that may or
may not be rediscountable at the National Bank, in particular through

IRG, which

acts as

a broker for the greater part of the bills

that it does not acquire for its own account, i.e., for uncertified bankers1
acceptances and uncertified trade bills, and for medium-term investment

Finally, the banks can obtain from the National Bank advances

against government securities for very short periods.
As during recent phases of very active credit demand on the part
of business and industry, expansion could not be kept within desirable
limits merely by raising interest rates, nor could it be influenced by
action upon bank liquidity; the National Bank established, for certain
periods, guidelines for maximum bank loan expansion, which it requested
the banks not to exceed.

For a time, these recommendations were sup-

ported by a 1 per cent currency reserve ratio.

Whenever the National

Bank has set credit expansion guidelines for the banks, the competent

supervisory authorities have made similar regulations with regard to
other financial intermediaries. The two-layer discount mechanism (iRG
and National Bank) in which two sets of discount rates are used at each
level, gives the monetary authorities greater flexibility in controlling
the volume, composition, and cost of central bank credit, while a
safety valve is provided through secured advances for very short periods.

Belgium is a clear example of the inadequacy of the discount mechanism in a small country to control domestic liquidity in the face of
strong foreign and international influences. The new control tools
have been used sparingly (thus the highest reserve ratio imposed was
1 per cent of deposits). While discount and other domestic operations
have usually tended to offset effects of international factors
in bank liquidity, the total contribution of reserves of foreign origin
to bank liquidity (mostly related to government borrowing) in the period
1960-66 has by far exceeded the volume injected by discount operations.


The organic law of the National Bank of Belgium dates back to
I85O when it was founded as a joint stock company.

Since 1935 the Bank

has also offered some central banking services to Luxembourg (which
joined in economic union with Belgium in 1921), but these have been
only partially used. The National Bank's activities have been gradually
modified by various laws and royal decrees adopted since the end of

The most important were the 1948 laws, under which the govern-

ment acquired half of the capital stock of the central bank and which
introduced important changes in the Bank's organizational structure.

The National Bank possesses most of the usual central bank powers.
The bank's discounting power is, however, limited to maturities of
four months or less, and its open market powers are circumscribed bylegal limitations on the Bank f s holdings of government debt.

Special official institutions, participate in the actual operation of
three of the main instruments of monetary policy, i.e., rediscounting
and lending on collateral, open market operations, and the setting of
various minimum liquidity and reserve ratios.

In the field of redis-

counting, the central bank determines policy, but the Institute for
Rediscount and Guarantee (IRG) operates as a primary discounting
facility for certain credit instruments.
whose capital

This latter institution,

is supplied by the commercial banks,, operates as a para-

governmental organization, under a board of eight members appointed by
the government.

it was established in 1935 in an attempt to prevent

a repetition of. the difficulties of the early 1930fs, when the banks
were unable to meet demands for cash by rediscounting with the central
bank because much of the paper they held was ineligible for rediscount,
for maturity or other reasons.

1. The limit, set in an agreement between the Bank and the
government, is B.F. 44,333 million (including 34 billion representing
consolidated war debts), plus an amount equal to the Bank's capital,
reserves, depreciation, and pension funds (in mid-1967 this amounted to
B.F. 5,510 million). This ceiling is to be raised by B.F. 6,2 billion
in Sept. 1968 and will be reviewed after three years. There are also
provisions for a supplemental credit line in certain contingencies,
such as a heavy postal check withdrawals.
2. While there is no statutory requirement that any of these
members shall be representatives of the National Bank, at the moment
three of the board members in fact are.

Bank operations are supervised by the Banking Commission.


credit institutions are under the supervision of the Minister cf
Finance, and private savings banks under that of the Central Small
Savings Office (Office Central de la Petite Epargne), of which the
Governor of the National Bank is the president.

Liquidity and reserve

ratios are imposed by the Banking Commission, after governmental
approval; the National Bank makes recommendations for those ratios
which are set with a policy objective•

Credit ceilings have been

imposed on a "voluntary" basis since 1964 by the National Bank on the
deposit banks and by the Finance Ministry on government credit institutions and insurance companies.

Ceilings for lending by savings banks

are set by the agency supervising this sector.
The Securities Stabilization Fund was established in 1945 to
regulate the market for long- and medium-term government securities.
At a later date, the Fund f s power to engage in open market operations
was extended to short-term government paper.
the National Bank and the government.

It is jointly managed by

Whereas, in the first few years,

the Fund financed itself primarily by borrowing on the day-to-day loan
market, since 1957 it has been issuing its own securities to commercial
banks and, more recently, to other financial institutions.
The Banking Commission was established in 1935* but its authority
to set capital and liquidity ratios was first used in 1946*

The liqui-

dity ratio, which was designed to freeze bank claims on the government
resulting from World War II was eliminated in 1962; since then a
reserve ratio has been intermittently imposed by the Commission.
The extent to which the specialized agencies can expand rediscounts
and open-market purchases without involving central bank credit,

directly or indirectly, is of course limited.

By providing highly

liquid assets to banks and other credit institutions and by acquiring
and trading in short- and medium-term commercial obligations (in the
case of the IRG) or government obligations (in the case of the Fund),
the IRG and the Fund have undoubtedly contributed to the development
of the money market and the markets for commercial paper and government securities in Belgium.

Nevertheless, the ability of the IRG

and the Fund to finance their operations outside the central bank--in
the day-to-day market, for example--Is immediately dependent on bank
credit and ultimately on central bank credit,

In Belgium, where ab:yat

50 per cent of the money supply consists of currency issued by the
central bank, the banks have exceptionally little leeway for credit
expansion without the support of the central bank.

In fact, in recent

years IRG and Fund operations have been supported indirectly by the
central bank in one way or another.
The private banking system consists of about 80 commercial banks;
the three largest, Societe Gene'rale de Banque, Banque de Bruxelles,
and Kredietbank, are country-wide branch systems that account for twothirds of all commercial banking assets.

There are several medium-

sized banks (such as Banque de Commerce and Banque Lambert) and a few
small banks which


of importance in specialized fields, such as

the diamond trade, public works, industrial finance, and consumer
Public financial institutions include the government-operated
postal giro system, which has substantial deposit liabilities, and a
nationwide public savings bank (Caisse Gene rale ^I^£§£g2?


The latter channels savings of individuals into government

bonds, construction, and medium- and long-term loans to industry, while
the former serves exclusively as a source of Treasury financing.
Credit Communal de Belgique makes loans to local governments on the
basis of deposits of municipal funds, but more than half its resources
are obtained by issuing bonds.

Finally, the Societe Nationale de

Credit a 1'Industrie (SNCI) raises funds by issuing governmentguaranteed bonds to make medium- and long-term loans to industry,
These public credit institutions, whose combined assets are about
equal to those of the commercial banks, have an important impact on
the money market and on banking practices ,

Since they bank exclusively

with the National Bank, their operations affect directly the credit
base of the commercial banks.

This impact is mitigated, however, by

the public institutions' sizable purchases of bills and acceptances,
originated by the banks, and placement of free balances in the day~today market.

Competition from public credit institutions has caused

the banks to enter new fields; for example, the success of the postal
giro system has stimulated the banks to broaden their branch banking
facilities, and the thriving term loan business of the SNCI has led to
expansion of medium-term loans to industry by the commercial banks.


The National Bank extends credit to the commercial banks, the
IRG, and to a number of other government credit institutions, largely
by rediscounting commercial bills and bankers1 acceptances,


bills must bear three Belgian names (including one Belgian bank) and
meet the Bank's quality and maturity standards.

Rediscounts are made

for a minimum of ten days, and discounted bills are kept until
maturity, but these provisions do not apply to rediscounts for the

benefit of the IRG.

The Bank's lending rates distinguish (as of the

end of 1966) seven categories of discountable paper (depending on
certification and payment provision status) and include three different rates on advances.
The discounting procedures provide for a prior certification for
bills and acceptances arising from foreign trade, which assures
eligibility for rediscounting when the bill comes within 120 days of
maturity (the maximum term' legally permitted for central bank discounting).

The Bank's review is designed primarily to assure:

(a) that an identifiable commercial transaction is covered by the bill,
and (b) that the term of the bill is consistent with the period of
time needed to complete the underlying transaction which may range up
to several years.
Discount quotas are set for individual banks on the basis of their
capital and reserves, separately for certified and other bills.-^ As a
matter of fact, quota ceilings have been reached in exceptional circumstances only.

The National Bank has almost never refused to dis-

count bills satisfying the qualitative eligibility requirements.

As a

matter of policy, the National Bank does not do any direct discount
business in Brussels with private firms, but it does engage in discounting in most of its agencies, where special discounting committees
consisting of wealthy individuals not only scrutinize, but also
endorse (for a fee) the paper offered.

1. They are computed as multiples of capital funds for the two
main categories of discountable paper: domestic commercial bills and
foreign trade bills and acceptances. The quota for certified bills is
communicated to the banks.


Advances provide liquidity at a higher cost and for very short
periods only.

Advances to banks against collateral of government

securities (including Treasury certificates and certificates of
indebtedness of the Securities Stabilization Fund) accounted in recent
years for less than 5 per cent of total central bank credit.


loans can be repaid after one day, and the central bank will not
allow these credits to be utilized for more than a few days.
The IRG operates as a
bills and acceptances.





It finances these operations in part by funds

borrowed (with government guarantee) from the day-to-day money market
as well as by rediscounting eligible paper with the central bank.


purchases (or rediscounts) bankers' acceptances and trade bills certified by the central bank within two years of maturity; for bills
within the 120-day limit,
central bank.

it offers more favorable terms than the

It also provides the third name necessary to make the

paper discountable at the central bank.

Prior to 1962 a very large

proportion (85 to 90 per cent) of bills and acceptances certified by
the National Bank were offered to the IRG.

Since 1962, when the high

liquidity ratios which had required large bank holdings of government
securities were eliminated, banks gradually found themselves able to
retain some eligible paper for longer periods in their own portfolios,
sometimes discounting it as it approached maturity.

Nevertheless, in

1966 approximately 70 per cent of paper certified by the National Bank
was still originally acquired by the IRG.

The IRG also














Bank, with maturities ranging from a few days to five years.

Some of

the paper traded in this market meets the requirements of the National
Bank and^ therefore could be eligible for rediscount with the central

The IRG operates within a ceiling for its holdings of non-

certified paper and promissory notes of banks.

The IRG acts as broker

for 30 to 40 per cent of all paper offered to it, which it places with
deposit banks and public credit institutions, and ap. principal for the
The IRG finances its operations by borrowing in the day-to-day
market, by rediscounting with the central bank, and by selling outright
and under repurchase agreements bills of long maturity.


It alone

amongst the money market participants, is a borrower only.
banks are usually small net lenders;





1. The IRG also extends credit lines to banks for general use
and to finance manufacturing operations, customers receivables, and
public works. This was originally one of its main, purposes, but i : .
trediscount business has grown in the postwar period to become its
principal function. The ceiling for these credits, which are not
discountable at the National Bank, established by the directors of
the IRG, was at the end of 1966 10.5 billion Belgian francs. Between
1958 and 1964, less than 10 per cent of these credits were taken up;
in 1965 and 1966 the proportion increased, reaching 30 per cent for the
latter year. The IRG charges l/2 per cent commission for these credits
and remits half of this fee for unused credits.
2. Financial commitments of the IRG are limited by the amount
of the government guarantee on IRG obligations, which now stands at
B.F. 20 billion; this guarantee cover's not only borrowing In the dayto-day market but also contingent liabilities created by credit lines
extended to banks, whether or not taken up by them, liabilities under
repurchase agreements and, most important, the contingent liabilities
inherent in its endorsement of commercial bills and bankers' acceptance*
rediscounted with the central bank.

quasi-governmental financial institutions are on both sides of the market,
"but are heavy net lenders; the Securities Stabilization Fund is sometimes a substantial lender and sometimes a substantial borrower.
Of the bills and acceptances acquired by the IRG and not subsequently sold in the market, the proportion

rediscounted with the

National Bank has fluctuated in recent years between 32 and 73 per cent.
The cost of credit available from the IRG tends to follow market rates.
When the IRG has to increase its dependence on central bank financing,
its discount rates approach jnore nearly the official discount rates.
IRG intermediation adds considerable flexibility to the cost of central b&nk credit and the volume of central bank credit made available
to the banking system directly or indirectly.

For example, between

July 6, 1964 and June 3> 1966, the official discount rate was unchanged,
but the schedule of IRG rates was altered 14 times.
The discount rates set by the National Bank and the IRG (which
adjusts its rates to conform with central bank rates, albeit sometimes with a lag) occupy key positions
rate structure.

in the short-term interest

Since the deposit banks tend to rediscount about one

third of their portfolios of bills and acceptances, rediscount rates
in the secondary market move with the rates set by the central bank and
the IRG.

In fact, banks often quote interest rates in terms of the

National Bank discount rate.

Bank deposit rates are set by agreement

between the National Bank and the Belgian Banking Association.


The main monetary tools now in use, in addition to the discount
mechanism, are open market operations, reserve ratios, foreign exchange
operations, and credit ceilings.

Since 1959? the authority of the Securities Stabilization Fund to
conduct open market operations has been extended to short-term securities with a view to influencing overall monetary operations (it was
limited to medium- and long-term securities previously).

The Fund in-

fluences liquidity of the monetary system by increasing or decreasing
its borrowing from the National Bank and by making or withdrawing
deposits with that Bank.

While its open market operations are often

quite large, the extent to which they inject or withdraw central bank
credit into or from the banking system is not.

These operations have

been of considerably smaller magnitude than discounting,, save in .1961.
Reserve ratios were introduced early in 1962, as. one of the moves
to increase the central bank's control powers.

The -Banking Commission

has agreed to set required cash reserves of up to 20 per cent of sight
and short-term deposits and up to 7 VeT cent of other liabilities and
savings deposits, if requested to do so by the central bank. A one per
cent ratio was in effect from mid-1964 to mid-1965.
Foreign exchange operations have also been experimented with
as a means of influencing domestic liquidity.

In 1966 for in-

stance, the National Bank sold on the "free" foreign exchange
market part of the proceeds of the government's foreign borrowing
in order to reduce the domestic liquidity affects of such borrowing
by encouraging capital outflows. Most outward capital flows and certair

other payments must be effected via the "free" as opposed to the
"official" market.

Operations of this market, which is fed by the

proceeds of inward capital flows, set' limits to capital outflows;
any official additions to the supply of "free" foreign exchange might
encourage capital outflows, but it is not clear how effective an
incentive this

proved to be when tight money markets $t home were

favoring borrowing abroad.
Beginning in January 1964 the central bank began to apply direct
restrictions on bank credit expansion by setting "voluntary" credit
ceilings for individual banks (they were in effect from January 1964
to July 1965 and again from April 1966 to June 196?), while related
ceilings on other credit institutions were set by other authorities, as
indicated on page 5*
entirely effective.

In general, however, moral suasion has not been

C A N A D A

Page s

Introduction. . . . . . .

, . . .


The Institutional Framework


Rediscounts and Advances


Availability of central bank credit


Central bank credit to money
market dealers


Relationship of the discount rate to
banks1 deposit and lending rates
Quantitative role of central bank credit



In Canada, monetary policy is a major expression of official
economic policy which has an influence on the level of aggregate
demand and on flows of capital into and out of the country.


nomic developments and credit conditions in the United States are
of considerable importance for Canada, and the relationship of its
interest rates to those of the U.S. is an objective of, but also a
limiting factor on, monetary policy.

Interest rate spreads do,

however, vary considerably both at the short and at the long end.
There is also considerable scope for the occurring of differences in
monetary conditions through the effect of variations in the mix of
monetary, fiscal and debt management policies on the availability of
Having well-developed money and capital markets and a centralized
banking system that operates on the basis of stable cash ratios, the
Bank of Canada employs open market operations and the discount mechanism as its principal monetary policy tools.

However, for a number

of reasons, discussed below, the banking system normally makes use of
the discount window only as a last resort; the most important instrument of monetary management is central bank open market operations.
The principle underlying discount policy in Canada is well stated in

1. Furthermore, since July 1963, as a counterpart for the
exemption from the U.S. Interest Equalization Tax on new issues of
long-term securities and exemption from guidelines affecting the
amount of investment by U.S. financial institutions in Canadian
securities, an agreement between the two countries sets a target
(which has been modified several times) for limiting the level of
Canadian international reserves.

the following excerpt from the submission of the Governor of the Bank
of Canada to the Royal Commission on Banking and Finance:
The present arrangements under which such advances
may be obtained are designed to limit the Bank's
role as lender of the last resort to exceptional
circumstances and to encourage the chartered banks
to use, whenever practicable, alternative methods
of adjusting their cash reserves in the markets
such as calling day-to-day loans or selling
The discount window has never been an important and continuous
source of funds for the Canadian banking system, except in particular
circumstances of short duration.

Several reasons account for this

fact, the chief one being the ease with which the banks can adjust
their cash positions by calling loans from money market dealers,
selling securities in a well functioning money market and, to some
extent,by converting short-term foreign assets into Canadian dollars.
Other reasons are the concentration of banking reserves in eight
branch-bank systems so that cash losses of some branches are offset
by the cash gains of others; the method of computing cash reserve
requirements, which gives the banks considerable flexibility in
adjusting their reserve positions; and finally, some reluctance to
borrow toward the end of the reserve period because such borrowings
are revealed in the month-end statement of assets and liabilities
published for individual banks.
The conduct of open-market operations is facilitated by the fact
that government securities are available in a broad range of maturities,
They are widely held and traded by banks, other financial institutions,

1. Bank of Canada, Evidence of the Governor of the Bank of^Canada
before the Royal Commission on Banking and Finance, May Jl,
p. 148.

and the general public, and constitute the most important asset in the
Bank of Canada 1 s own portfolio.

Additional tools of monetary manage-

ment are shifts of government balances between the chartered banks and
the central bank,

and n moral suasion".

The most significant use of

the latter tool took place in 1956 when the banks voluntarily agreed
to maintain a 7 VeT

cent secondary liquid asset ratio.

Also, since

the Bank of Canada has no legal power to control credit selectively,
it has on occasion exerted a selective influence on credit extension
through moral suasion.


The Bank of Canada, the youngest central bank among those covered
by the present study, is vested with customary central banking powers.
It is fully owned by the Canadian Government and its Board of Directors
is appointed by the government.
The banking system is highly centralized.

Eight chartered banks

form the nucleus .of the commercial banking system and operate nearly
6,000 branches and/or offices throughout the country.

In addition, the

financial system includes a variety of other institutions which carry
on certain forms of banking business:

savings banks, mortgage loan

companies, credit unions and consumer credit companies, some operating
nationally, some serving whole provinces, others more limited areas.
Until July 196? the law required the chartered banks to hold vault
cash or central-bank deposits equal to 8 per cent of their total

1. The manipulation of government balances by the Bank of Canada-with the approval of the Finance Minister--provides a technique for
smoothing fluctuations in bank liquidity resulting from payments into
and out of the government's account at the central bank and, in addition,
serves as an important instrument for short-term adjustments in bank
reserves. The share of government deposits placed with each bank is
determined by a formula worked out by the banks themselves,

Canadian dollar deposit liabilities.^

Under a voluntary agreement

with the Bank of Canada, these banks held also an additional secondary
reserve, consisting of day-to-day loans and Treasury bills equal to
7 per cent of their total Canadian dollar deposit liabilities, thus
making for a "required" liquidity ratio of 15 per cent.

In addition,

the chartered banks normally held a liquidity cushion consisting of
additional Treasury bills, day-to-day loans, other loans to investment
dealers and brokers callable on demand, and a large portfolio of
Government of Canada bonds concentrated mostly in the shorter maturity

Under the new Bank Act which became effective May 1, 1967 the

required reserve ratio (still to be held in the form of vault cash or
central-bank deposits) has been raised to 12 per cent for demand
deposits and lowered to 4 per cent for time-deposit liabilities, and
the Bank of Canada's power to vary them has been removed.

The Bank of

Canada was given the power to require the banks to maintain their
statutory cash requirements over a semi-monthly instead of monthly

Also, the Bank of Canada has been empowered to impose a

variable secondary liquidity ratio ranging up to 12 per cent of'total
Canadian dollar deposit liabilities, to "be held at the commercial bank's
discretion in any mix of cash reserves in excess of the mininum requirements,

1. Actually, the Bank of Canada had the power to raise the cash
reserves to 12 per cent, but never used it. There is provision for a
penalty of 10 per cent per annum on any cash reserve deficiency but
the banks are always careful not to have deficiencies.

Treasury bills and day-to-day loans; the Bank of Canada has now set
this ratio at 7 per cent.
There is no equivalent to the Federal funds market in Canada.
The chartered banks normally adjust their cash reserve positions by
calling in day-to-day loans or by disposing of holdings of government

These banks have also some scope for obtaining temporary

liquidity from foreign sources by drawing down their foreign assets
(consisting mostly of call loans, short-term securities, and deposits
with foreign banks) or by increasing their short-term foreign currency
liabilities and converting the proceeds into Canadian dollars.
However, their elbow room to use this channel as a source pf domestic
liquidity is limited to some extent by the tradition of keeping their
net foreign assets position roughly in balance.


Central bank credit is available to the chartered banks and the
two federally-chartered Quebec Savings Banks through rediscounts and
collateral advances, and to money market dealers,2 under repurchase

The Bank of Canada has the power to make short-term

advances to the federal and provincial governments, but in practice,
such advances have been extremely rare.

1. As with the old Act, deposit liabilities
than Canadian dollars are not subject to explicit
ments. The new Bank Act (article 72) states that
maintain "adequate and appropriate assets against
in foreign currencies."

in currencies other
reserve requirethe banks must
liabilities payable

2. There are about 15 money market dealers including the largest
investment dealers, which have entered into arrangements giving them
the right to obtain central bank accommodation at their initiative.

Availability of central bank credit
Although rediscounting of commercial paper is an important
feature of Canadian banking operations, the commercial banks as a
matter of practice obtain central bank accommodation through collateral advances because they hold a large portfolio of government
securities which can be used as collateral.
The Bank of Canada has the power to make advances to commercial
banks and to Quebec Savings Banks on such terms and conditions as it

The lending authority of the Bank covers a wide range of

paper acceptable as collateral,1 but in practice all advances have
been secured by government paper.
The Bank of Canada does not put an explicit ceiling on commercial
bank borrowing from the central bank.
attractiveness of such borrowing

However, it can reduce the

by progressively increasing the

discount rates on consecutive advances in any one month.

The first

advance to a chartered bank in any calendar month (up to a certain
confidential amount specified for each bank) is made at the official
discount rate, which is a penalty rate in that it has always been
above the rates on day-to-day loans and short-term Treasury bills.
A second advance in the same calendar month, or a renewal of an
advance, or an advance in excess of the specified amount, may bear

1. Acceptable collateral, as defined in the Bank of Canada
Act, consists of federal and provincial government securities;
United Kingdom securities within six months.of maturity; United
States Government securities; most bills of exchange and promissory
notes endorsed by a chartered bank; Canadian municipal securities;
securities issued by a local school authority (corporation or
parish trustee); mortgages; gold or silver coin or bullion or
documents of title relating thereto.

interest at a negotiated rate above the discount rate.

Advances are

made and renewed for multiples of seven days and the banks are
charged the full interest for seven days even if repaid earlier.
Central bank credit to money
market dealers
Money market dealers may obtain central bank accommodation by
selling government securities with a maturity of 3 years or less to
the Bank of Canada under an agreement to repurchase them within a
maximum period of 30 days.

The price at which these securities are

resold to the dealers is such that they incur a cost equal to the socalled money-market rate (see next paragraph) or the discount rate,
whichever is lower.

In contrast to the chartered banks, money market

dealers are not required to pay interest for any minimum period of
time and, in practice, the agreements are usually outstanding for only
a day or two.

They are given lines of credit on the basis of their

volume of business, inventories, and alternative sources of financing.
The credit lines-of dealers

were designed in such a way as to assure

liquidity of the day-to-day loans through which the commercial banks
provide finance to the dealers.
Relationship of the discount rate to
banks 1 deposit and lending rates
For the first twenty years of the Bank of Canada's operations,
the discount rate was of little significance and was changed only three

However, after a short-term money market developed in 1954 and

the use of advances rose substantially under tightening credit conditions, the Bank of Canada made frequent increases in order to keep the

1. The terms of access to central bank credit will be reviewed
before the semi-monthly reserve averaging period becomes effective.

discount rate above market rates.

In 1956, the Bank of Canada shifted

to an automatic technique for setting the discount rate known as the

tied rate", which is unique in the history of central banking.


the period 1956-62 the Bank of Canada1s discount rate was fixed weekly
at a margin of l/4 of a percentage point above the latest weekly tender
rate for 91-day Treasury bills.
The tying of the discount rate in Canada reflected a central bank
philosophy that the discount rate should not be used to lead or influence market rates or as a means of indicating the views of the
central bank with regard to changes in economic conditions or of a new
posture in monetary policy.^-

The main reason for tying the discount

1. The Bank of Canada wanted to attach no policy significance to
these adjustments in bank rate, and hoped to minimize any disruptions to
the economy that changes or expectations of changes might cause. According to a press release issued at the time of the institution of tied rates:
...the bank rate is not changed arbitrarily or with a
view to bringing about other interest rate changes.
On the contrary, it has been desired since the development of the money market ...that the bank rate should
be kept in line with other interest rates and should
move when they do, but not usually otherwise. The
present technical change in the method of setting the
bank rate from week to week is intended to clarify
this relationship and remove what has evidently been
a source of some public misunderstanding.
Four years later this opinion still prevailed. The Governor of the
Bank of Canada wrote in the I960 Annual Report:
It will be apparent that there is no past history in
Canada of having changes in the bank rate made with a
view to influencing other interest rates, or as a means
of indicating the views of the central bank with regard
to changes in economic conditions or monetary policy.
The Bank ! s view has been that moving the bank rate would
not be the best method of giving such indication, which
if they were to be given at all, would be the subject of
public statements.
By pegging the bank rate in this manner, the Bank of Canada
appeared entirely willing to avoid using it for policy purposes. This
impression was convenient at a time when monetary constraint was being
aggressively used for the first time, and when the Bank came under strong
criticism for causing the substantial rise in Canadian interest rates.

rate to the weekly bill tender rate in 1956 was to assure its penalty
character; the resulting gradual changes in the cost of central bank
credit were thought to be preferable to frequent changes by discretionary amounts.

Tying permits raising the cost of central bank

credit unobtrusively in situations when it might be difficult to
obtain support for a discretionary rate increase.

Indeed, the tying

technique was introduced following a period in which six successive
increases occurred within 14 months.

However, rigid linkage amounts,

in effect, to giving up direct control over the discount rate and
substituting for it indirect control of the market (Treasury bill)
rate to which it is tied.

Since the Bank of Canada could substan-

tially influence the bill rate (and thus the entire structure of
short-term rates) through managing cash reserves and by varying the
amount of such bills it purchased at the weekly auction, it kept a
good deal of indirect control over the rate which automatically
determined the discount rate.

During the period in which the dis-

count rate was tied, the Bank of Canada had a substantial portfolio
of Treasury bills, and, in effect, did not follow a neutral policy
(by merely rolling over its bill portfolio).
While indirect management of the discount rate proved effective
in normal periods, it was considered inadequate to achieve an immediate, substantial increase in the cost of money when it appeared
necessary to the authorities in June 1962 to counteract, a threat to
the exchange value of the Canadian dollar, and it was abandoned at
that time as part of a program to deal with a foreign exchange crisis.
The Bank of Canada has concluded since that time that the fixed rate
provides an important element of stability in the money market rate

structure that had been missing during the era of the tied discount

Discussions between*the Bank of Canada and the government at a

time when changes in the' rate are contemplated may on occasion bring
consideration of monetary policy into sharper focus.

At other times,

changes in the discount rate merely confirm basic policy changes that
have been having effects on market interest rates for a considerable
Since the reintroduction of a fixed discount rate in June 1962,
the Bank of Canada has had, in effect, two discount rates.

The Bank

extends advances to the chartered banks at the fixed rate, and enters
into repurchase agreements with money market dealers at the moneymarket rate (which is still set weekly by the central bank at l/4 of
a percentage point above the 91 -day Treasury bill rate) or at the
fixed rate, whichever is lower.

Since the fixed rate has always been

kept above the 91-day!Treasury bill rate, money market dealers either
way obtain central bank accommodation at what is in fact a penalty
The rationale behind the use of a double-base discount rate is
that it gives the central'bank more flexibility in its operations.
There may be times when, for example, the central bank may wish to
see short-term rates move lower without the necessity of taking an
overt rate action that might be construed as signaling a shift in the
basic direction of monetary policy.• In these circumstances, the use
of a separate money-market discount rate provides the money market
dealers with the assurance that they will obtain central bank credit
close to current (and declining) money-market rates" rather than at
the unchanged (and higher) Bank rate which would tend to counter the

downward pressures on short-term rates.

Obviously, if in times of

rising interest rates the spread between the fixed discount rate and
the Treasury bill rate becomes less than 1/4 per cent, the dealers
will opt to get cheaper accommodation at the fixed rate, and therefore
the double-base discount rate would in effect become a single rate.
The fixed discount rate was set at 6 per cent in 1962, following
a serious foreign-exchange crisis, as part of a comprehensive stabilization program designed to restore balance-of-payments equilibrium.
Subsequent changes in the Bank of Canada's discount rate have been
made quite frequently, for both internal a < external reasons, innJ
cluding the interest ^-sensitivity of private capital flows between
the U.S. and Canada.
There is no direct link by law or custom, and therefore no fixed
spread, between the central bank discount rate and commercial bank loan
and deposit rates. However, until May 1, 1967 bank lending rates were
limited under the Bank Act of 1954 to a rate of interest or discount no
higher than 6 per cent per annum on domestic loans.

Thus, rate move-

ments in the money and capital markets above 6 per cent tended to cause
pressures on the chartered banks, which on such occasions were faced
with difficult problems of nonprice rationing.
Testifying at the Royal Commission hearings in 1962-63,
Governor Rasminsky opposed a direct statutory linkage between the
central bank discount rate and commercial bank lending or deposit
rates, pointing out the disadvantage of interest rate rigidities in

1. To some extent the banks had gotten around this limitation by
various service charges.

financial markets. Under the new Bank Act effective May 1, 1967; the
ceiling on commercial bank lending rates was lifted to 7 l/4 per cent
for the balance of the year, and was eliminated altogether after
January 1, 1968.
Quantitative role of central bank credit
Between 19$8 and 1967, the yearly averages of coimnercial bank
borrowing from the central bank ranged from 0.001 per cent to 0,26 per
cent of the chartered banks1 required reserves*

During the same period,

the yearly averages of government securities held by the central bank
under repurchase agreements with money market dealers ranged in absolute
amounts from Can. $2.4 million to Can. $7*6 million, and as a ratio of
chartered banks1 required reserves from 0.24 to 0.69 p©x cent. During
the same period, the ratio of commercial bank borrowing at the central
bank to their loans to the private sector averaged less than 0.03 per



Introduction. . . . . . . . . . . . . . . . . . . . . .


II. -'"Institutional Structure . . . . . . • _•. - •


Mbn&tary authorities . . . . .




Structure of the banking system. . . .


Structure of liquid assets . . . . . . .


III'. The Instruments of Monetary Policy. .....


Rediscount ceilings


Liquidity ratios



Cash reserve requirements


Open market operations


Direct restrictions

• .


Moral suasion


IV, Techniques on Rediscounts and Advances

Access to central bank credit



Eligibility requirements


The cost of Bank of France credit


Bank of France credit practices.


Linkage of lending and deposit rates
to central bank rates




France, like most other Continental European countries in which
international economic transactions play a major role, has found the
regulation of the cash base of the banking system complicated by the
effect of external influences

on bank liquidity.

Since 1958, the

expansion of the cash base of the banking system in France has been
brought about very largely by increases in official holdings of international assets.

In the six years ended December 1966, when there was

a reversal in France's external payments position, official holdings
of international assets trebled and accounted for nearly four-fifths
of the expansion in the cash base.

In these circumstances, the cur-

tailment of inflows of foreign funds was a major policy objective
which the centra], bank fostered by keeping the banking system supplied
with sufficient cash to maintain Paris money rates low relative to
those in major centers abroad.

Prior to that time, the cash base of

banks had been enlarged mainly by discounting at the Bank of France,
or by some very large loans by the Bank to the government.
Due to the difficulty of reducing or offsetting bank liquidity
supplied by surpluses on international transactions, French monetary
authorities have recently relied heavily on direct controls over bank
credit expansion to control inflationary pressures.

Open market

operations of the kind employed in the United States have never been
a factor in supplying funds to the banks in France.

A major objective

of French monetary policy has also been to influence foreign exchange
flows implemented by regulating interest rates on the Paris money market.

For this purpose, policy instruments developed to control dis-

counting were used and elaborated upon.

Such success as has been

achieved, in restraining inflows of foreign funds is attributable not
so much to regulation of the foreign exchange position of banks or
prohibition on paying interest on foreign-owned franc balances as to
employment of other monetary policy instruments to minimize money
market stringencies that might attract funds fron abroad.
Because the existing monetary policy instruments were not well
adapted to the relatively new situation of large payments surpluses,
and for other-reasons, French monetary authorities have made important
changes in policy instruments and banking regulations in the last
several years.

Cash reserve requirements were introduced to supple-

ment and eventually to replace required liquidity ratios.

The number

of channels for central bank credit has been somewhat reduced and the
related structure of rates simplified.

Efforts are. being made to

reduce the importance of rediscounting commercial bills as a means of
obtaining Bank of France credit.

Efforts are also being made to

develop an active market in short-term government securities so that
the Bank of France can engage in open market operations, which have
long been inhibited by long-standing taboos against central bank
lending to the government

as well as because of the underdeveloped

state of the money and capital markets.

All of these changes affect

in some way the regulation of rediscounting at the Bank of France,
which is basic to the French system of monetary controls.
Rediscounting at the Bank by the banking system, which includes
public and semipublic financial institutions, is restricted by a
system of ceilings and liquidity ratios, and by a prior authorization

There have been numerous changes since the early fifties

in provisions designed specificallytoachieve quantitative limitations
on expansion of bank credit.

Since discounting within ceilings is considered a right rather
than a privilege, commercial banks use fully what is in effect a line
of credit at the central bank.


at " a


Beyond this line all rediscounts



ec,i;; above the ordinary discount rate.

2 l/2


In recent years the Bank of

France has supplied liquidity to banks with the objective of keeping
market rates below this ultimate penalty rate

and within a range

compatible with foreign exchange policy objectives.
For a long time, flexible liquidity ratios, under which banks
were frozen first into Treasury bills and later also into a wide variety
of paper that was exempt from discount ceilings, were used as an important tool to control access to the discount window and to facilitate
adjustment of the banks 1 cash positions.

Until recently, they were

manipulated jointly with special techniques at the discount window
developed to avoid end-of-month stringencies.

One of such ratios is

still in force, but it is scheduled to be abolished gradually.

The disccunt mechanism has been also used as a means of selective
credit control, in particular to support medium-term financing of
housing and industrial equipment expenditures and exports.


credit controls in France make use of moral suasion and a procedure of
prior authorization by the Bank of France to make certain credits automatically eligible for rediscount.

1. From 1951 through 1967 banks could rediscount up to 10 per
cent of their ceiling at an intermediate penalty rate called "hell"
rate. The highest levels at which the two penalty rates ("hell" and
"superhell") were set were 8 and 12 per cent, respectively, in 1958
when the discount rate was 5 per cent.



Monetary authorities
Responsibility for formulating monetary policy is shared by the
Bank of France and the National Credit Council (N.C.C.)* which was
established by the same 1945 law that nationalized the Bank of France
and the four largest commercial banks.

The President of the N.C.C.,

which has 43 members, is the Minister of Finance. However, the Governor
of the Bank of France is the de facto head of the Council and generally
the presiding officer at its






two officers, the N.C.C. consists of representatives of several government departments, public and semipublic financial institutions, and
various economic and social interests; it has its own small secretariat
drawn from the staff of the Bank of France.
Technically, the Bank of France has primary responsibility for
decisions affecting its own operations only--mainly related to rates
and terms for rediscounts and advances.
may only advise the Bank.

In these matters the N.C.C.

On the other hand, matters that require

action by the banks, as for example, maintenance of liquidity ratios,
are technically the responsibility of the Council which is concerned
with banking practices.

In practice, the Council acts through the

agency of the Bank of France.
In addition to being responsible for monetary and banking control
measures, the N.C.C. provides a medium for coordination of views on
the objectives and techniques of monetary policy.

In this process,

leadership is provided by the Bank of France, but ultimate responsibility rests with the government.

A similar working relationship obtains between the Bank of France
and the Banking Control Commission, which was set up by the nationalization law primarily to establish rules for protecting the liquidity
and solvency of the banks, and to supervise the adherence by banks to
banking regulations.

The members of the Banking Control Commission are

the Governor of the Bank of France, who is its ex officio president,
two representatives of the government, one representative of the commercial banks and one representative of bank employees.
Structure of the banking system
The principal credit institutions that are classified as banks are
the banques de depots (deposit banks), banques d'affaires (investment
banks), banques populaires (cooperative credit societies catering to
the banking needs of small manufacturers, traders, and artisans),
caisses de credit agricole (agricultural credit cooperatives), and the
Banque Francaise du Commerce Exterieur (French Bank for Foreign Trade)
which finances foreign trade on its own account and also assists other
banks in such financing.

The deposit, investment, and long- and medium-

term credit banks are under the jurisdiction of the Banking Control
Commission and are known as the "registered banks."

Their assets com-

prise nearly 70 per cent of the assets of the banking system as a
The former distinction between deposit banks, which could not
accept deposits with a maturity of more than two years, and investment

1. At the end of 1966 the Banking Control Commission supervised
250 French banks in metropolitan France with assets of 146.7 billion
francs ($29-7 billion), of which 197 were deposit banks, 33 were investment banks, and 20 were long- and medium-term credit banks. In addition,
the Banking Control Commission had under its jurisdiction 10 French
banks operating overseas, 43 foreign banks operating in France, and 12
banks operating in Monaco.

banks, which could not accept deposits for a shorter maturity, was
virtually eliminated on January 1, 1966.

(The two types of banks

remain, however, subject to different regulations with regard to investments in shares.)

The deposit banks perform all, and the invest-

ment banks some, of the functions that would be classified in the
United States as commercial banking, but the latter also engage in
activities undertaken by investment banks in this country.
discount houses are classified as deposit banks.

The seven

The four largest

deposit banks were nationalized in 1945., and two of them were merged
Savings institutions (Caisse dfEspargne) have no direct access to
central bank credit.

However, nearly all of the funds of the savings

institutions are deposited with the Caisse des Depots et Consignations
which reinvests them in approved securities, so that in the normal
course of their business, no need for rediscounting savings bank assets

The Caisse also manages the liquid funds of the social security

system and pension fund reserves.

It has access to central bank credit.

The banques populaires and the agricultural credit cooperatives have
their own central rediscount institutions

(the Caisse Centrale des

Banques Populaires and the Caisse Nationale de Credit Agricoie,
Several semipublic intermediate financing institutions play a very
important role in the French banking and credit system and have rediscount privileges at the Bank of France.

They include the Credit

National, which provides long- and medium-term financing to public and

1. Additional financial establishments that may make loans, but
do not accept deposits from the public, include the following main
categories: societes finaneieres (financial societies, which do mainly
an investment management business), stock brokerage houses, and instalment credit firms.

private enterprises from funds acquired primarily by the issuance of
bonds; the Credit Foncier de France, with its subsidiary, the
Comptoir des Entrepreneurs, both of which grant mortgage credit from
funds derived primarily by the issuance of bonds; the Caisse Centrale_
de_ Credit Hotelier, Industriel et Cominercial, which provides mediumterm credit for the bariques populair^s, and the Caisse Centra.Ie de
Credit Cooperatif^ which is the central institution of nonagricultural
cooperative credit institutions.

Only the Comptoir des Entrepreneurs

(which supplies credit to contractors of major public works projects)
is a substantial discounter with the Bank of France of paper that it
originates; the other institutions merely rediscount paper that has
been previously discounted with them by banks or their member institutions.

Thus, in effect, there is a two-tier discounting, with spe-

cialized discount institutions dealing with a large number of primary
credit institutions, mostly of purely local significance, and rediscount ing credits with the Bank of France, as needed; in some cases,
they discount their own short-term notes drawn against a portfolio of
discounted medium-term paper.
Indeed, an outstanding characteristic of the French banking system
is its heavy reliance for liquidity upon rediscounting, either at the
Bank of France or at the semipublic financial Institutions.

This cir-

cumstance had its origins in the traditional willingness of the Bank
of France to rediscount freely, and the high proportion of cash in the
money supply, which makes the banks quite sensitive to liquidity drains.
All registered banks (see above) may in principle open a discount current account at the Bank of France, and in practice many banks have
several such accounts distributed among their branches.

The Banque

Francaise de Commerce Exterieur may also discount directly with the
Bank of France.

The banques populaires may have an account with dis-

count facilities at the Bank of France, but individual agricultural
credit cooperatives may not.
Structure of liquid assets
The structure of short-term assets acquired by French banks
depends to some extent upon the kind of business that they are permitted to conduct, upon the standards of eligibility for rediscounting
and advances from the Bank of France, and the kinds of paper the Bank
may purchase on the open market.

Moreover, prior to their abolition

at the end of 196?, two separate liquidity ratios imposed by the N.C.C.,
one prescribing minimum holdings of Treasury bills (planehers), the
other a broader liquidity ratio (coefficient de tresorerie), constituted
an additional and important tool of credit control (see below).
About 80 per cent of all commercial bank credit is extended in the
form of discounted trade bills.

Largely as a result of the heavy

reliance of banks upon the Bank of France as a source of loanable funds,
and the conditions imposed by the Bank for such accommodation, a major
part of their business consists of discounting short-term bills.


credit is extended to the private sector largely in the form of discounts of commercial bills, acceptances, warrants, and cross endorsements of promissory notes, all of which are described in French banking
statistics as "discount of bills."

At the end of .1964, "private paper"

1. For many years, the Bank has not accepted new private customers,
It now has only about 800 accounts of nonbank, nonfinancial enterprises,
and for about 15 years the Bank has also systematically discouraged the
credit demands of these private customers.

(autres effets)

constituted over 50 Ver

registered banks.

cent of the total assets of

At the large deposit banks this ratio was closer

to 60 per cent, and even for investment banks it was nearly 40 per

A considerable part of private paper consists, however, of

loans to government-owned enterprises, such as railroads, aircraft
factories, etc.

Short-term government securities comprise


7 per cent of total assets of registered banks, and cash and deposits
with the Bank of France and the Treasury, 2 per cent of total assets.
Most of the nonliquid assets of the deposit banks were advances and

Customers are expected to use overdrafts to meet only

marginal requirements because such credits cannot be the basis for
obtaining central bank credit.
Other than resorting to the central bank directly, individual
French banks can increase their domestic short-term (under one year) borrowing only through the Paris money market.

The main suppliers of funds

to the money market are the commercial banks, stockbrokers, the various
semipublic institutions that manage large amounts of funds, as well as
the Bank of France. x

The banks lend their unemployed resources, and

when rates are firm, rediscount at the Bank of France within discount
ceilings for the purpose of supplying the funds so acquired to the
money market.

French banks may also borrow abroad.



During most of the postwar period a principal objective of monetary policy in France was to direct bank credit into approved uses and


See pages 106-07.

2. Until January 31> 1967 they were required to maintain a balanced position in foreign exchange on spot and forward combined. Their
borrowings of a foreign currency were required to equal loans in the
same currency to either residents or nonresidents•

to control its expansion.

In mid-1964, keeping money market rates

below the level that would attract inflows of funds from abroad became
another major objective.

With the development of a current account

deficit in 1966 the emphasis shifted to keeping capital from flowing out,
and subsequently interest rate policy has been adapted to the state
of the foreign balance.
At first French monetary authorities sought to control expansion
of bank credit by restricting its monetization through ceilings on
central bank credit and liquidity ratios.

But in 1958 ceilings were

introduced to control directly expansion of bank credit to the private

Such ceilings were in effect for about a year and again from

February 1963 to June 1965.

The suspension of formal limits on credit

expansion was accompanied in 196 5 > however, by an admonition from the
Governor of the Bank of France to the effect that the limits would be
reimposed retroactively if credit expanded at too fast a pace.
Rediscount ceilings
Ceilings as a measure of generalized credit control on rediscounting at the Bank of France were introduced in September 1948.


rediscount ceilings were associated with each bank's discount current
account at the Bank of France, but were effectively restrictive for
small banks only.
count rate only.

The ceilings apply to rediscounts at the basic disAt first banks were required to bring their redis-

counts within the ceilings only at the end of the month, but since 1951
they have been required to keep within the ceilings at all times.
Individual bank's rediscount ceilings were initially set at approximately the level of rediscounts outstanding on September 30> 1948.
global ceilings have risen subsequently because of adjustments in the


ceilings of individiaal banks, and on a few occasions the ceilings have
been raised across-the-board for reasons of overall policy.^-


each bank's discount ceiling is fixed on the basis of a complex formula
that takes into consideration mainly a number of quantitative factors
(such as deposits, assets and capital accounts).
Several kinds of paper are exempt from rediscount ceilings:


particular, bills representing medium-term credit to finance housing,
industrial equipment and exports (approved through the prior authorization procedure; see below), grain storage bills and short-term
foreign trade bills.

Although ultimately rediscountable at the Bank

of France, most paper representing medium-term credit must be discounted first with one of the intermediate financing agencies.


the system making medium-term credit rediscountable at the Bank of
France was first introduced in the early postwar years, it was expected that the intermediate financing agencies, which are collectors
of savings, would hold the bulk of this credit to maturity.

In the

195Ofs claims upon the resources of these agencies were so great,
however, that the agencies were constrained to pass on to the Bank
of France the bulk of the medium-term credit instruments discounted
by them.

1. Most notably, the rediscount ceilings were raised by nearly
25 per cent in the inflationary period of 1955-57 and then lowered by
about 35 per cent in the second half of 1957 for the purpose of offsetting the monetary effects of new advances granted by the Bank of
France to the Treasury at that time. From 1957 to the end of 1959
the rediscount ceilings were stable at a level of about 4.3 billion
francs. Since 1959 the global rediscount ceilings have risen somewhat every year until at the end of 1965 they totaled about 7 billion

The Bank of France requires as a condition for rediscounting
that its prior authorization be obtained for bills representing purely
financial transactions and for certain medium-term paper.

The exemp-

tion from discount ceilings of certain categories of credit mentioned
in the preceding paragraph served to promote certain activities by
preferential credit arrangements.

The institution of the coefficient

de tresorerie (see below) was, in effect, a way of making these types
of credit in practice not freely discountable at the Bank of France,
for only paper held above the level required to satisfy the coefficient
could be rediscounted outside the ceiling.

In addition to exemption

from discount ceilings, export credits have benefited from a preferential discount rate of 3 per cent since 1957-

At the end of I960,

.just before the inauguration of the coefficient, banks held nearly
5 billion francs of this paper discountable at the Bank of France
outside of the ceilings, and were thus in a position to almost double
the volume of their rediscounts without having to pay the "hell" rate.
The coefficient forced the banks to hold about 90 per cent of this
otherwise rediscountable paper in their portfolios, although the Bank
of France, in exempting this paper from the ceilings, had given an
implicit commitment to rediscount it.
Liquidity ratios
Prior to 1967;, banks were not required to keep any particular
cash reserves, but they were subject to two related liquidity ratios.
Both of these ratios had essentially the same initial purpose:


force banks to hold assets that would otherwise have provided the basis

for an excessive expansion of cred-it, in the first case by rediscounting
them or by letting the' short-term government securities run-off, and in
the second, by rediscounting at the-Bank of France outside of ceilings.
For nearly two debades &, required liquidity ratio was used to
immobilize large bank holdings of Treasury bills inherited in large
part from World War II and early postwar deficits.

The so-called

Treasury "bill floor'* (planeher) was instituted in 1948 and required
banks to hold Treasury paper 'in an amount not less than 95 Ver

cent of

their holdings as of September 30 of that year, and to place 20 per cent of
their subsequent increase•• in deposit liabilities in such securities.
This rate was fixed at a uniform 25 per cent of deposit liabilities in
1956, and was reduced' to 20; per cent in I96l.

An improvement in

government finances made it possible to,, gradually reduce (between 196l
and 1966) the Treasury bill floor .requirement, which French monetary
authorities long' regarded as providing the Treasury with an inflationary source of financing.

The floor was abolished effective

September 1, 1967.

1. For purposes- of safeguarding the solvency of banks, a different agency, the Banking Control Commission, prescribes a ratio of
liquid assets to short-term liabilities (rapport de liquidite). It
defines liquid assets for this purpose as cash, deposits with the Bank
of France -and the Treasury, deposits with banks and correspondents (including call loans), Treasury bills,- and similar securities drawn on
or guaranteed by certain government agencies, such as the railways,
bills and acceptances discountable at the central bank, coupons collectible and in suspense accounts, claims on foreign exchange dealers
and stock brokers, subscriptions to securities, securities that are
eligible to guarantee advances from the Bank of France, and other'
securities that are traded on the public securities markets. The last
item may comprise at most only 5 per cent of short-term liabilities.
This scheme was intended to apply to all classes of banks, but a
specific ratio (60 per cent) has been prescribed only for the deposit
banks. The inve stmenf "banks are expected to be made subject to the
liquidity ratio some time in the future.

In 196l, an additional liquidity ratio, the coefficient de
tresorerie, was introduced.

It required the banks to hold a percent-

age of their deposit liabilities in certain liquid assets, including
cash, Treasury paper held to meet the floor ratio, and just those kinds
of paper that could be rediscounted at the Bank of France outside of
the banks1 ceilings. The coefficient had an upper limit of 36 per
cent, and its lower limit was the floor ratio for Treasury bills but,
in fact, the,coefficient was varied only between 30 and 36 per cent.
Thus, as the banks were allowed to reduce their holdings of Treasury
bills, they were required to hold larger amounts of medium-term or
other paper exempt from discount ceilings. The coefficient was a
powerful tool for controlling access to the discount window; indeed,
when in use it was regarded as the principal instrument for controlling the liquidity of banks. While the main purpose was to prevent excessive use of Bank of France credit, the ratio was frequently
lowered by a few points in order to allow the banks greater access to
the central bank in periods of tightness due to temporary factors,
such as end-of-month cash drains. Such temporary reductions served
to keep money market rates from rising above a level that would attract
inflows of funds from abroad. While the liquidity ratio (coefficient
de tresorerie) originally was intended both as a credit-rationing
device (with preferential treatment for government securities) and as
a quantitative credit-control device (since it limited the discounting
of medium-term paper), in the recent past it was used primarily for

1. Although the coefficient de tresorerie could have been fixed
separately for each class of bank, the same ratio was applied to all

short-run quantitative control purposes, (being altered eight times in
1966 alone),. Although .formally. abolished in January 1967, the coefficient, de tresorerie was replaced at that time by a similar liquidity
ratio known variously as the coefficient de retexiue or the portefeuille

Since the.abolition, of the coefficient de tresorerie left

banks with considerable holdings of medium-term credits discountable
at the Bank of France outside of their discount ceilings, the new
ratio, which requires the banks to hold a portfolio of such mediumterm credits equal to a certain percentage, of their liquid, liabilities,
was designed to prevent banks.from making use of this excess liquidity.
During 1967, the required ratio was reduced several times and. by
October it had reached 16 per cent.

It is expected that the portefeuille

minimum will be, further reduced^ and eventually abolished, in the next
few years when rediscount ceilings, and cash reserve requirements will be
relied upon to control b&ak liquidity..
Cash reserve requirements
The two liquidity ratios mentioned, earlier were designed primarily
to control pressures at the discount window,., and at this they have been
fairly successful. They are being gradually supplemented by legal
reserve requirements, which became, fully effective in October 1967*
Under the new system,. the Bank of France may require banks to maintain
at the central bank cash .balances of. up to 10 per cent of their deposit

In introducing the new reserve system, the Finance

Minister gave the following three reasons; for the change:

(l) align-

ment of French monetary control techniques with, those in- other major
countries; (2) removal of major constraints on.the kind of assets
which banks may hold; and (3) desirability of developing a; free market
in government securities, a necessary precondition to achieving French
objectives to make Paris a. major European capital market.

Open market operations
Prior to January 196?, the Bank of France used two kinds of
Supplementary accommodations to cushion short-run fluctuations in bank
liquidity, both of which were referred to as "open market: operations".
One was used to meet the day-to-day needs for funds of about $G leading
banks which had been given an open market "limit" or quota ax the Bank
of France, in addition to the rediscounting quotas (or ceilings).


such bankcould draw automatically on Bank of France credit at the basic
discount rate up to a limit which in practice was set at about 10 percent of its discount ceiling.

Such drawings took the form of sales to

the Bank under repurchase agreement of paper already en deposit wL'/n
the Bank.

These en pension sales, which were negotiated through the

discount houses,-^ actually constituted an additional line of central
bank credit.
The other kind of "open market operation" was used solely to meet
end-of-month strains in the money market when cash payments for wages,
salaries, and rents tended to reduce the liquidity of the banks.


technique is similar to that described above, but only 10 to 12 of the
most important banks were involved; the rate for such exceptional accommodation, which on occasion reached a substantial volume, was usually
set by the Bank above the basic discount, rate.

Using estimates of

sources and uses of funds, supplemented by personal contact with
Vne die-count houses arid the JO largest banks (which absorb 8^ per
cent of the funds made available), officials at the Bank of France made

1. Each bank uses one specific discount house for I L S operations
in the money market, including interbank sales of funds and "open
market" operations of the Bank of France.

projections of the volume of funds needed at the end of the month and
asked banks to deposit the necessary collateral.

Unlike the Bank's

rates for regular operations, which are fixed in advance and remain
unchanged for long periods,. the rates charged for end-of-month repurchase operations were fixed by the Governor on a day-to-day basis.
Although both kinds of operations were always used to ease money market
pressures and were ostensibly at the initiative of the banks, in the
second kind of operation the Bank of France took the initiative in estimating the amount of funds needed to keep market rates within the desired

Since January 1967, "the Bank of France has been using one

single rate in all open market operations.

Direct restrictions.
Direct restriction of certain kinds of credit is also an important
instrument of monetary policy in France.

Credits to the nationalized

industries are restricted to the level of 1958 by "the Caisse Nationale
des Marches de I'Etat, whose endorsement is required to make such
credits negotiable.

Residential construction credits are restricted

by a 1964 agreement, signed by the Minister of Finance, the Governor
of the Bank of France, and the Governor of the Credit Foncier, according to which the total volume of outstanding special construction loans
would be progressively reduced and new authorizations for such loans
also would be held within an annual ceiling.
In addition to -controlling certain categories of loans, the volume
of credit extended by the entire banking system to any individual borrower is controlled (see below, page 123)•

1. The original intention to reduce such loans from 10 billion
francs at the end of 1964 to 8.4 billion francs at the end of 1968 was
later (August 1967) largely nullified by raising the ceiling to
9.5 billion francs.

Moral suasion
Direct government ownership of .large segments of industry and of
commercial banking offers various for implementation of
official policies.

To relate credit po]icy to overall goals of govern-

ment economic policy the Commissioner General of the Plan issues credit
guidelines on behalf of the N.C.C.

The latest one jssued, on

September 12, 1963, asked that credit not be extended for speculative
X")urposes, including land speculation, and that priority should be given
to export industries, U; those industries being exposed to new foreign
competition oy reduced tariffs, and to those projects designed to
rationalize production.

How effective moral suasion and the prior-

authorization procedure have been in directing credit into approved
channels is hard, to say.


Access to central bank credit
Bank of France credit in the generic sense of financing or refinancing the private sector may be extended in various forms.


techniques used include rediscounts of Treasury and specified r r Lval,e
short-term paper held by businesses;, banks, financial establishments,
and public and seir.ipub i :c financing Institutions; purchases of shortterm (up t > < years) private and Treasury paper, with or without trie
r •
sellers agreeing to repurchase; advances to the public as veii as
banks against co L]ater?i..i of certain long-dated securities of public

ir"rom 193i> until March i'96o, the Bank also offered advances

to banks only for up to 30 days against collateral of certain shortterm public securities.

As more fully described above, rediscounting

at the Bank by the banking system, including the public and semipublic

financial institutions, is restricted by a system of ceilings and
liquidity ratios, and by a procedure requiring prior authorization.
The Bank of France may not directly discount paper for the
Treasury and it is forbidden to operate in the market "for the benefit of the Treasury."

Central bank credit to the government must

take the form of loans, which require ratification by the legislature
in the form of a convention, or treaty, between the Bank and the

But outstanding government bonds can be used as collateral

for advances and Treasury bills may be purchased outright by the Bank
of France.
Many of the legal provisions governing the extension of credit by
the Bank of France reflect the view, entirely common at the beginning
of the nineteenth century, that the bank of issue should engage in
normal commercial banking.

Thus it is still technically possible for

a member of the general public to rediscount securities or commercial
bills at the Bank or obtain an advance, provided the paper presented
for rediscount or as collateral meets all of the eligibility requirements,

Except, however, for a few private customers of long standing,

Bank of France credit is, in practice, granted only to banks, certain
public and semipublic financial institutions, and a few registered
financial establishments,

of which only the instalment credit estab-

lishments generate any appreciable amount of discountable paper.


Bank may, however, refuse any request to rediscount or make advances
even when eligibility requirements are met, except when grain storage

1. For list of the specialized credit agencies, see the 19th
Annual Report of the National Credit Council for 1964, page 190.

bills guaranteed by the National Cereals Office are presented for
rediscount or when,Treasury bills are presented by the nonbank public.
In addition to direct discounting foi private business accounts
(which is slnall), and rediscount ing for banks and other financial
institutions, the Bank of France makes secured advances, but at a
rate higher than the discount rate.

Until December 21, 19&7, when

the facility was withdrawn, the Bank also made advances to the banks
for thirty days at a rate that was often below the discount rate;
these advances were, however, subject to very low ceilings.
Eligibility requirements
To be eligible for rediscount at the Bank of France, Treasury
bills, commercial bills of exchange and other commercial paper must
have a' remaining maturity of three months or less and bear three good
signatures (the third signature may be replaced by a pledge of securities or goods); the Bank also may require additional guarantees.1
Bills corresponding to a loan of money or line of credit without any
immediate connection with the transfer of goods or services ("finance"
bills) require prior authorization of the Bank in addition to the same
guarantees as commercial bills.

Medium-term credits for specified pur-

poses (housing, industrial equipment, exports) become eligible by a
process in which the originating bank obtains the required third
signature from the appropriate intermediate financing agency through
a transaction involving the deposit of the original documents with it

1. A decree issued in December 1966 authorizes banks to make
short-term nonguaranteed loans based on the general credit standing of
the borrower rather than on individual commercial transactions. Legislation is in preparation to empower the Bank of France to rediscount
such two-name instruments (rediscounting is now limited to paper bearing three names--the debtor, the creditor, and the banker).

and drawing of short-term notes by the originating bank against the
collateral of the medium-term paper.

These notes are then sold to

the Bank of France under repurchase agreement.

Effective January 1,

1966, the Bank of France extended to seven years from five the maximum
original maturity of certain kinds of medium-term credit for equipment and construction that it would admit for rediscount, providing
that the remaining maturity was only three years.
The securities eligible for purchase and sale by the Bank of
France in the "open market" are negotiable short-term (two years or
under) public securities and- private bills eligible for rediscount
at the Bank.

In practice, the securities bought by the Bank for its

so-called "open market" operations are bonds and notes of the French
Railways and the Caisse Nationale des Marches de X'Etat, bankersf
acceptances, and paper previously approved for rediscount.
The cost of Bank of France credit
The cost of .marginal borrowing by the banking system from
the Bank of France is reflected in the money-market rate for dayto-day money secured by private bills and, since the abolition of
the plancher and the coefficient, Treasury bills.

This rate re-

flects in turn the degree of demand for central bank credit.


Bank of France has a hierarchy of rates and there is a corresponding
order in which the banks present different kinds of paper to the
Bank (or to the intermediate financing agencies) to obtain cash.
Short-term export paper, which benefits from a preferential rate
of 3 per cent, and is accepted without limit outside the discount
ceilings, is normally presented first.

Next comes medium-term

export paper, which provides funds at a cost of 3.10 per cent,
including the commission of the Banque Francaise du Commerce


As a result, at the end of 1966, the Bank of France held

83 per cent of all outstanding short- and medium-term export paper.
The next category of paper to be discounted at the Bank would be
ordinary commercial paper which, within applicable ceilings, is discounted at the basic discount rate, and thereafter grain storage bills
guaranteed by the Office National Interprofessional des Cereales and
equipment credits to nationalized industry guaranteed by the Caisse
Nationale des Marches de lfEtat, both at the discount rate.


the banks would discount equipment credits to private industry and
medium-term construction credits at a cost of 3*95 per cent, which includes the 0.45 Ver

cent commission of the Credit Nationa1 or the

Caisse des Depot.
' The level of money market rates depends upon the degree of utilization of central bank credit facilities.

When many banks have

unused margins for rediscounting within the ceilings, the rate for dayto-day money secured by private bills tends to fluctuate closely around
the basic discount rate, since banks with surplus funds may employ them
to reduce their rediscounts at the Bank of France or to lend in the
money market.

As rates become firmer, banks with unused margins within

the ceilings will rediscount at the Bank of France for the purpose of
lending to the market.

When all, or nearly all, banks are up to their

discount ceilings at the Bank, rates for day-to-day money will tend to
move up first to the rate for rediscounting medium-term paper at the
intermediate financing agencies and then (prior to October 1967) to the
"hell" rate and to the rate for exceptional advances as money market
conditions tighten. 1

1. Before mid-1964 money market rates rose in periods of extreme
tightness to the "superhell" rate, but subsequently, by means of its
"exceptional" end-of-month operations the Bank made the "superhell"
rate, in effect, inoperative.

Since the beginning of 1967, the Bank of France has intervened in
the money market on the buy side to avoid a decline in market rates
below levels which authorities consider appropriate.

In times of boom

conditions, with high and rising interest rates, the Bank has raised
the whole structure of its rates (excepting for export paper), and
correspondingly lowered it when inflationary pressures have eased.
One or more of the Bank of France's rates for discounts or advances
has been changed seventeen times in the last eleven years ending 1966,
but the basic discount rate was changed only eight times during this

Two of the three increases were by 1 percentage point while

four of the five reductions were for 1/2 of 1 per cent each. On
several occasions the size and timing of the changes were influenced
by balance-of-payments considerations at variance with the requirements
of the domestic situation.
Bank of France credit practices
As a rule, routine rediscounting
France up till 11:00 a.m.

takes place at the Bank of

After that hour the Bank of France intervenes

in the open market, either by selling or by buying eligible paper under
en pension (repurchase) agreements in order to achieve its rate objectives.
Bills discounted outright must have at least 90 days to maturity,
and such discounts must be for the remaining life of the paper.

1. Local or regional banks normally discount with their Paris
correspondents; thus a good deal of the paper originating throughout
France is submitted for rediscount or repurchase operations in Paris.

Repurchase agreements, on the other hand, are made on paper with
periods to maturity ranging from 15 days to 2 years, and under present
Bank policies may be for as short a period as two days.

Paper which

is not eligible for discounting because of maturity can be sold under
a repurchase (en pension) arrangement and repossessed later by the
borrowing bank and then rediscounted when it comes within the 90-day
maturity !range.
Banks inform the discount house, through which they ordinarily
operate in the money market, early in the day whether they will have
excess funds or whether they will need to borrow.

First, each dis-

count house conducts an internal operation that is comparable to
intermediation in Federal funds in the United States.

Then banks

still short of funds will arrange to sell paper en pension to the
Bank of France through the discount houses.

If the market is firm,

banks with a margin under their discount ceilings will also borrow
from the Bank in order to lend to other banks.
Of the approximately $30 billion of short- and discountable
medium-term credit extended to business and individuals by the French
banking system at the end of 1966, about 84 per cent ($25 billion) was
backed by bills.

The heavy reliance upon bill financing is due to the

fact that Bank of France credit is most cheaply and readily available
on the security of short-term bills.

Since the abolition of the

plancher and the coefficient (see pages 111-113), Bank of France credit
operations are based upon Treasury bills as well as upon private paper.
The examining and processing, of private collateral to determine whether
it meets eligibility requirements and for other reasons requires employing a large staff.

The bulk of paper discounted within ceilings is related to normal
sales transactions and is always acceptable as long as it fulfills the
applicable maturity and signature conditions.

Rejection of particular

credits which fail to meet these conditions can have no effect upon
monetary conditions because the right of each bank to rediscount up to
its full quota is not questioned and the supply of eligible paper is
more than ample to make up for any rejections of substandard paper.
In addition to three valid signatures and the meeting of proper
maturity requirements, the Bank requires that its prior authorization
be obtained in order to discount finance bills and medium-term credits
as well as all credits that will bring the volume of loans in whatever
form to any on£ enterprise to over 10 million francs ($2 million).


last requirement makes a considerable volume of ordinary commercial
paper subject to the prior authorization procedure which is quite cumbersome.

For each credit coming under this procedure, the borrower

must submit to its bank a file ("dossier") which must include (l) balance sheets of the firm for the last three years; (2) an estimate of
the value of trade credits, inventories, and investments; (3) a statement of all bank accommodations already obtained;

and (4) plans for

1. The Bank of France and its branches excainine about 43,000 credit
dossiers a year, and the entire procedure requires a minimum of two
months for each dossier. Once a credit is approved, however, bills can
be drawn on it and discounted at the Bank of France with no more delay
than is required for commercial paper.
2. The Central Risks Office (Service Central des Risques), which,
is attached to the General Discount Department of the Bank of France,
collects and collates data on the total volume of credit furnished to
any given borrower on the basis of monthly reports by banks and other
financial institutions. The information is available to the Discount
Committee for its decisions to grant central bank authorization. The
overall amount of credit outstanding to any borrower is also communicated each month to those banks and financial institutions which have
reported a credit in the name of that borrower, although information as
to the source of the borrower1s other credits is not divulged. The
Central Risks Office also tabulates the data according to the purpose
of each credit in order to provide information on the extent to which
the qualitative credit guidelines of the National Plan have been followed.

use and repayment of the credit applied for, together with evidence
showing that no alternative means are available for raising the required

This dossier is studied by the Discount Department of the Bank

of France (or one of its branches if the credit is small enough and
presents no complications) not only to ascertain the quality of the
loan, but also from the standpoint of whether it conforms to current
guidelines on the allocation of credit in accordance with the National
Economic Plan.
Linkage of lending and deposit rates to central bank rates
Neither the lending nor the deposit rates of the banks are now
formally linked to the lending rates of the Bank of France.

The system

of minimum commercial bank lending rates was abandoned at the beginning
of 1966 after a period of several years in which the connection with the
Bank of France discount rate was progressively loosened.

The N.C.C.

does set maximum interest rates payable by banks and financial institutions on sight and time deposits and certificates of deposit (bons
de caisse) but not in any fixed relationship to movements in the Bank's
discount rate.

In general, however, changes in maximum rates payable

on deposits have followed with some lag changes in money market conditions.

Similarly, the heavy re1 lance of the banks on Bank of France

credit (at the end of 1965 the Bank financed over 20 per cent of shprtterm and medium-term credit .to the economy) makes it inevitable that
bank lending rates should reflect the cost of borrowing from the Bank
of France.







Introduction. • • • • . . . • • • • • • •


, .

The Banking System



The Discount Mechanism
A c c e s s t oc e n t r a l b a n k c r e d i t .

• # * • • • - • • • •

1 2 9

Limitation on the availability of central
bank credit


Rate policy


The relationship between central bank rates
and rates in the credit and capital markets. . .
Borrowed reserves in relation to total reserves


of credit institutions

Other Tools of Monetary Policy. .



. . . .


Minimum r e s e r v e r a t i o s , . • • • • • • • • • • • •


Open m a r k e t o p e r a t i o n s


In the Federal Republic of Germany the authorities have sought
means to maintain monetary control without resorting to direct restriction of international capital movements.

To this end, they nave

modified the traditional monetary policy instruments and introduced
other tools.

Flexible reserve requirements have been employed during

periods of monetary restraint to discourage net borrowing abroad:
requirements against net liabilities of German banks to nonresidents
have been set at substantially higher levels than those against gross
domestic deposits,"
similar fashion.

The discount mechanism has been employed in a

The ceiling on the amount that each bank may discount

at the central bank may, at the authorities' discretion, be reduced by
an amount equal to the increase in a bank's foreign borrowing above a
specified level.

The authorities have also, at various times, employed

swaps between the central and commercial banks to encourage the latter
to hold balances abroad rather than to sell them to the Bundesbank.
The Bundesbank's principal monetary policy tools are flexible
:,ash reserve requirements and discount policy.

Due to "he narrowness

of the money market, the Bank does not conduct open market operat ! c x j r n lz<jc . . initirrjive but ini'luenccs th;i
:.rf : m


Tor t\e so-

called "open market'1 paper by adjusting ito posted selling and repur-.
chase rates.

The scope of flexible reserve policy is 1 Lifted} however,

by the range within which reserve requirements can charge.


the restrictive effects of increases in reserve requirements have been
offset to a considerable extent by sales of open market paper to the

I. In addition, there is a 2L) per cent withholding tax on interest
earned by foreign holders of West German securities.

Bundesbank at the initiative of commercial banks, as well as by

Central bank purchases of open-market paper are, however,

subject to a global ceiling, and ceilings apply to discounts available
to each credit institution.

The third way in which banks adjust their

cash positions is by obtaining advances against securities—the socalled Lombard loans--from the Bundesbank at a rate which is usually
1 per cent above the Bank's discount rate.

Unlike discounting within

ceilings, advances are regarded as a privilege, not. a right, and they
are permitted to remain outstanding only for very short periods.
In periods when the Bundesbank has been attempting to enforce
monetary restraint, the authorities have tightened up discount policy
not only by increasing the discount rate, but by reducing the coefficient by which the discount ceilings are established (as a multiple of
net worth) and thereby reducing the commercial banks' quotas at the
discount window.

The Bundesbank's experience, especially in the past

seven years, indicates that the currently available policy tools can
at best achieve only a gradual, indirect and delayed effect on the
lending activity of credit institutions and that their use is subject
to inhibitions arising from official concern with rate levels in
capital markets.

Consequently, the Bundesbank has sought at times the

power to impose quantitative ceilings on credit institutions' lending
to the non-bank sector.

The Bundesbank has also been among the strong-

est advocates of legislation under which expenditures and revenues of
the Federal, state (Laender), and local governments would be brought into
a framework of coherent fiscal policy; considerable progress in this
direction was achieved by the passage of the Stabilization Law of 1967.
On the whole, however, the German experience since the shift to convertibility reveals the limitations on use of monetary policy during periods
of substantial trade surplus and unrestricted international capital flows*

The Bundesbank is wholly owned by the Federal government and its
Council is appointed by it.

It is an autonomous institution and legally

it can pursue a policy independent of the Federal government.

In fact,

a close relationship is maintained between it and the cabinet and, more
specifically, the Ministers of Finance and Economic Affairs. •
The Bundesbank succeeded in 1958 the Bank Deutscher Lander (which
operated along very similar lines) and its organization is patterned
on that of the Federal Reserve System, consisting of a head office
(in Frankfurt) and eleven central banks (Landeszentralbanken) of the
individual states (Laender) which constitute the Federal Republic. 1
The head office handles all transactions with the Federal government,
as well as open market operations, foreign exchange transactions, and
other transactions with foreign countries and organizations.

In addi-

tion to those of the Federal government, all state government accounts,
with insignificant except ions, are held with the central bank system.
The commercial banking structure is dominated by three large institutions with networks of branches throughout the country.


are also about 100 banks whose operation is restricted to a single
state, region, or locality, as well as a large number of other more
specialized institutions mentioned below.

1. The Laender central banks serve as offices of the Bundesbank
in each Laender and carry out the policy decisions reached by the
Central Bank Council. Each Laender central bank acts as the fiscal
agent to its Laender and carries out on its own responsibility central
banking operations such as accepting central bank balances, establishing rediscount quotas, and providing central bank credit at the stated
rates for rediscounts and advances'with all credit institutions within
its geographical area.



Access to central barxk^ credit
Central bank credit is available to all credit institutions
subject to minimum reserve requirements (see below page 135);
however, central bank credit facilities are used m6re extensively by
commercial banks than by any other type of institution.

The normal

avenue for obtaining central bank credit is to discount eligible paper
within quota limits.

The discount credit at the central bank is con-

sidered by the credit institutions as a source of liquidity
which is available at the stated'rate as a matter of right,

In con-

trast, the Bundesbank considers the more expensive advances against
securities a privilege to be granted only for very short-term balancing
out purposes ("bridging credit").
Access to Bundesbank credit depends on an institution's having
paper eligible for rediscounting or as collateral against advances
("Lombard credit").

Eligible commercial bills have to be endorsed by

three parties "known to be solvent" and the bills must mature within
tLree months of the Bundesbank's purchase date.

Bankers1 prime

acceptances which serve to finance foreign trade, promissory notes of the
Import and Storage Agencies,, and exporters' bills endorsed by a bank
and by the Export Credit Company are also discountable.

However, the

Bundesbank specifically excludes bills used to finance instalment sales, construction projects, and purchase or manufacture of
building materials,
"Lombard credit" (advances) constitutes a safety valve, even
though, in principle, advances against securities are not granted as
a matter of right, but as a privilege, but"the frequency of its use

does not alter the contractual terms on which it is made available.
Advances are designed to meet only very short-term requirements ('usually
at month end) arising from day-to-day cash flows. Assets that can serve
as collateral for advances include bills of exchange eligible for rediscounts, Treasury bills and bonds of the Federal'government, Laender
governments, or the Federal Special Funds that appear in the Debt
Register and equalization claims (bank claims on the Federal government
arising from the currency reform of 1948).

Normally, government secu-

rities are used as collateral. However, the granting of advances depends
not only on the availability of the acceptable collateral, but also on
the would-be borrower!s financial condition, the purpose of the borrowing, and the general credit policy of the Bundesbank.
Limitation on the availability of central bank credit
West German credit institutions tend to accommodate their customers
with loans as long as they are able to supplement their resources by
using central bank credit, even if in the process they become increasingly sensitive to restrictive monetary policy.

Each credit institu-

tion's access to the discount window is limited by its discount quota
which is established by the central bank of the Laender in which its head
office is located.

Originally, the discount quota was imposed for the

purpose of protecting the central bank's exposure.

It was realized

only later (in 1951) that the quota might be useful in controlling

The quota depends in the main on the type of credit institu-

tion ancj. on its equity capital.

It is currently determined as a fixed

multiple of an institution's net worth and is reviewed frequently.
(The method for the computation of quotas has not been published.
However, any institution can easily ascertain the amount of its quota.)

131 .
Since quotas increase automatically with the growth of bank equity
funds, the coefficients have been reduced from time to time to
avoid excessive credit expansion. The most recent such acrossthe-board reduction


quotas occurred in May 1966.

In fact,

across-the-board reductions in quotas have become ' policy tool.
Quotas may be reduced depending on the individual institution's
record of compliance with the' rules and regulations of the Bundesbank
and the Federal Banking Supervisory Office as well as for other reasons.
Since September 1964 the Bundesbank has been using reductions in
the discount quota in order to discourage credit institutions from borrowing abroad.

The discount quota of each credit institution has become

subject to reductions by the ajnount of its foreign borrowing in excess
of the average amount outstanding at month end during January-June 1964.
(Borrowing abroad to finance imports is not counted against the discount quota.)

In effect, quotas of a considerable number of banks are

subject to deductions at one time or another, with some deductions
clearly amounting to sanctions.
Since credit institutions cannot discount in excess of their quotas
undtr any circumstances, they seek, in practice, to maintain a substantial leeway.

Bank attitudes with regard to quotas are, however,

pubjeat to QhmngB, For instance, in 1965-66 banks exhausted the leeway
under Qmdit lines more rapidly than officials of the Bundesbank had
on the Tmeis of previous experience.

1. At the beginning of 1967* roughly one-third of the rediscounting
institutions reporting daily to the Bundesbank had some kind of deduction from their regular quotas in force for one or another reasons, but
these penalty deductions involved mostly the quotas of small banks and
cooperative lending institutions, and deductions totaled only about 5 percent of aggregate total of regular quotas.

Supplementary quotas for amounts up to 25 per cent of the












supplementary quotas include the following:






short-term seasonal

financing bulges in agricultural areas; (b) peaks in foreign trade
financing, chiefly in terms of extension of export credit; (c) special
assistance to institutions located near the Iron Curtain, to assist
them in adjusting to the loss and disruption of their normal trade
areas; and (d) assistance to banks engaged in entrepot trade.
In addition to advances, granted for very short periods only,
credit institutions may also obtain central bank credit outside the
discount quota by selling prime bankers1 acceptances (indirectly) to
the Bundesbank or by selling to it instruments arising from the extension of medium- and long-term export credit.

Prime bankers1 accept-

ances can be sold to the Privatdiskont A.G. which, in turn, rediscounts
them with the Bundesbank without


Bank holdings of such assets

constitute secondary liquidity because they can be immediately
converted into cash.
Rate policy
The Bundesbank discount rate is uniform and has been changed with
some frequency.

The Lombard rate is kept at a penalty rate level (usually

one per cent above the discount rate) and normally constitutes a
ceiling on money market rate fluctuations.

The discount rate was fre-

quently changed between 1957 and I96l; for instance during 1959-60,

1. A global limit of DM 1 billion set in May 1966, at a time when
such rediscounts rose sharply in response to restrictive monetary policy,
has been lifted in the meantime. However, this move was partly offset by
enlarging the quota for the purchase of exporters1 bills endorsed by the
Export Guarantee Company by DM 600 million to DM 900 million and subsequently (in 1967) to DM 1.8 billion.

the discount rate was raised three times in a span of 9 months from
3 to 5 per cent,

This was done in an effort to restrict the impact of

a large foreign trade surplus on domestic liquidity.

However, such a •

boost in domestic interest rates encouraged a massive inflow of capital.
This development forced the German authorities to reverse their monetary
policy in November I960, and the discount rate was reduced in three
successive steps to 3 Ver

cent, by May 196l.

Balance-of-payments con-

siderations prevented the Bundesbank from any further change in the
discount rate until January 196 5, when rising interest rates abroad
reduced the danger of inducing a further large inflow of foreign capital,
and subsequently rate changes were made more often.

For example, during

four months in 1967, the discount rate was lowered four times, each
time by l/2 percentage point.
-The repercussions of frequent discount rate changes on the capital
markets have complicated implementation of Germany's monetary policy.
The effects of such changes are transmitted to the capital market through
the commercial .banks, most of which are active in the securities markets as
underwriters, brokers and dealers, and buyers for their own account,
using their security portfolio as a buffer whenever changes in monetary
policy occur.

The Bundesbank has found it necessary from time to time

to support the prices of bonds issued by government agencies in order
to offset the capital market effects of policies aimed essentially at
the money market only.

Until August 1967, support operations were

undertaken for the account of the various agencies whose securities
were involved rather than for the Bundesbank's own account.

While such

purchases did not add to the volume of central bank credit outstanding,
but merely shifted balances at the- central bank from the government

agencies to the banking system, such operations tended to ease
commercial bank reserve positions and thus to offset restrictive
monetary policy.

Since August 1967 the Bundesbank has been also

engaging in open market operations in long-term securities for its
own account.
The relationship between central bank rates and rates in the
credit and capital markets
Practically all money rates are, or until recently were, linked
to the Bundesbank1s discount rate.

The Bundesbank's r&te on advances

against securities always changes with its discount rate and is
usually 1 percentage point above the discount rate.

Also, until

April 1967 credit institutions' rates

on loans and deposits were

formally linked to the discount rate.

Ceilings on credit institutions1

lending rates were set by the Federal Banking Supervisory Office and
varied directly with the discount rate.

Business loans were 4 l/2 per-

centage points above the discount rate and bills discountable at the
Bundesbank were 3 percentage points above the discount rate.


linkage of deposit rates to the discount rate was less direct, and
changes in deposit rates usually lagged behind changes in the discount

On April 1, 1967 the legal ceiling on lending and deposit rates

was removed in order to let market forces set these rates.
Borrowed reserves in relation to total reserves of credit institutions
German credit institutions have relied heavily on Bundesbank credit

In order to finance a continuously expanding credit supply

to the private sector, rediscounting and other borrowing at the Bundesbank
increased whenever the foreign balance or the Bank's foreign exchange
operations restricted bank liquidity.

This occurred, for instance, when

the Bundesbank offset the accumulation of its foreign assets (1959, i960),
and when

the Bundesbank chose not to offset the decline in its foreign asset

holdings (1962), as well as when the restrictive monetary policy was
reinforced by a decline in official foreign asset holdings (1964-1965).
The increasing importance of discounting in periods of reserve
shortage is reflected not only in the level of central bank credit and
in its share in the credit institutions' total reserves (which may
rise to one fifth or one third), but also in its rising relation to
loans granted to the private 'sector, and to the Bundesbank foreign
assets portfolio,


Minimum reserve ratios
The central bank is authorized to set variable minimum required
cash reserve ratios against all sight, time, and savings deposits.
These ratios apply to a variety of credit institutions which accept
such deposits:

(l) commercial banks, (2) the postal check and savings

banks, (3) giro institutions, (4) savings banks, (5) central organizations of industrial-agricultural credit cooperatives, (6) industrial
and agricultural credit cooperatives, (7) installment credit institutions, (8) credit institutions with special functions (such as the
Reconstruction Loan Corporation).

Mortgage banks are exempt (as of

July 1, 1965) from the requirement to hold minimum reserve balances
with the Bundesbank.
Reserve assets consist only of

nonearning balances with the

Bundesbank, and they can be counted toward the liquid assets that
have to be maintained under other laws.

The statutory maximum

1. Credit institutions have also to observe certain guidelines
concerning their liquidity and solvency. These are expressed as ratios
of prescribed assets to worth and liabilities. These'
ratios are administered by the Federal Banking Supervisory Office and
are not used as an instrument of monetary policy.

reserve ratios are 30, 20 and 10 per cent against sight, time, and
savings deposits, respectively.

Established reserve ratios vary not

only with the type of deposit "but also with the type of depositor and
the location and size of the credit institution, so that the number
of specific ratios applicable at any given point of time is quite

They are changed quite frequently.

Any reserve

deficiency is subject-to a fine of 3 percentage points over the rate
on central bank advances.

Since November 1959 the reserve ratios •

have been changed across-the-board by an equal per cent (not equal
percentage points) in order to maintain the same structure of reserve

Independent manipulation of reserve ratios against nonresident

deposits (and allowing, at times, for bank borrowing abroad to be
counted as an offset against such liabilities) has been used to regulate
the liquidity of the banking system.
Open market operations
The Bundesbankfs short-term open market operations are passive in
nature due to the narrowness of the money market, and other factors
which limit the scale on which the authorities can operate.

Open market

1. During a short period (the second half of I960), increases in
deposit liabilities above a base period level were also subject to
(higher) marginal reserve requirements.
2. Reserve requirements are computed on the basis of the monthly
average of deposit liabilities outstanding on four statement days (the
23rd and the last business day of the preceding calendar month, the
7th and 15th of the current calendar month). The reserve period, which
is the current calendar month, permits individual credit institutions
to average out sharp oscillations. This is especially important in
Germany where there is no equivalent to the American "tax and loan

operations are undertaken only directly between each credit institution
and the Bundesbank which restricts itself to changing from time to time
its buying and selling rates for Federal Treasury bills and bonds as
well as short- and medium-term securities (of up to two-year maturity)
of certain government agencies.

The decision of how much to buy or sell

at the posted rates, which are changed somewhat more frequently than the
discount rate, is left to the credit institutions.

The credit institu-

tions have come to regard their holdings of this "open .market" paper
as secondary liquidity (most open market paper was created by issuing
securities to replace--"mobilize"--book claims against the Federal
government arising from the postwar currency reform.

The amount of

"mobilization" paper is limited to DM 8 billion, but within this limit
credit institutions have been able to counteract, at least temporarily,
the Bundesbank's policy aiming at the level of free reserves.






The Institutional Framework


Central Bank Credit


Accommodation to credit institutions
and group institutes


Accommodation to the central
government and private individuals


The relationship of bank deposit and
lending rates to the discount rate . . . . . . .

Other Instruments of Monetary Policy
Direct controls over private credit flows
Manipulation of commercial banks' net
external position*




The Bank of Italy appears to have no clearly defined discount
policy; there are no formal policy statements or regulations setting
forth its objectives in this area.

Discount policy is administered

flexibly, and day-to-day policy depends to a large extent on the
effect that Treasury operations and balance-of-payments developments
have on bank liquidity.

Moreover, the emphasis appears to be on

changes in credit availability effected through other means rather
than the discount rate, which has remained unchanged since June 1958 •
Discount policy nevertheless occupies an important place in the
monetary policy arsenal of the Bank of Italy.

Accommodation is mostly

in the form of advances rather than rediscounts.

The Bank has broad

discretionary powers in implementing its discount policy, with respect
both to form of accommodation and type of asset accepted.

These powers

give the. Bank considerable leverage in directly controlling the expansion of credit.

The monetary authorities maintain control over liquidity

available to Italian banks from their foreign balances by instructing
the banks to maintain their net foreign-exchange position vis-a-vis
foreigners at specified levels and granting at times at its discretion
cost-free forward-exchange cover.

Finally, the Bank of Italy also has

substantial control over a third source of bank liquidity--i.e., the
volume of Treasury bills held in excess of the banks' compulsory reserve
The central bank's obligation to support the government's budget
is one major loophole in its control over liquidity.

However, to date,

the moderation of the government in employing its power to obtain

credit from the central bank has prevented any serious slippage in
monetary control.

Reserve requirements, introduced originally in 1926

as liquidity ratios for the protection of depositors, have been used
since World War II also as a tool of monetary policy.

The use of this

tool has proven cumbersome because of the complex formula used to determine reserve ratios (see page 148). Their effectiveness is also limited
by the fact that these reserve requirements can be satisfied in such a
way as to yield a return fairly close to market rates.



Overall monetary policy is formulated by the Interministerial
Committee for Credit and Savings.

It consists of the Minister of the

Treasury (its chairman), six other ministers,

and the Governor of the

Bank of Italy and meets seven or eight times a year.

Its policy deci-

sions are embodied in decrees signed by the Minister of the Treasury
or in regulations issued by the Bank of Italy.

Thus, the discount rate

is established by a decree of the Minister of Finance acting upon recommendation

of the Governor of the Bank.

Execution of monetary policy

is entrusted to the Bank of Italy, which has a network of regional branches.
The Bank of Italy is owned by five categories of institutions all of
which are in whole or in part publicly owned.

Although the government

itself has no direct voting participation in the central bank's capital
or in any of its governing bodies, the Bank of I:,aly is In e. '
the control of the Treasury.

However, the stature and prestige oi t ^

Bank's Governors have given it considerable autonomy and great weight in
policy decisions in the whole area of government financial policy.
In the international field, the Bank of Italyfs functions are complemented by the Exchange Office (Ufficio Italiano dei Cambi), which--

1. Budget, Foreign Trade, Industry and Commerce, Public Works,
State-owned Enterprises, Agriculture,,
2. These institutions are: savings banks, public law banks, banks
of national interest, social security institutions, and insurance

though nominally an independent public body--is in effect an affiliate
of the Bank.

The Exchange Office carries out most of its domestic

operations through the Bank of Italy's branches, which act as its
agents*. The Italian lira it needs to acquire foreign exchange is supplied to the Exchange Office through an unlimited line of credit from
the Bank of Italy.
The Italian banking system grew over the years into a heterogeneous
conglomerate of institutions (some of them nearly 500 years old and
(pioneers of banking) which are not easily fitted into precise classifications according to type of activity.

All of them engage to a

greater or lesser extent in short-, medium-, or long-term lending.


distinction drawn by the Banking Law of 1936, further sharpened by a
1963 amendment, divides the Italian credit system into two sectors.
One sector consists of banking institutions'that take most of their
deposits as "short-term savings" (defined as demand deposits and savings
and time deposits with a maturity of one year) and are forbidden to
accept deposits with more than eighteen months1 maturity.

The other

sector consists of institutions that accept medium- and long-term
savings of no less than eighteen months1 maturity, but, with one exception, raise most of their funds by issuing bonds in the capital

The former are called "credit institutions" (aziende di

credito) and the latter "special credit institutions" (istituti
speciali di credito).
The credit institutions, which are fully under the Bank of Italy's
supervision, number about 1,300 (with over 9,000 branches)5 of these
about 350 account for about 99 per cent of total deposits.


categories of these credit institutions--Cooperative People's Banks,
savings banks, and joint-stock banks and private banks--belong to group
institutes established by them to hold part of the members' liquid
reserves and to provide them with services--such as issuing

bank drafts (assegni circolari),

clearing operations, technical

assistance, and to representing them in dealing with the Treasury and
other branches of the government.
The special credit institutions number about 70, of which some
15 are engaged in mortgage credit, 12 in agricultural credit, and the
rest in industrial credit and miscellaneous activities.


Central bank credit is available to all the credit institutions
and group institutes, and also to private industry and individuals.
The central government, but not the local governments, has direct,
access to Bank of Italy credit.

to credit institutions and group institutes

Central bank accommodation to credit institutions and group
institutes takes three forms: advances on collateral, rediscounts of
commercial paper and Treasury bills, and "deferred payments" at the
clearing house.^

1. Assegno circolare is an instrument very widely used by the
public in Italy, where the practice of payment by check for general
payments is virtually nonexistent.
2. On June 30, 1966, total liabilities and net worth of the
group institutes amounted to lire 1,320 billion ($2.1 billion equivalent), most of which are presumably assets of the member institutions.
3° In principle, special credit institutions, except those extending credit to agriculture, have no direct access to central bank
credit. However, under unusual circumstances they may obtain advances
on collateral, on the same terms as nonbank borrowers; -the volume of
such advances has been insignificant--less than 0.5 P^r cent of the
Bank of Italy's total advances in recent years.
4. A fourth type of central bank accommodation consists of the
rediscounting of Storage Agency Bills, i.e., bills issued to finance
the government's farm price support program (particularly the price
of wheat). These bills are first discounted with the credit
institutions at rates ranging from 5»5 to 6.5 per cent per annum, but
are automatically eligible for rediscount at the Bank of Italy, and
are for the most part passed on to the latter. Such rediscounts have
risen from lire 383 billion at the. end of 1958 to lire 714 billion
at the end of November 1966. Thus, in this instance, the Bank of Italy
acts as agent for the government, and discount policy is presumably
adjusted to take account of the automatic rediscounting of Storage
Agency Bills. Consequently, the discussion in the text is confined to
"ordinary" rediscounting.

The accommodation granted by the Bank of Italy is mainly in the
form of advances on collateral.

These are made on the basis of lines

of credit which the Bank opens in favor of the banks against securities deposited with it when the line of credit is established.


paper eligible as collateral consists of government and governmentguaranteed securities, mortgage bonds, and bonds of "equivalent
rating/' 1

The line remains open for four months and is renewable.

The commercial banks are not expected to draw the credit at; once and
remain fully indebted for the duration of the credit period; rather,
it is expected that there would be a continuous flow of drawings and

In 1967, "the Bank of Italy introduced a new credit

instrument--advances on collateral with a fixed maturity of 8, 14 or
22 days, which, when granted, must be drawn in full.

In every other

respect, they resemble the line-of-credit advances.
The second type of accommodation consists of rediscounting
of commercial paper and Treasury bills.

In practice,, the bulk of

paper consists of commercial bills, since the banks prefer to keep
Treasury bills for other operations.

Bills presented for redis-

counting must have a maximum of up to four months to maturity from
the day it is taken up by the Bank of Italy, and bear the signature
of at least two persons known to be solvent.

In normal times redis-

counting is a marginal item in the total of the banks f borrowing
from the central bank.

In case of tightness, banks will first use

their credit lines for advances, and only when these are running

1. This category comprises bonds issued by important official
financing institutions such as "Istituto Mobiliare Italiano", other
special credit institutions, and.the nationalized enterprises (iRI,
ENI, and EKEL).

short will they resort to rediscounting.

Italian banks as a group

"borrow continuously from the central bank, which is always prepared to
meet seasonal and cyclical needs.
Collateralized advances as well as rediscounting is available as
a privilege, subject to the discretion of the Eank 'of Italy.

The Bank

has established individual credit ceilings for lines of credit and
fixed-maturity advances for .each bank, as well as for local branches of
banks with a national network of offices.

As a rule of thumb, these

ceilings are set at 5 per cent of the bank's total deposits, but they
are occasionally reviewed and revised.

Branch managers of the Bank of

Italy, who are intimately acquainted with the needs of the local banks,
have a certain degree of discretion in increasing these ceilings, but
refer decisions concerning substantial upward revisions to the main

An individual bank does not know what its ceiling is, and the

Bank of Italy does not discuss the 5 per cent figure publicly.
is no ceiling for rediscounting.


Aggregate advances and rediscounts

have never reached 5 per cent of total deposits of all banks.
Finally, a minor avenue of central bank credit open to banks has
been a system of "deferred payments" (prorogati pagamenti) for meeting
adverse clearing balances at the local clearing houses operated by the
Bank of Italy.

Such accommodation

is granted--normally for one day

1. Excluding rediscounts of Storage Agency Bills, ordinary rediscounting is relatively insignificant compared to advances on collateral;
however, in times of liquidity pressures (for instance, most of 1963
through early 1964), the relative share of rediscounting has tended to
increase. In normal times, total central bank credit was very small
in proportion to the banks 1 lira loans to the private sector (less than
1 per cent) and relatively small in proportion to the banks 1 required
reserves (3 to 6 per cent).

and exceptionally up to four days--to clearing house members against
collateral of the kind accepted by the Bank of Italy for regular

Since the introduction of fixed-maturity advances, however,

recourse to "deferred payments" as an extra source of funds has been
officially discouraged and since July 1967, there has been no end-ofmonth outstanding balance.
The large banks generally prefer to obtain central bank credit
through collateralized advances, rather than rediscounting, mostly
because the former method is generally more flexible and less costly
but also because they do not want their customers to know that they
needed to have recourse to central bank credit.

Bank of Italy rates

for rediscounts and advances have been identical since 1950, but, in
the case of advances, interest is charged only on outstanding debtor
balances and banks have the option of repaying the loan at any time,
whereas rediscounts are outstanding for the remaining life of the

Large banks resort to rediscounting at the central bank

chiefly to meet unusually heavy withdrawals and sharp increases in
drawings under confirmed credit lines.

The smaller banks resort to

rediscounting more frequently.
Accommodation to the central government
and private individuals
.Since 1948 the Bank of Italy has been required by law to grant
the Treasury unsecured short-term overdraft facilities of up to 14 per
cent of the original ordinary budget appropriations as well as supplementary expenditures approved by Parliament.

The Bank of Italy is also

authorized to subscribe without limit to securities issued or guaranteed

1. In normal years these deferments (year-end basis) did not amount
to more than 0.5 per cent of the banks 1 required reserves. During the
1963-64 "squeeze" they amounted to nearly 2 per cent.

by the state.

It also rediscounts special paper issued in connection

with the governments agricultural support programs.
Discounts by the Bank of Italy for private individuals were forbidden by law in 1936; however, there are no legal bars to the Bank
making advances on collateral to private customers on Treasury bills,
bonds issued or guaranteed by the government, bonds of mortgage credit
institutions, Italian and foreign legal tender gold coins, gold bonds,
foreign government securities payable in gold, and raw and processed

The Bank of Italy intends to eliminate the remaining private

accounts as quickly as feasible, but it wants to retain the legal
authority to make direct loans for emergency purposes.

In 1958 ad-

vances to individuals still amounted to 14 per cent of total advances,
but have subsequently declined, and were about 1 per cent in the last
three years.
The relationship of bank deposit and
lending rates to the discount rate
The volume of commercial bank borrowing at the central bank is
influenced by availability rather than cost.

In principle, there are

no obstacles to large and frequent changes in the discount rate, but
for several reasons, chiefly the lack of an organized and interestsensitive money market, the central bank prefers to rely more on other
controls to regulate credit in the economy.

The Bank of Italy!s dis-

count rate was last changed in June 1958; after having been unchanged
for eight years.
The Italian interest rate structure is regulated under a voluntary
"Interbank Agreement" which sets minimum lending rates and maximum

deposit rates.

It went into effect in February 1954, and while it

has been renewed annually with slight amendments, it is generally
believed that the established rates are now frequently exceeded for
medium- and large-sized deposits.

Because of the boom conditions that

characterized the Italian economy in much of the postwar period, the
banks have generally enjoyed a "lender!sft market.

Thus it appears

that the minimum rates have frequently been exceeded (reportedly by up
to 3 per cent).
Maximum rates payable on deposits stipulated in the Interbank
Agreement are not directly tied to the discount rate.

However, since

changes in the discount rate are accompanied by changes in Treasury
bill rates (and in the rate paid by the Bank of Italy on compulsory
reserves), the banks adjust deposit rates to remain competitive with
Treasury bills.
By contrast, minimum lending rates are directly linked to the
official discount rate (but vary according to the type of lending).
The commercial'banks1 discount rate for commercial paper is set by the
Agreement at 1.50 per cent above the official discount rate.


June 1958 the minimum lending rates for prime customers have been
5 per cent for discounts of paper up to four-month maturity, and 7

cent plus a quarterly commission of 0.125 per cent on the highest debit
balance outstanding for collateralized loans.

1. The enforcement of the Agreement is entrusted to a special
committee—presided over by the President of the Italian Bankers
Association and including representatives of the major banking groups-which may impose penalties of up to a hundred times the amount paid to
a depositor (or charged to a borrower) above (or below) the maximum
(or minimum) agreed rate.
2. Until recently when Euro-dollar rates were still below Italy's
domestic minimum lending rates, the Italian banks, to meet competition
of foreign banks, had kept rates on foreign currency loans to their
prime customers below the rates on lira loans.

The temptation of credit institutions to borrow from the central
bank in order to relend at higher rates, thereby profiting through rate
differentials, is countered by the tight control exerted by the central
bank over the volume of its credit.

No type of paper, other than

Storage Agency Bills, is automatically eligible for rediscount or as
collateral for a loan.

The Bank of Italy determines how much credit it

wishes to extend in the light of prevailing monetary policy and then
scrutinizes every credit application individually.


Other important instruments of monetary policy are controls over
maximum expansion of bank credit, and manipulation of the commercial banks 1
net foreign assets position*

The monetary authorities also set and vary

reserve requirements, engage in open-market operations, and may impose
ad hoc direct and selective controls, such as those over securities
issued by both the banking and the nonbanking sectors.
Different reserve requirements apply to individual categories of
banking institutions and types of liabilities, and the reserve coefficients are to some extent progressive«,

Reserve requirements are satis-

fied in the form of interest-bearing deposits with the Bank of Italy for
the first 10 per cent of total deposit liabilities in excess of net
capital resources and the balance, at the option of the Bank, by holding
additional cash balances, Treasury bills or certain long-term securities.

Changes in the ratios are infrequent and this tool is not

used vigorously.1

Also, open-market operations are still a potential

rather than an actual instrument of monetary management, since an

1. Reserve requirements for credit institutions were changed only
once (in 1962) since being modified in 1947; those for savings banks
and First Class Pledge Banks have not been varied since they were
introduced in 1958; and those for Rural and Artisan Banks have been
varied only once (in 1955) since being introduced in 1932. However,
from time to time the Bank of Italy has used this instrument as a
countercyclical weapon by changing the types of financial assets that
can satisfy the requirements (e.g., mortgage bonds were included
recently to boost the depressed construction sector).

important institutional reform in November 1962, aimed at establishing
an organized money market, has not yet produced any significant results.
Recently, however, the Bank of Italy has been dealing with banks in
long-term securities on a fairly large scale.
Direct controls over private credit flows
Direct controls over the banks' loan expansion are implemented both
under- legal authority and through moral suasion.
larly effective

due to

The latter is particu-

the wide discretionary powers which the Bank

of Italy already enjoys in rejecting or accepting applications for rediscounts or advances and the large proportion of state ownership of
many leading banks.
The Bank of Italy must give prior authorization for accommodation
(and loan renewals) by a commercial or savings bank to any one customer when

such accommodation brings the customer's total liability

to the bank beyond the so-called "legal limit on credit" (limite legale
di fido), defined as one-fifth of the paid-up capital and reserves of
the lending bank.

Introduced in 1926 to safeguard depositors, the

scope of this rule has been considerably extended in the postwar period
as inflation greatly reduced the capital/deposit ratio of banks. 1


exercise of this power has been useful, at least at certain times, as a
tool of monetary policy.

It enables the Bank of Italy to exert a

selective and restrictive influence on the quantity and quality of bank
credit and. enables commercial banks to resist local political pressures
for funds to support local government spending.

For example, of all lira

denominated loans to the private sector outstanding at the end of 1962 and

1. Whereas in 1938 the capital/deposit ratio was about 12 per.
cent, it dropped to less than 2 per cent in 1947 and was still not
much more than 3 per cent in mid-1966.

1963 about 25 per cent were approved by the Bank of Italy, and over
70 per cent of these were granted by the big banks.

This instrument

has been used to prevent speculative inventory-building during boom
periods and to ensure that short-term credits are not used for longterm financing of fixed investment.
The "legal limit on credit" of course varies greatly in amount
from one institution to another and rises as a bank's capital resources increase.
sized banks, the

Therefore, while effective for small- and mediumusefulness of this instrument is limited in the

case of the few banking giants. * Limitation of the large banks 1
lending is achieved mainly through moral suasion.

As a result of

the close relationship the central bank has with these institutions,
in most of which the government owns a controlling interest (directly
or indirectly through holding companies), the Bank of Italy has
obtained their cooperation in slowing down loan expansion, or in
applying more stringent "qualitative" criteria.
Finally, direct control over flows of credit in the economy
is enhanced by the authority of the Bank of Italy to give (concurrently with the Ministry of the Treasury and subject to approval by
the Interministerial Committee) or withhold approval of all issues of
shares and bonds (with the exception of bonus shares) made through the
intermediary of institutions subject to the Bank of Italy's supervision,
or if the securities are to be listed on the stock exchange.1


1. The power to authorize special credit institutions (see
page 141) to float bond issues is vested with the Governor of the Bank,
of Italy.

requirement extends also to bonds issued (other than mortgage bonds)
by credit institutions.

Authorization may be delayed or speeded up

in line with current objectives of monetary policy.
Manipulation of commercial banks' net external position
The manipulation of the commercial banks 1 net foreign exchange
position, which has been used vigorously since August I960, has become
one of the most significant tools of monetary management.

The author-

ities can affect this position by instructing banks to adjust their
net foreign exchange holdings vis-a-vis foreigners to specified levels
and thus bring about outflows of funds when they wish to reduce the
banks1 domestic liquidity and permit inflows when domestic liquidity
is desired.





The Institutional Framework


Central Bank Techniques


Availability of central bank credit


Rediscounts and advances


Penalty rates. . .•


Ceilings on discounts and advances .


Other monetary policy instruments

. . .

Commercial bank interest rates


Relationship of Rediscounting to Other Instruments
of Monetary Policy


Quantitative Role of Central Bank Credit Policy . . . .




The Japanese authorities (the Bank of Japan in close cooperation
with the Ministry of Finance) are well equipped to control external
sources of liquidity and to maintain monetary control through their
power to regulate the cost and availability of central bank credit,
the more so because the Japanese banking system, being chronically in
need of liquidity, is heavily dependent on the central bank.


exchange control powers enable the authorities to exercise a significant influence over changes in the central bank's holdings of international assets and thus over changes in the cash base that result
from movements in the balance of payments. Commercial banks1 foreign
borrowing is "guided" by the central bank.
Discount policy plays a central role in Japanese monetary policy,
although the Bank of Japan to some extent also employs flexible cash
ratios and open market operations to achieve its aims.

Under condi-

tions that have existed since the end of World War II there has been
only a very limited scope for use of cash reserve ratios. Access to
the discount window is considered a privilege. A scale of rates is
established according to the type of paper offered by the borrowing

Ceilings are set on the amount that will be lent to individual

banks at the basic discount rate, and a penalty rate is applicable to
borrowing in excess of the ceiling. The structure of discount rates,
the range of paper acceptable, and ceilings on borrowing, all are
subject to change—and indeed are frequently changed—in accordance
with the authorities1 monetary policy objectives, which, in turn, are
closely geared to overall economic policy.

The authoritiesf control is strengthened by the close links that
exist between the structures of discount and market rates. The Bank of
Japan determines the maximum rate below which commercial bank lending
rates are permitted to fluctuate. Within this range, the prime bank
lending rate, which is the minimum rate charged by commercial banks on
commercial paper eligible for rediscount at the Bank of Japan, is at
present set by the Banking Association at a level no higher than the
basic discount rate. The authorities also control the rate that
banks may offer in the market for short-term deposits.
Other policy instruments include so-called "window-guidance,"
under which the authorities have, from time to time, used moral suasion,
developed into a system of close supervision of each bank's day-to-day
activities, to influence the commercial banks1 lending policies. They
also include selective credit controls, such as those over the financing of securities and imports (there are no specific monetary controls applied to consumer and housing credit).
In November 1962, the Bank of Japan

reintroduced discount ceilings

and began to buy and sell securities.
Until fairly recently, the traditional instruments of monetary
policy appear to have been considered adequate to deal with both domestic and external disequilibria.

However, since 1964, increased reliance

began to be placed on fiscal measures for implementing overall economic


The Bank of Japan is, in fact, operated as part of the government's
economic administration in close liaison with the Ministry of Finance.
Some 55 per cent of its capital is owned by the Ministry of Finance, the

remainder by local authorities, financial institutions, and other
private corporations and individuals. The Bank is managed by the
Governor, the Vice Governor, and the Board of Directors; the directors
are usually selected from the Bank's senior staff.

Overall policy is

determined by a Policy Board consisting of the Governor, four outside
members (required to be experienced in banking, industry, commerce,
and agriculture) appointed by the Cabinet, and approved by both
houses of Parliament, and two direct representatives of the
government. This Board is not concerned with the Bank's management on a current basis.
The banking system is dominated by 13 so-called "city banks"
which operate branches throughout the country and account for 60 per
cent of the assets of the banking system.

In addition, there are some

65 local commercial banks and a variety of other trust banks, long-term
credit and other specialized banks, mutual savings and loan banks,
credit associations,- and agricultural credit cooperatives.
The outstanding feature of Japan's financial structure is the
extremely low ratio of the banks1 liquid assets to total assets and the
heavy indebtedness of the commercial banks to the Bank of Japan. This
"overloaned" situation resulted from the inflationary aftermath of
World War II, which led to high debt-equity ratios for Japanese industry generally.

Virtually the entire debt consisted of short-term bank

loans. While correction of this weakness in the banking system and
business has been a policy objective., there has been a reluctance to
permit long-term interest rates to rise to a level that would have promoted the development of an adequate supply of long-term capital to
reduce dependence on short-term bank loans; hence a large proportion of

investment continues to be financed through commercial bank

credit, and the banks' cash reserves are in turn replenished through
credits from the central bank.
Cash, deposits with the Bank of Japan and other financial institutions, call loans, and credit extended to financial institutions, represent the liquid assets of the banking system as a whole.

Its liquidity-

is affected greatly by Treasury operations. All funds of the Japanese
Government are held on deposit in the Bank of Japan. The proceeds of
tax collections are immediately deposited in it. The proceeds of
government borrowings are likewise immediately deposited in the Bank of
Japan. Thus, the liquidity of the commercial banks is adversely affected
when the government receives taxes or when it borrows. The Japanese
public likes to hold currency, and therefore, its demand for additional
currency increases the pressure on the liquidity of the commercial
banks. Thus, liquidity of the commercial banks is adversely affected
when the government receives taxes or borrows and when the public increases its holdings of bank notes.
The banks maintain liquid asset ratios which they deem suitable;
there are no required ratios. Deposits with the Bank of Japan to meet
legal reserve requirements--the maximum of which at present is 1 per
cent of deposit liabilities—are of minor importance.

In recent years

liquid assets, including such deposits, have ranged between 2.5 and
3.6 per cent of the banking system's total assets, with the bulk
accounted for by vault cash .

1. During 1958-64, liquid asset6 of the city banks averaged
1.8 per cent of their total assets, while local banks1 holdings during
the same period averaged 6.9 per cent. The city banks hold only small
amounts of claims on the government readily convertible into cash. At
the end of October 1965, $57 million equivalent, or less than 1 per
cent of total assets, was held in this form. Since then, holdings of
long-term paper have increased.

The reintroduction of ceilings on commercial bank rediscounts and
advances in November 1962 stimulated the city banks to search aggressively for sources of investable funds, especially in the call-loan

During 1963-64, when Japanese monetary policy was restrictive,

the proportion of the city banks1 resources obtained in the call-loan
market expanded significantly.

On the average during 196O-65, 58 per

cent of the funds borrowed by the city banks came from the Bank of
Japan, 29 per cent from the call-loan market, and 13 per cent from
other financial institutions. The call-loan market is supplied by
local banks, trust banks, and mutual loan and savings banks.

In the

same period, city banks supplied less than 2 per cent of loanable funds
to the market, but borrowed more than 65 per cent of the available


Availability of central bank credit
It has been the. practice of the Bank of Japan to restrict its
rediscount facilities to commercial banks, even though the law does
not limit its extension to any specific category of borrower. However,
lately, there has been a tendency to expand the range of financial
institutions with access to central bank credit.

Private corporations

and individuals have not in practice had access to the Bank of Japanfs
Rediscounts and advances
Rediscounts and advances are the main source of central bank
credit in Japan.

Individual banks borrow from the central bank on a

continuous basis; the main borrowers are the city banks, both as
regards to volume and duration of borrowing . Local banks borrow less

and for shorter periods. The level of the discount rate structure,
the range of instruments eligible for rediscounting and as collateral
for advances, and the ceilings on borrowing from the central bank at
the regular rates--all are subject to change in accordance with
Japanese monetary policy.
Commercial bills,1 including notes drawn by specified selling
organizations, and export trade bills, are eligible for rediscount at
the applicable rate. Government bonds and bills, government-guaranteed
bonds, bank debentures, specified municipal and corporate bonds, rediscountable commercial bills, export trade bills, and other general bills
considered suitable by the Bank of Japan are eligible as collateral for
The rate structure is fairly complex. The Bank of Japan presently
maintains five "basic money rates," depending on the type of paper diso

counted or pledged as collateral.

Discounted commercial bills are

charged the Bank of Japan's "basic discount rate," which is subject to
frequent change, usually in conjunction with the whole range of rates.
The rates applicable to export paper are lower than the basic rate,
whereas the rates applying to advances secured by specified government
securities are higher.
Export financing is a very important part of bank lending in Japan.
About half of all export financing is through commercial bank paper,

1. Two-name paper either drawn or accepted by a purchaser of goods
for resale in settlement of the purchase and payable by the buyer.
2. Prior to September 1967, when import trade bills and over-,
drafts ceased to be eligible for discounting, the structure consisted
of seven basic money rates.

which is rediscountable provided the remaining maturity does not
exceed three months and there is a supporting letter of credit.
Although much foreign trade is financed abroad, exports before shipment are financed domestically, and rediscounts of and advances on
these bills have been substantial.

This rate structure makes the

discounting of export bills the preferred means of obtaining central
bank credit although, presumably because of a shortage of such bills,
the banks borrow from the central bank mainly through advances.
Penalty rates
The Bank of Japan has used a system of ceilings on discounts and
advances and of npenaltyff rates on borrowing-above-the-ceilings more or
less continuously since 1912. In the post-World War II years, the
system has involved the application of three levels of rates: basic
rates on discounts and advances, and two sets of higher rates on borrowing

exceeding specified percentages of a (frequently revised) ceiling for

each bank.

Because of the commercial banks' heavy reliance on central bank

credit, particularly during the early postwar reconstruction period,
the maximum


rates, rather than the relatively low basic

rates, determined the actual cost of borrowing.
The discount rate structure has been subject to several major
changes in recent years.

In March 1957 the complex

system was replaced by one single set of




rates. These

arrangements were continued under the "New Monetary Adjustment
Measures" that were introduced in November 1962. At that time the

1. Until September 1967, commercial banks could also obtain overdrafts at the Bank of Japan, but this facility was little used because
the last rate was 1.09 percentage points above the basic rediscount rate.

Bank of Japan began more active operations in government securities in
order to facilitate the adjustment of commercial banks1 reserve posi- •
tions (see page

9). Such open market operations, together with adjust-

ments (so far, with one exception, downward) in the commercial banks1
ceilings on discounts and advances have, for all practical purposes,
eliminated commercial bank borrowing from the Bank of Japan in excess
of individual discount ceilings. Since the end of 1962, therefore, a
rising proportion of central bank credit to the banking system has been
provided through increases in the Bank of Japan1s holdings of securities.
Discounts and advances have declined somewhat in relative importance
although they have continued to expand in absolute terms.
Ceilings on discounts and advances
When ceilings for central bank credit (discounts and advances combined) were reintroduced in 1962, the total ceiling was set at the level
of total borrowing at that time from the Bank of Japan by the 10 city
banks ceilings, and each bankfs ceiling was fixed at the
amount of its actual borrowing.

However, after 1964, the ceilings of

individual banks were determined as a percentage of the total ceiling.
The percentage applicable to a particular city bank depended upon its
capital, deposits, and the amount of money borrowed by it in the callmoney market.

Finally, since August 1967, a more complex formula has

been in effect. A fixed factor is applied to capital funds (including
surplus and undivided profits), and from this figure the amount of borrowing in the call-money market and from the Bank of Japan is subtracted.

A percentage of this aggregate is assigned to each bank.

The new method gives an advantage to banks with large and increasing'
capital funds. At present, the ceiling is revised every three months.

In determining credit ceilings, the Bank of Japan excludes export
financing credits.
to the

It also excludes certain credits granted by it

city banks which,in turn, made loans to two companies organ-

ized in 1965 for the purpose of stabilizing the stock market (see
page 13). The proceeds of the loans by the Bank of Japan were available to the borrowing banks to reduce their regular borrowing. Thereafter, the ceilings of these banks and the total overall ceiling were cut
by approximately the amount of such special loans.
Within the credit ceiling applicable to each bank, central bank
loans and discounts are not formally limited in duration nor are the
rates charged by the central bank changed with the term or the frequency of such borrowing.

However, in practice, individual loan

agreements often specify a maximum and a minimum time to maturity.
These maturities are determined by the central bank; they vary from
2 days to 3 months, depending on the authorities1 assessment of the
projected cash needs of the individual bank.
Other monetary policy instruments
An important change in implementing monetary policy in the postwar period was the expansion of open-market operations. Although
open-market operations had been conducted for some time on a small
scale for strictly limited purposes, it was not until 1958 that the
Bank of Japan began to sell bills held in its portfolio to local banks
in order to absorb surplus funds. Since i960 open-market purchases of
government-guaranteed bonds have been undertaken to offset the tightening effects of seasonal inflows of funds to the Treasury.


November 1962 the Bank of Japan began more active sales and purchases
of securities, but these operations are still of limited significance

due to the shortage of outstanding government securities.1 However,
large amounts of seven-year government bonds have been issued since
1966, mainly to banks, and purchases of such bonds by the Bank of
Japan in 1967 almost equaled that year's increase in note circulation.
Commercial bank interest rates
The Bank of Japan, in conjunction with the Ministry of Finance,
has the authority (under the Temporary Rates Adjustment Law of 1947)
to set maximum lending and deposit rates for all banks. At present^
the prevailing commercial bank rates on deposits are at the ceiling
set by the authorities.

Lending rates, however, are determined within

the Bank of Japan's maximum rates (which have not been changed since
1957) by interbank agreement through the Banking Association. Effective rates are currently lower than maximum rates; for instance, in
January 1968 the rate for discountable prime bills--lowest in the rate
range--was 4.75 per cent, while the maximum rate was 6.21 per cent,
i.e., the same a s the central bank's basic rediscount rate. Changes
in the "prime" or "standard" lending rate follow almost automatically
changes in the discount rate. The rates payable by commercial banks
on deposits are not linked to the discount rate. They tend to change
very infrequently; only one change has been made in the last ten years.

1. In December 1965, the Bank of Japan, in addition, introduced a
repurchase system for foreign-exchange bills (denominated in United
States dollars) against which previously the central bank had extended
loans. Credit supplied to each bank under the repurchase agreements is
subject to a separate ceiling determined by the central bank. Reportedly this arrangement has so far not been used by the Bank of Japan,
which considers it as a safety valve to give commercial banks access
to foreign exchange, mainly dollars, to meet their external commitments.



Although authority to impose flexible reserve requirements was
granted to the Bank of Japan in 1957, it was not used until 1959-


central bank has authority to impose separate ratios on time and all
other deposits, for the latter category up to a maximum of 10 per cent,
Since their introduction, reserve requirements have been changed six
times, mostly to reinforce the effect of discount rate changes. In
July 1965 (the most recent change) the required ratios ranged between
0.25 per cent and 1.0 per cent., the exact ratio applicable to a particular commercial bank depending on the amount and category of its
deposit liabilities. There is a uniform penalty on all reserve deficiencies, levied at a rate of 3»65 percentage points above the
basic discount rate. Although there are no formal liquidity ratios,
window-guidance includes guidelines on liquidity.
Moral suasion .in the form of "window-guidance" is used by the
Bank of Japan as a form of credit control, particularly in periods of
monetary restrains. The central bank advises the commercial banks
regarding their lending policies and other uses of funds; in addition,
this advice is used by the banks as a guide in dealing with customers.
Until May 1963, a formal system of window-guidance was based on a
monthly review of commercial banks' lending, on which detailed reports
were submitted to the central bank, and on projections of sources and
uses of funds.

In January 1964, monetary policy was tightened, and

thereafter window-guidance was based on a three-month review of the
commercial banks1 lending and on guidelines that limited all banks to
explicit and uniform rates of credit expansion.

In April 1965 the

review period was extended to six months, and in June 1965 the formal

system of window-guidance was abandoned, since at that point the Bank
of Japan considered the commercial banks1 cautious attitude under
conditions of domestic sluggishness effective enough to curtail
lending; but it has been applied again since September 1967.
The authorities regard window-guidance as a temporary and supplementary monetary tool to be applied especially when monetary restraint
is indicated.

The Bank of Japan believes that in ordinary circum-

stances the lending activities of commercial banks ought to be left
to the banks1 own judgment and discretion, and that adequate guidance
is provided by their knowledge of, and desire to cooperate with, overall government economic policies.
The banking systemfs high reliance on central bank credit suggests
that the importance of window-guidance should not be underestimated.
Nevertheless, one of its important elements is the authorities1 emphasis
on its use to persuade the banking system to accept market discipline.
Window-guidance does not involve the use of formal penalties; it is
carried out on the basis of the relationship between the central bank
and individual commercial banks, and depends on the latter's cooperation and desire to avoid expression of official criticism, which in
Japan is a major factor shaping business behavior. There is no set
procedure for window-guidance, which may be applied to individual banks
or through general directives to all commercial banks.
The Ministry of Finance has also the power, under the Securities
Transactions Law, to impose margin requirements on securities transactions; the Bank of Japan is authorized to control the conditions of
lending by financial institutions to securities companies. While the
Ministryfs authorization has been actually applied, that of the Bank of

Japan has not.

Other credit control instruments, such as predeposits

for imports, are administered by the Ministry of International Trade
and Industry with the agreement of the Ministry of Finance.
Toward the end of 1964 the persistent weakness in the stock market
prompted the Bank of Japan, together with other financial institutions,
to undertake extensive support operations. This support took the form
of central bank credit--on an unspecified emergency basis and reportedly
amounting to about $1 billion equivalent--to quasi-governmental stockbuying and holding agencies.


The private sector's heavy reliance on central bank credit is a
main feature of Japan's financial structure. .In individual years since
1958> central bank loans and discounts have accounted for between
4.6 and-11.7 per cent of bank loans to the private sector. Foreignexchange inflows are the other principal source of liquidity for the
banking system.

However, open-market operations have become gradually

more important since November 1962; indeed, in the four years ended
September 1966, the Bank of Japan's holdings of securities increased
substantially more than its discounts and advances.






Structure of the Banking System


The Mechanism Through-Which Monetary Policy


The instruments of monetary policy

Rediscounts and Advances


Access to central bank credit
Commercial bank practice with respect to
central bank credit
Linkage of commercial bank lending . id
borrowing rates to central bank rates.




. . . . .



In recent years, the Netherlands has relied heavily on direct
credit controls and on management of liquidity of external origin.
The discount mechanism, as well as all other indirect instruments of
monetary policy, has played a secondary role in monetary management,
because until recently the liquidity position of the banks was in
general very ample and because these positions were very different
from bank to bank.
The Netherlands Bank has been hindered in its efforts to achieve
internal monetary stability by the conflicting requirements of external

This conflict between domestic and external policy objectives

has resulted in the subordination of indirect means of monetary control
in favor of direct controls over bank credit expansion.

Variation of

the cash reserve ratio was discontinued because, in the words of the
Bank, "the resulting sterilization of liquidity would have led to sales
of foreign exchange to it without effectively reducing the liquidity
of the banks."

On the same grounds, open market operations have not

been used restrictively to any significant degree.
The discount mechanism performs essentially as a safety valve,
serving to accommodate the banks in meeting seasonal swings in their
cash needs caused by changes in the bank note-circulation, the balance
of payments, or government financial operations.

Changes in the dis-

count rate serve in the main to signal changes in the economic situaIn general, the BankTs discount rate is a ceiling for the rates



Netherlands Bank, Report for the year 1964, p. 104.

on short-term Treasury bills and call money.

The main focus of monetary

policy in the Netherlands is, however, upon the availability of credit
rather than upon interest rates.


The table below shows the number of total assets, as of the end of
1967, of the registered credit institutions supervised directly or indirectly by the Netherlands Bank.


Total assets
(Millions of guilders)





Unaffiliated agricultural
credit banks *



Security credit institutions





Type of institution
Commercial banks
Central institutions of the
agricultural credit banks*

General savings banks

* With 1,254 member credit banks and 1,268 member savings banks.
Source: Netherlands Bank, Report for the year 1967.
Although the Netherlands has a large number of commercial banks,
a very large proportion of commercial banking business is done by a
relatively few banks, and the concentration of banking has been considerably reinforced by important mergers that have taken place after

Branch banking is highly developed.

In the spring of 1968, the

three largest banks in the Netherlands controlled about three-fourths
of the assets of all commercial banks.
The money market is probably less important in terms of total
turnover relative to the size of the country than the money markets of

the United States and the United Kingdom.
of the money market

Participants on both sides

are commercial banks, the bill brokers (discount

houses), and the two central institutions for agricultural banks.


central government and local authorities appear in the market mainly
as borrowers and the two giro transfer services, institutional investors,
savings banks, and large business firms appear mainly as lenders in the

In the past the Netherlands Bank intervened occasionally on

one or the other side of the money market, but since the spring of 1964
the Bank has not engaged in open market operations.
The commercial banks may obtain funds from the money market, which
is concentrated in Amsterdam, either by borrowing at call or by selling
Treasury bills; but the former is quantitatively more important.


1958* after the beginning of convertibility, when the banks began to
invest abroad on a large scale because of the interest incentive, repatriation of funds has become an important means for adjusting
cash positions..
The higher level of interest rates abroad has been the main factor
inducing the commercial banks to keep a substantial proportion of thuiliquid assets in foreign investments.

During the early 196O's the

Netherlands Bank discouraged the banks from repatriating funds to meet
temporary tightness in the money market.

In 1965, however, the Bank

ceased to buy Treasury bills from the bill brokers under repurchase
agreement, and offered instead to sell dollars forward, often without
charging a premium, while simultaneously making spot purchases.


explained in the 1965 Annual Report of the Netherlands Bank, "The banks
were thus enabled to acquire guilders by temporarily repatriating funds
from abroad instead of by temporarily parting with Treasury paper."

The instruments of monetary policy
The Netherlands Bank is charged (by an Act of 1948) with responsibility for regulating the value of the guilder in such a way as to
be most conducive to the welfare of the country, and (by an Act
amended in 1956) with supervising the credit system.
The instrumentsmof monetary policy available to the Bank are:
control over the volume of central bank credit in the forms both of
borrowing by the credit institutions and of open market operations;
operations in the foreign exchange market; control over borrowing
from or lending to foreigners; variation of cash reserve requirements;
and direct limitation of the volume of credit extended by banks and
other credit institutions.
In its use of discount policy, open market and foreign exchange
operations, the Bank is empowered to act without consulting either the
government or the credit institutions.

Two other principal instru-

ments of monetary policy--variation of cash reserve requirements and
credit guidelines--can be employed in practice only by securing the
voluntary cooperation of the credit institutions.

Although the Act

for the Supervision of the Credit System (as amended in 1956) empowers
the Bank to issue general directives to the credit institutions on
cash reserves and on lending policies for the purpose of regulating
the value of the guilder, it can do. so only after failing to secure
the necessary voluntary cooperation.

In such case, the Bank!s direc-

tives to the credit institutions must be approved by the Finance
Minister and ratified by the legislature within three months, after

which they may have a maximum validity of two years.

The Bank has never

found it necessary to issue general directives implementing monetary policy
to the credit institutions.
The Bank is also empowered to issue general directives of unlimited
duration to the banks and other credit institutions for the purpose of
ensuring their liquidity and solvency and these directives sometimes have
an effect on the credit situation.

For example, in 1964, the Netherlands

Bank issued a directive to the savings banks requiring them to keep 10 per
cent of deposits with a high rate of turnover in the form of primary liquid
assets, i.e., cash and sight deposits in other banks.
Although the Netherlands Bank is authorized to undertake open market
operations and impose cash reserve requirements, it currently makes no use
of these policy instruments.

Whereas formerly the Bank eased temporary

pressures in the money market by purchasing Treasury bills from bill brokers
under repurchase arrangement,- the Bank's present policy is to employ operations in the foreign exchange market for the same purpose.
An agreement between the credit institutions and the Netherlands Bank
concerning maintenance of minimum cash reserves is still formally in effect.
The agreement, concluded originally in 1954, provides that the commercial
banks and the central institutions of the agricultural credit banks maintain
balances at the Netherlands Bank, as prescribed by it, ranging up to 15 per
cent of deposit liabilities, with the first 15 million guilders of deposits

However, the required cash ratio has been zero since September 1963,

when the Netherlands Bank established direct and specific limits on credit
expansion that ..involves the possibility of interest-free compensating deposits
at the Bank.

The required cash reserve ratio was reduced to zero because,

given the tightening effect of the increase in the bank note circulation, the
maintenance of the cash reserve ratio would have led to repatriation of funds
from abroad rather than to an effective reduction in the domestic liquidity •
of the banks.

Direct controls over the rate of credit expansion was the principal
instrument of. monetary policy between i960 and 1967.

Agreement with the

organizations representing the banks and agricultural credit institutions on a general formula for restricting credit expansion was first
reached by the Netherlands Bank in i960.

This formula was to be applied

when necessary, and the permitted rates of expansion were to be determined

at such time..
The agreement on credit restriction was activated in June 196l,

suspended at the beginning of 1963, and reactivated in September 1963,
and has since been renewed, after consultation by the Bank with the
representative organizations, at 4-month intervals.

The permissible

expansion of lending was expressed in terms of a formula relating the
3-months' moving average of each bank's outstanding loans to its
average lending in the first half of 1963.

Variations in the per-

missible rates of credit expansion were made to take into account
seasonal movements in lending.
The agreement on credit restrictions applied only to short-term
lending to the private sector, that is, to loans with a maturity of
under two years.

The Netherlands Bank acted to close the loophole for

long-term lending on May 1, 1965 when, after consulting with the
representative organizations, it requested the banks not to let the
increase in their long-term assets exceed the increase in their longterm liabilities.
Under the original agreement, banks which exceeded the prescribed
limits were requested to hold at the Netherlands Bank an interest-free
deposit which could


100 per cent of the amount of excess

lending; this remained in the Netherlands Bank for one month.

Application, of penalties was further tightened in June 1966 when the
Netherlands Bank reached agreement with the representative organizations concerning the withdrawal of certain exemptions granted in the
computation of the compensating deposits from those banks which exceeded
their ceilings for three successive months, or during four months in a
period of six months.

The Bank required that under certain circumstances

the deposits be maintained at the prescribed level at all times instead
of requiring merely that the average monthly level of deposits comform
to the requirement.

At the end of 1966 the Bank expressed its wish that

the banks should restrict short-term lending to local authorities so as
not to exceed the average amount of such credit for 1966.
Changing economic conditions and especially the easing of demand
pressures brought about a change in the Netherlands Bank's policy in

The requirement of compensating deposits for exceeding the credit

ceiling to the private sector was removed in March, and the ceiling
itself was abolished in June.
Discount policy is used mainly by the Netherlands Bank to signal
a change or intensification of its monetary policy and, at times, to
influence commercial bank lending rates.

Although there is no formal

linkage between central bank and commercial bank lending rates, changes
in the former tend to be reflected in the latter.
The Netherlands Bank also uses administration of foreign exchange
controls and its authority to operate in the foreign exchange markets
to influence domestic monetary conditions.

From time to time the Bank

intervenes in the forward exchange market in order to encourage the
commercial banks to increase or decrease their holdings of foreign
exchange, thus exerting an indirect effect upon the domestic liquidity
of the banking system and on conditions in the money market.

Under the Foreign Exchange Control Decree of 1945, the Bank may
also order the commercial banks to restrict their foreign borrowings.
In 1964, for instance, the Bank directed each bank authorized to deal
in the foreign exchange markets not to permit its foreign liabilities
to exceed its foreign assets
($1.4 million).

by more than 5 million guilders.

Under the same decree, foreign capital issues and

loans to nonresidents "also require a license from the Netherlands

The Bank thus regulates foreign issues in accordance with the

requirements of domestic monetary policy, at times withholding approval
for a long time or refusing it altogether.


Access to central bank credit
All ''registered" credit institutions, including savings banks, as
well as bill brokers have access to central bank credit.

However, the

Bank accommodates savings banks only on the condition that they refrain from making new investments while they are indebted to the Bank.
The Bank also has a smaller number of private customers, who occasionally take a secured advance from the Bank at a rate of one per cent
above the rate charged credit institutions for similar advances.
Local authorities have access to the discount window, but their
access is subject to formal quantitative restrictions.-'-

These restric-

tions appear to be directed more at restraining short-term borrowing

1. Only those local authorities whose floating debt does not
exceed 25 per cent of current revenues are allowed access to the Bank ! s
credit facilities.

by local authorities than at reducing the amount of such paper actually
discounted or used as collateral for advances from the Bank.^
The Netherlands Bank regards access to its credit as a privilege,
not a right, and the credit institutions are expected not to use its
facilities on a continuous basis.

The Bank has no formal guidelines

governing the amount of credit that the banks and bill brokers may
take up, and relies upon moral suasion to keep use of its credit within

Banks and other credit institutions have traditionally re-

sorted to central bank credit only to a small extent.
Credit is made available through discounting eligible paper as well
as in the form of advances at a higher rate.

The Bank may refuse credit

to prospective borrowers and it has at times made access to its resources dependent upon the conduct of the borrowers.

Generally the

banks try to manage their cash positions in such a way that they have
no need to borrow from the Netherlands Bank.

However, the tradition

against such borrowing tends to break down when the banks are subject

very strong liquidity pressures.

Apart from the local authorities,

there are no formal quotas or ceilings, nor is there an official maximum
duration for advances.

However, the Netherlands Bank does exert moral

suasion on banks making excessive use of its credit facilities.
The Netherlands Bank may discount bills of exchange and promissory
notes having two signatures and having a maturity in accordance with the
customs of trade, bills and notes of the Netherlands Treasury, and

1. The national government has in general no access to the discount
window, but the Netherlands Bank can, at its own initiative, buy Treasury
bills directly, as it did, for instance, in the summer of 1968, to avoid
seasonal pressures in the money market. The Bank is also authorized by its
statutes to grant an interest-free line of credit up to gld. 150 million
($41 million).

debenture bonds redeemable within six months.
unsecured credits or advances.

The Bank may not grant

However, the range of assets that the

Bank may accept as collateral for advances is quite broad, since it
includes all discountable assets, plus other securities, merchandise,
warehouse receipts, and coin and bullion.

The Bank itself has set a

limit of 105 days on the maturity of short-term securities (Treasury
paper, commercial bills and bank acceptances) that it will accept for
In addition to the discount .rate--its rate for discounting bills
of exchange—the Bank specifies rates for three other kinds of transactions:

discount of promissory notes; interest on loans and advances

to private customers; and' interest on loans and advances to others.
The principal effective rate is the rate on advances to others, which
category includes banks and bill brokers.

This rate is regularly the

same as the rate for discount of promissory notes, and both rates are
generally 50 basis points higher than the discount rate.

The rate for

advances to private customers is regularly one percentage point higher
than the rate for advances to banks and bill brokers.
Commercial bank practice with respect to central bank credit
Borrowing from the Netherlands Bank by the banks, bill brokers,
and local authorities often takes the form of secured overdrafts
(advances on current account).

These advances are obtained mainly

against the security of Treasury bills and notes which the banks have
in safekeeping at the Netherlands Bank.

Such overdrafts accounted for

62 per cent of the 273 million gld. of average outstanding borrowing
by the Bank f s nongovernmental customers in 19&7; the remainder represented discounts of Treasury paper and bank acceptances.


they are legally eligible, in practice the Bank rarely discounts
commercial bills or accepts them as collateral for advances as long as
the borrower has short-term Treasury paper in its portfolio.

The pref-

of banks for advances, despite the fact that the rate is 50

basis points higher than the iBank1 s discount rate, stems largely from
the fact that an advance can be for as short a period as one day.


banks normally need recourse to the central bank only for short periods,
and discounts at the Bank must be for a minimum of 10 "days.
Banks having debit balances at the check clearings obtain virtually automatically advances from the Bank to cover them; normally
the banks repay within the same day and there is no charge.


obtain funds for repaying advances from the Bank by borrowing in or
recalling funds from the call-money market, by selling Treasury bills,
or by converting foreign exchange.
Netherlands Bank credit taking the form of open-market transractions was used restrictively but infrequently in recent years.
Because the major factors influencing the money market, such as the
foreign balance, Treasury receipts and expenditures, and seasonal cash
drains tend to affect the liquidity of banks and bill brokers in the
same direction at the same time the volume of central bank credit often
fluctuates sharply from week to week, and even from day to day.
One reason for the negligible recourse to the Netherlands Bank
through the middle sixties was that whenever tightness in the money
market threatened to induce the banks to repatriate funds held abroad,
the Netherlands Bank would temporarily lower the required cash ratio.
The fact that banks could average their balances at the Netherlands
Bank over a reserve period in order to conform to the required cash

ratio also served to deter recourse to central bank credit because
banks could draw down their large balances at the Netherlands Bank
to meet temporary liquidity drains.

In 1963, the required ratio was

reduced in three steps to zero, where it has since remained.
In the period after the cash ratio became inoperative, banks
were required to keep deposits at the Netherlands Bank only if they
exceeded the prescribed limits on credit expansion.

On the other

hand,as a result of the decline in the banks1 foreign investments'and
the increase of bank note circulation, the average amount of borrowing
from the Netherlands Bank has increased in the past few years, so that
the ratio of bank borrowing to cash balances rose sharply.

Linkage of commercial bank lending and borrowing
rates to central bank rates
In setting their lending rates, banks are not restricted by
either regulations or formal conventions.

Neither are the banks re-

quired to inform anyone except their customers of their lending rates.
Lending rates apparently tend to run from 2 to 2 l/2 percentage points
higher than the discount rate of the Netherlands Bank.

It is also

reported that the banks will not usually lend at less than 5 per cent,
so that changes in the Netherlands Bank!s discount rate below the
3 per cent level have little effect upon commercial bank lending

rates; the bank's discount rate has not, however, been below this
level since November 1959.
Similarly, no formal regulations govern rates paid on deposits.
As a consequence

of sharp competition in this field between the

banks, especially in recent years, these rates are relatively high.
Changes in the rates of the Netherlands Bank are often made in
concert with other monetary policy measures. The fact that commercial
bank lending rates tend to follow changes in the Bank!s discount rate
reflects not a direct causal link between these rates, but rather the
whole complex of monetary policy and the economic climate in which
that monetary policy is made.






The Mechanism Through Which Monetary Policy


Legal status of the central bank
The banking system


. 183

The Discount Mechanism


Relationship of Discounting to Other
Instruments of Monetary Policy.
Controls over the distribution of




Operations in government securities


The mix of monetary instruments in
implementing policy




Monetary policy in Sweden is the responsibility of the central
bank, but its implementation is considerably assisted by the operations
of the National Debt Office.

Both are official bodies responsible

to Parliament.
The Swedish discount mechanism, supported by a variety of other
policy tools, is an effective instrument for influencing the cash base
of the banking system.

Furthermore, broad exchange control powers

enable the Riksbank to restrict foreign financial borrowing by Swedish
residents, although not commercial borrowing associated with trade,
and hence to restrain unwanted increases in the central bank's international assets and the associated injections of liquidity into the
cash base when %he Swedish external balance on current account is not
in surplus.
The Riksbank primarily influences the overall volume of bank
credit by prescribing the terms of its advances to commercial banks,
by open market operations in cooperation with the National Debt Office
(which is responsible for management of the government debt), and by
recommending liquidity ratios which, for all practical purposes, are

Advances by the Riksbank to commercial banks are normally

made at the discount rate, or at one point above the discount rate if
the banking system, collectively, has been in debt for more than five

Furthermore, and even higher penalty rate (currently twice the

discount rate plus 3 P e r cent) is imposed on individual banks which
borrow excessively in relation to their capital accounts or which do
not meet the recommended liquidity ratio.

The penalty rate is

particularly effective in controlling the banks' borrowing because

of large swings in the commercial banks 1 cash liquidity associated
with an

extreme bimonthly pattern of government receipts and

Sales of Treasury bills and government bonds are conducted
primarily by the National Debt Office.

Such transactions are the

most important instrument used to reinforce the impact of changes
in the official discount rate.

The overall effectiveness of open-

market operations as a restrictive device is limited by the absence
of specific cash reserve requirements for the banks, prescribed or
traditional; because the market for short-term government securities
outside the banking sector is insignificant; and because in periods
of very high demand for credit, sales to the banks might require
rather high interest yields.
In certain circumstances the liquidity ratio offers a partial
substitute for reserve requirements because under certain conditions
the penalty rate may be charged on advances when the liquidity ratio
is not observed.

On the other hand, its use as a monetary tool is

limited because it is also designed to influence the distribution
of credits in favor of securities of the government and specified
mortgage institutions.


Legal status of the central bank
The Riksbank, a fully government-owned institution, is expected
to implement the government's economic policy as enunciated in the
budget message and accepted by Parliament.
exchange control.

It also performs a number of banking and other

functions for the government.

It administers foreign

As the government's banker, it makes

funds available to the National Debt Office 1 and receives deposits
from that Office and from the central government--but not from central
government business enterprises or from local governments.

It acts

also as depository for the Investment Reserve System, which is independently administered by the Labor Market Board.

Fluctuations in the

balances of this System, which was established in the 193Ofs and expanded in
1955 as a means by which to foster, through the constitution of taxfavored reserves, countercyclical capital spending, have in recent years
accounted for the bulk of the movement in the funds of other depositors.
The Riksbank works closely with the National Debt Office with a
view to integrating

debt management and general monetary policy.


the other hand, the Riksbankfs roletwith respect to Investment Reserve
funds is passive^ the Bank maintains no direct working relationship
with the administering board.
The banking system
The banking system is highly centralized.

It consists of five

large nationwide banks (one of which is government owned), and nine
regional banks.

Of the five large banks, four have branches throughout

the country, while one is active in the Stockholm area only.


are, in addition, two specialized central institutions which serve as
lenders of last resort for savings banks and agricultural credit
associations, respectively.

1. The National Debt Office is an official body with the same
legal status as the Riksbank. It administers the public debt and is
responsible for managing the funding and borrowing operations of the
central government.

The banks adjust their liquidity, in the first instance, by buying
and selling government securities and foreign exchange.

Daily residual

adjustments are made by borrowing in the day-to-day market (in which
the banks, the National Debt Office, and some other financial and nonfinancial institutions participate).

Borrowing against collateral at

the central banks is a last resort.


Central bank credit to the commercial banks is in the form of
advances against collateral, which may be Treasury bills or bonds
quoted on the stock exchange; in.fact, Treasury bills and government
bonds predominate.
The rate that the central bank charges on advances is a key determinant of the interest rate structure.

Published commercial bank loan

and deposit rates customarily move with the official discount rate.
In periods of tight monetary policy, however, advances are actually
made at rates commonly somewhat higher than published rates.
Advances are normally made by the central bank to meet only
temporary needs of the banking system.

Banks may obtain advances

(against bill or bond collateral) at the published discount rate for
a minimum period of three days--provided the banking system as a whole
has not remained indebted for more than five days.

On the sixth day

on which the banking system, taken as a whole, remains indebted to
the central bank, all borrowers remaining or becoming indebted to the

1. The only discounts, strictly speaking, which the Riksbank
makes are not for banks but for nonfinancial business concerns. The
amount of such direct lending is not significant.

Bank must pay interest at a rate one percentage point in excess of the
discount rate.

Some time must elapse with no bank borrowing before

the published discount rate is again applicable.
In addition, a penalty rate amounting to the official discount
rate, plus 3 pe** cent, has been intermittently applied to individual
banks whose borrowing from the Riksbank was high relative to their
capital and/or to banks not observing recommended liquidity ratios
(see below).

The relationship of the penalty rate to the basic

discount rate has been changed several times in recent years.


a lower effective penalty rate applies to banks that observe the
prescribed liquidity ratios.

To make the restrictive effects aimed

at by the penalty rate system fully effective, banks are prohibited
from borrowing at the basic rate in order to'relend to other banks.
If the Riksbank suspects any such transactions, it can apply the
penalty rate to the total amount borrowed from it by the "channellingrt
The National Debt Office also may supply liquidity to the banking

This Office, as noted above, has authority to borrow at the

central bank and, since 1964, has been empowered to lend in the dayto-day market.

Such lending has been made to even out the swings con-

nected with the bimonthly tax collections; the National Debt Office
operations are always carried out in consultation with the Riksbanko
On the other hand, the National Debt Office borrows extensively
in the short-term market every other month between the 10th--when the
central government transfers funds to the local authorities (which

deposit them, with the banks)—and the 20th--when tax payments are made
to the central government.

The effect of these borrowings is to smooth

out money market conditions since the banks have a surplus of funds at
the same time.

By contrast, after the 20th of the month tax collections

cause a squeeze on the banks which tightens up to the end of the month
and then gradually weakens.

It is during this bimonthly squeeze that

the banks are usually forced to get advances from the Riksbank, thus
providing the Riksbank with its best opportunity to restrain commercial
bank lending through the use of the penalty rate.



Central bank lending to commercial banks in integrated

with other

monetary policy tools, especially minimum liquidity ratios and openmarket operations.

The Riksbank also has the power to set variable

reserve requirements up to 15 per cent of deposits, but used it for
the first time in December 1967.

The central bank operates in the

foreign exchange market to maintain the external stability of the

However, administration of foreign-exchange controls aims at

assisting domestic monetary policy, by insulating the Swedish
credit market to some degree from markets abroad.
Controls over the distribution of credit
The Riksbank exercises considerable control over the distribution
of long- and short-term credits—by. setting liquidity ratios applicable
to commercial banks, by prescribing the "desirable" holdings of

government securities and credits to the housing sector for other
financial institutions (such as insurance companies and savings banks),
and by control over bond issues.

Although a 1962 law gives the

Riksbank compulsory powers in these fields, the bank appears to prefer
the voluntary approach, leaving its legal powers in reserve.
Liquidity ratios have been designed to assure priority for
government borrowing and for the financing of residential construction;
they are also closely related to the cost of central bank lending, since
banks not conforming to the recommended ratios have on occasion been
charged penalty rates on their borrowing from the central bank.


addition, liquidity ratios serve to reinforce the pressure on banks to
curb lending financed by open market sales of long-term securities.
Since liquidity .ratios serve two different purposes, they have not
been used flexibly as a tool of monetary policy.

In fact, the


recommendedtf liquidity ratios have been left unchanged since 1961.
The liquidity ratio varies with the size of the bank; the size

classification has been gradually reduced from five groups in 1952
(with considerable variation in the liquidity ratio), to two (with
only a moderate difference in liquidity ratios).

Since I96l, the

agreed liquidity ratios have been 3° P e r cent for the larger and
25 per cent for the smaller banks.
While in certain circumstances, the liquidity ratio, combined
with the penalty rate on advances, may fulfill the same role as legal
reserve requirements, it is not an adequate substitute for variable
reserve requirements designed to sterilize unanticipated increases in
bank liquidity and because it alters the distribution but not the volume
of the banks' earning assets.

In December 1967, the Riksbank for the

first time used its power to impose reserve requirements. The ratio
in force from January 2 to mid-February was 2 per cent of deposits
for the five big banks and 1 per cent for other banks and a higher
central bank discount rate was in effect over the same period.
Operations in government securities
Government securities operations are conducted by the Riksbank,
and more importantly, by the National Debt Office in consultation with
the Riksbank.

Indeed, central bank credit is injected into and with-

drawn from the Swedish economy by both types of operations, inasmuch
as the National Debt Office obtains needed funds from the Riksbank by
means of securities transactions, and also keeps its funds on deposit
with the central bank.
Such operations are used to strengthen the effectiveness of changes
in the official discount rate. Thus increases in the discount rate are
frequently accompanied by National Debt Office refinancing into longerterm government bonds, in order to put the banks1 cash and liquidity
position under pressure. Further, a change in interest rates offered
by the National Debt Office on new long-term government security issues
complements changes in the official discount rate as a pace-setter for
changes in market rates of interest.
The mix of monetary instruments in implementing policy

The discount mechanism in Sweden is used primarily to meet the
extreme bimonthly squeeze on bank liquidity caused by the pattern of
tax receipts and expenditures. Annual average net borrowing (indebtedness minus sight deposits) of the commercial banks from the Riksbank
in the 1959-67 period has generally increased as monetary policy
tightened (with the exception of 1964 when there was a large external

surplus) and decreased as it eased, with a strong underlying upward
trend in average gross borrowing by the banks.
At the same time, changes in the Riksbank's holdings of government
securities—which largely reflect transactions with the National Debt
Office—have been used to cushion swings in external assets and
Investment Reserve Deposits. The net impact of all three accounts
has tended to expand the banking system!s reserves each year, as has
net changes in all the Riksbank's assets and liabilities (including
advances and government current-account deposits) affecting bank

In general, the amount of funds supplied by all such

Riksbank transactions has varied roughly with the posture of monetary

Furthermore, commercial bank credit appears to have responded

to monetary policy with considerable sensitivity.
Overall, it would appear that the tools of the Swedish monetary
authorities are adequate to control domestic credit in the face of
farily wide fluctuations in Swedenfs external position.

In fact,

since 1962, central bank operations have had the effect of adding to
liquidity at an increasing rate, relatively unaffected by fluctuations
in the Riksbank's foreign exchange holdings.





Introduction. . . . .



The Banking Structure


The Instruments of Monetary Policy



Techniques of Central Bank Policy on Rediscounts

and Advances


Eligibility requirements


Access to central bank credit


Official rates


Commercial bank practice with respect to
central bank credit
Linkage of central bank rates to commercial
bank lending and borrowing rates




In Switzerland, perhaps more than in any other of the countries
surveyed, the inflow of international capital has vitiated monetary
control through traditional instruments generally, and particularly
through the discount mechanism, and has led the authorities to rely
mainly on direct controls over bank credit. The stability of the currency, combined with the country's international neutrality, has made
Switzerland a major refuge for flight capital. Consequently, its
banking system has become highly liquid:

the banks' holdings of cash

and liquid assets far exceed minimum required ratios, which in any
event are not employed for monetary policy purposes. Although the
central bank

is equipped with limited open market powers, which it

uses to deal with end-of-month pressures in the money market, its
portfolio of marketable securities is tiny relative to the cash
balances and other liquid assets of the banking system.


because of the liquid state of the banks, but also for domestic
political reasons and above all to discourage further capital inflows,
the Swiss central bank has held its discount rate among the lowest in
the world, and has thus fostered an interest rate structure that is
low relative to those of other centers. Hence, the major Swiss
banks hold a substantial proportion of their assets abroad and adjust
their cash positions mainly through exchange operations. Access to
central bank discounts and advances is regarded as a privilege, and
the authorities encourage the large banks, at least, to rely on their
own resources rather than to resort to central bank credit.

In prac-

tice, such borrowing is relied upon to only a minor extent for adjusting
the banks' cash position.

Until the early 1960's, monetary policy in Switzerland was strongly
reinforced by Confederation budget surpluses that were partly sterilized.
In the last few years, however, budget surpluses of the Confederation
were substantially lower, and both federal and cantonal expenditures rose
The Swiss monetary authorities have been concerned about the feebleness of the available instruments of monetary policy, and have not found
the reliance on voluntary agreements with the banks (see below, page 4)
entirely satisfactory.

In his report to the 1966 annual meeting of

stockholders of the National Bank, President Schwegler said, "The method
of voluntary arrangements available since I960 met with only limited

The government has therefore proposed to enlarge the National

Bank's powers .substantially. The most important new powers sought are
as follows:

(l) Variable minimum cash reserve requirements related to

the increase in deposit liabilities of a bank and differentiated
according to whether the depositor is a resident or nonresident; (2) power
to impose credit ceilings, which are to be set in relation to the growth
of real national product; (3) open market sales by the National Bank of
its own obligations; and (4) authorization to engage in forward foreign
exchange operations.


The Swiss banking system is considerably less centralized than
those of other European countries surveyed.

Half of its assets are

held by 240 cantonal, mortgage, and savings banks, and loan associations.

However, there are five large banks whose assets at the end of

1966 comprised 35 per cent of the total assets of the banking system.
These large banks, and certain "other" banks hold the bulk of the

system's foreign assets, the total of which was officially estimated
in the fall of 1967 at $5-4 billion equivalent, • an amount twice as
large as the entire cash base (bank balances at the central bank plus
currency in circulation) at the time.
The power to regulate Swiss monetary affairs is diffused, reflecting the country's constitutional arrangements. Although the
Swiss National Bank has certain of the powers normally vested in the
central bank, the federal government retains important regulatory

The procedure for the adoption of new monetary legislation is

cumbersome: such legislationrtiustoften be ratified by popular referendum.
The central bank is owned to the extent of 40 per cent by private
stockholders, the rest by the cantons, the cantonal banks, and other
public law corporations. The influence of the stockholders is very
limited, the management of the bank being appointed for the most part
by the Federal Council, The Bank advises the federal authorities on
monetary policy and administers measures decreed by the Federal


Since many of the tools of monetary policy are not available
to the Swiss National Bank for indirectly influencing credit conditions,
chief reliance has been placed on direct controls on credit expansion
and foreign capital flows and, more recently, building activity.
The Swiss National Bank has the power to grant or deny access to
its credit facilities, to set its rates, to buy and sell foreign exchange spot and short-term securities, and to veto credits of one year
or more to foreign borrowers in amounts over 10 million francs ($2.3' mil- .

Except for the last one mentioned, these powers of the National

Bank have been rendered ineffectual by a persistently high degree of
money-market liquidity, which results largely from Switzerland's
position as safe-haven and intermediary for foreign funds. The
liquidity of the market has prevented the National Bank from building
up an open market portfolio and also has made it unnecessary for the
banks to make much use of the discount window.

Consequently, monetary

policy in the postwar period has been put into effect primarily by
means of voluntary "gentlemen's agreements" between the banks and the
National Bank.
In 1955 and 1956, for instance, gentlemenfs agreements provided
for holding minimum balances at the National Bank.

Other gentlemen's

agreements have aimed at checking the inflow of foreign funds by prohibiting payment of interest on foreign deposits, and by providing
that several months1 notice be given for withdrawal.

In the spring

of 1962 the Bank concluded an agreement with the banks restricting
the growth of bank credit, which agreement was renewed in 1963/ given
the force of law by the Federal Assembly in 1964 and ratified by
referendum in 1965*

In 1965 the banks also agreed not to assist the

investment of foreign capital in Swiss real estate or mortgages and to
sell Swiss securities to foreigners only to the extent that Swiss securities have been sold by foreigners to the bank concerned.
Cash and liquidity ratios are prescribed by a separate agency,
the Banking Commission, which may waive the requirements in individual
cases, but does not vary them according to the needs of monetary policy.
The required cash and liquidity ratios are intended to provide standards
relating to the liquidity and solvency of the banks, and are not used
as instruments of monetary policy.

Swiss banking conditions in the postwar period have been
characterized by a high degree of liquidity, as a result of balanceof-payments surpluses, and the liquidity of the banks has therefore
considerably exceeded the amounts necessary to meet the ratios prescribed by the Banking Commission. At the end of 1966 the prescribed ratio of cash assets to total deposit liabilities, including
medium-term bank bonds, averaged 2.4 per cent for all banks, whereas
the actual ratio maintained by the banks averaged 6.6 per cent.
Similarly, the prescribed ratio of cash assets to short-term liabilities averaged J.4 per cent, whereas the actual ratio was 20 per
cent, and the prescribed ratio of cash and liquid assets combined to
short-term liabilities was 44 per cent, and the actual ratio was 73 per
cent. The liquidity ratios must be met at all times, but there are no
penalties for noncompliance, and the available statistics refer to
year-end statements, which include a considerable amount of "windowdressing" to increase the apparent cash-asset ratio.
Other than borrowing from the National Bank, the principal source
of short-term borrowing open to Swiss banks is the interbank callmoney market. Usually, the large banks are lenders in the call-money
market and the cantonal banks and other categories of banks are borrowers; the market is small. Until recently the large banks were
accustomed to adjusting their cash positions mainly by liquidating shortterm foreign investments across the foreign exchange markets. Due to
seasonal patterns in cash payments and also the desire of banks and
other institutions to show a good cash position on their balance
sheets at the end of June and December, and to a lesser extent at the
end of the first and third quarters, the Swiss banks have in the past

repatriated sums running into several hundred million dollars. Because
this process of


and other end-of-the-year transactions

had an unsettling effect on the foreign exchange markets, the Swiss
National Bank in the past few years has arranged swap transactions with
the banks, swapping, in turn,, the dollars received with the Bank for
International Settlements or foreign central banks. Furthermore, in
circumstances where foreigners (nonresidents) rather than Swiss banks
were putting funds into Switzerland, the National Bank passed on to the
banks for investment purposes, on a swap basis, rate-secured balances
of foreign exchange which it had taken over from foreign central banks
within the framework of swap transactions.
The Swiss National Bank does not conduct open market operations in
the sense of buying and selling securities in the market.

In its

endeavor to offset certain foreign flows, however, the Bank has placed
securities ("rescriptions") of the Confederation directly with the
banks and sterilized the proceeds, charging interest costs to its own

To relieve itself of part of the cost of these sterilization

transactions, the National Bank has purchased U.S. Treasury securities
of the foreign currency series (Roosa Bonds).

Rescriptions can be used

as collateral for loans by the National Bank to tide the banks over
periods of stress at the end of the month, quarter,

or the year; or,

alternatively, when the maturities are within the proper range, the
National Bank may repurchase them for the same purpose. These open
market operations have had the effect of smoothing money market rates,
but they are not regarded as having restricted bank liquidity

Eligibility requirements
Paper eligible for rediscount by the Swiss National Bank includes
Swiss bills and checks bearing at least two independent signatures of
known solvency, Federal treasury bills, cantonal and communal Treasury
bills endorsed by a bank, Swiss bonds, and Federal Debt Register

All discountable paper must have a maturity of three months

or less.
The collateral for advances by the National Bank may be Swiss
bonds, Federal Debt Register claims, discountable bills, and gold in
bars or coins.
Access to central bank credit
. The Swiss National Bank is not restricted by law as to whom it may
grant credit. The Bank has authority to make advances to the Federal
government but, primarily because the government's budgetary position
has been strong, such advances have been negligible in recent years.
As a carry-over from earlier times, business firms other than banks
have accounts at the National Bank and may discount private bills with

New accounts are not opened for business firms except in special

circumstances, and the list of firms having access to direct discounting
at the National Bank is being gradually reduced by closing accounts of
firms that have not borrowed for a number of years.
About 20 agricultural cooperative organizations also have accounts
at the Bank and can discount with it the paper of their members.
Direct lending to these organizations is in line with the general Swiss
policy of supporting agriculture.

In general, the National Bank is not obliged to grant credit to
any customer, whether business firm, bank, or government.


in response to a request from the government, the Bank has undertaken
to discount.automatically bills financing the "compulsory stocks" of
essential raw materials, foodstuffs, and fodder.
Official rates
In the postwar period, the rates of the Swiss National Bank for
discounts and advances have been changed six times—the first increase
following more than 20 years of stability.

In general cases, the rate

changes followed trends in money market rates that had been developing
for several weeks or months.

Officials of the Bank consider that the

role of the discount rate is to "sanction" market rate changes, and
the Bank has dnly exceptionally used the discount rate to lead the

The National Bankfs lending rates are always well below com-

mercial bank rates for loans and advances, which constitute the bulk
of the business of the commercial-type Swiss banks.

Advances by the

Bank are subject to call at 10 days1 notice or less.
In addition to the basic discount rate, the

National Bank sets

special rates for two kinds of compulsory stock bills—those financing
storage of food and fodder and those financing the storage of other
strategic materials.

The commercial b&nks discount the compulsory

stock bills at the same rates as does the National Bank, which endeavors to set the rates at the lowest level that will induce the banks
to hold the bills.

Since 1957, when they were introduced, the rates

for discounting compulsory stock bills have been sometimes above and
sometimes below the Bank's official discount rate.

The Bank's rate

for advances always exceeds the discount rate by either a full or half
of a percentage point.


Commercial bank practice with respect to central bank credit
All banks have accounts at the National Bank, but normally only
the small banks borrow in the form of discounts or advances. The
National Bank has fostered a tradition that the large banks should
rely on their own funds and not borrow from the central bank.
In recent years, over three-fourths the relatively small amount
of National Bank credit in use has taken the form of rediscounts of
bills (mostly commercial bills, including compulsory stock bills)
since the discount rate is always below the rate for advances. In
relation to total bank credit) the maximum level of National Bank
discounts and advances in recent years has been on the order of
l/2 of 1 per cent.

National Bank credit tends to rise at the end

of each caleridar quarter due to window-dressing, and the range of
fluctuation is fairly large.

In 1967 average outstanding National

Bank discounts and advances amounted to Sw.F. 143 million, compared
with a weekly peak of Sw.F. 248 million.
In the last few years, the needs of the banks for cash assets for
end-of-year purposes were met to a great extent by foreign currency
swaps arranged by the National Bank rather than through borrowing from
1. The supply of bills held by the banking system is ample: at
the end of 1966 (the latest date for which information on all banks is
available) the banks held Sw.F. 5-5 billion of bills, of which about
half were eligible for rediscount, while the largest amount of bills
held by the Swiss National Bank on a weekly statement date in the last
five years was Sw.F. 252 million (on June 30, 1965). Similiarly, the
amount of paper held by the banking system eligible to be used as security for advances from the Bank vastly exceeds the current level of
such advances.
2. These swaps, under which the Bank buys foreign currency assets
from the banks spot and sells them forward, are not shown in statistics.


Linkage of central bank rates to commercial
bank lending and borrowing rates
Commercial bank pinimum lending rates are set by interbank
agreement; they are not set with reference to the discount rate of
the National Bank.

Commercial bank minimum lending rates are not

There is no formal link between deposit rates and central bank
lending rates, but in deciding to change the discount rate the
National Bank considers the trend and level of bank bond and deposit
rates along with call-money rates. The rates paid on bank time
deposits, other than savings deposits, are set in the market and
fluctuate from week to week.

Medium-term bank bonds, however, are

sold on tap* at a given rate which can be changed only after two
weeks1 notice to the National Bank. The rates on these bonds therefore fluctuate less than time deposit rates, but they conform to
the general trend of deposit rates.







The Institutional Framework


The Bank of. England
The banking structure

. . .


The structure of commercial banks1
liquid assets


Rediscounts and Advances


The discount market


Technique and practice of central
bank lending




In the United Kingdom, monetary policy is implemented largely by
control of interest rates.

The British discount mechanism is used

primarily to give the authorities (a term used in the United Kingdom
to convey the notion that the Bank of England acts as an agency of
the government) control over interest rates in the London money market,
which is regarded as necessary in order to achieve broad objectives of
national policy and to protect the international position of sterling.
Since, in contrast to the United States, the British Treasury does not
maintain large working balances, meeting day-to-day financing requirements of the government is an important objective of monetary policy.
Ordinarily, the discount mechanism is administered with a view to preventing sharp fluctuations in Treasury bill rates because wide.swings
in bill rates would be communicated to the bond market and would adversely affect the governments funding of longer-term debt.


discount mechanism, which links the large banks to the central bank
through the discount market also provides a means for influencing the
employment of short-term banking funds, and this aspect of the discount
mechanism is obviously also a matter of considerable concern to the
Control of money market rates involves strictly limiting access
to the Bank of England's discount window.

Access is granted only to a

select group of specialized intermediaries--the twelve recognized discount houses.

In return for this privilege, the discount houses submit

a syndicated bid and undertake to cover the weekly Treasury bill tender,
thus assuring the central government that its short-term financing requirements will be met.

For its part, the Bank of Englandfs strategy

at the weekly Treasury bill tender is designed--by manipulating the

amount of bills offered and by means of open market operations—to
keep the discount market initially "short" of cash so that the
authorities then have the option of providing assistance through
open market purchases or through more costly (to the discount market)
rediscounts or loans from the Bank.

The Bank may (see page 215)

charge a rate above or below the discount rate.
by the market at the discount window is


Enforced borrowing

a device by which the

Bank of England can, when necessary, make clear to the market that it
would like to see rates held firm or rising.

To such signals, which

are also transmitted via frequent personal contact with Bank of
England representatives, the market normally responds by maintaining
or raising the interes.t rate at which it bids at the next tender.
Having achieved the desired result, the Bank of England can permit
borrowing to disappear because the amount of borrowing is not by
itself an indicator of market conditions.

A failure- to obtain the

response sought can be expected to lead to sustained or intensified
central bank pressure and further costly borrowing by the market at
the central banK.
Open market operations in the gilt-edged securities market are
designed to pursue broad quantitative credit policy objectives as well
as to reinforce the effectiveness of rate policy.

Through such opera-

tions, pressures on the banks' cash are passed on to the discount
houses, whose liabilities largely consist of secured call-loans from
the banks.

In the face of calls from their creditors, the discount

houses obtain'relief through recourse to the discount office, an
accommodation which the central bank, of course, cannot refuse.


at least in the short-run, pressures on the banks1 cash positions
have tended to be offset by the provision of reserve balances through'
the discount window, without relieving pressure on their liquidity.
Under these circumstances the maintenance of monetary control
depends primarily on the extent to which the authorities are willing
to employ interest rate policy to attain their objectives. The means
by which the authorities can influence the interest rate structure
are powerful. Established conventions link many bank lending and
money market rates to the central bank discount rate, thus providing
the authorities with a lever for raising or lowering the entire
spectrum of short-term money rates, as well as bank lending rates.
If used boldly, official interest rate policy can exert a significant
influence on credit flows.. However, for a number of domestic and
international reasons, the range within which the discount rate can
be moved is limited.

Since the end of World War II, the traditional

modus operanfli of British monetary policy has been supplemented by
direct and quantitative controls. The controls, however, have been
operated in a very informal fashion, deriving their main strength
from the authority which the Bank and its governor enjoy and the
willingness of banks and of other financial institutions to cooperate,
in part, to avoid their formalization with the attending rigidities
and overt sanctions•
To supplement rate control, the authorities have sought various
means to regulate the level of total liquidity held by banking and
nonbanking institutions, and further to regulate the amount of credit
supplied by the banking community.

For example, to backstop their

interest rate policy, the authorities lay some stress on their control

over "banks1 holdings of liquid assets by means of required liquid
asset ratios and "special deposits11 at the Bank of England. These
liquidity controls are formally applicable only to the London clearing
and Scottish banks. The Bank of England expects other banking institutions to maintain liquidity standards suitable to their particular
pattern of business. The impact of a special deposit call (or conversely release of*deposits) is spread by Bank of England open market
purchases (or sales) of Treasury bills to other categories of liquid
Nevertheless, a number of factors in recent years have reduced
the strategic importance of liquidity controls over the banking

First, the clearing banks themselves often have been able

to readjust their portfolios by selling government securities to
obtain needed liquid assets.

In addition, a resurgence of commercial

bill finance has provided the banks with a means of extending credit
while at the same time improving their liquidity positions, because
many commercial bills qualify as liquid assets. This growth of the
banks1 holdings of commercial bills is the result of a number of
factors. To some extent it reflects the growth of consumers1 instalment credit extended largely by finance houses which rely on commercial paper to obtain liquidity. To cope with the tendency of the
clearing banks to augment their liquid asset holdings through transactions with the nonbank public, and the tendency for peripheral
institutions to expand into any credit gap left by curbs on the major
banks, the authorities have gradually widened the group of institutions

to which it issues credit directives. These directives (in fact,
"requests") have been used to impose both quantitative restrictions
and qualitative guidance on lending (including commercial bill finance) by almost all banking institutions.


The Bank of England
The Bank of England is also the chief adviser to the central
government on all domestic and international monetary matters, but
the government has considerable direct influence on its policies.
The Bank is perhaps more deeply involved than most other central
banks in assuring day-to-day financing of Treasury operations and
in the management of the public debt.
Until the end of World War II, the linkages that made possi1
the expression of official government policy through the central
bank action were largely, although not entirely, informal. The Bank
of England Act of 1946, which transferred the Bank!s capital stock
to the Treasury, also formalized the basic relationship linking the
Bank of England with the central government. The Governor, Deputy
Governor, and the Court (equivalent to a Board of Directors), consisting of sixteen members, are now appointed by the Crown. Most
importantly, the Act gave the central government the statutory power
to obtain central bank compliance with its policies by issuing directives to the Governor of the Bank of England, after due consultation
with him.

But long before the 1946 legislation, it had been er<"

lished that no change in the central bank discount rate would be made
without prior approval of the government. The .Bank of England Act

of 1946 also gave the central bank the power, subject to Treasury authority, to issue general directives to any banker;

in fact, the Bank of

England has never found it necessary to issue a formal directive in
order to secure compliance by the financial community.
In addition to official and foreign central bank accounts, the
Bank of England maintains accounts for various types of banking
institutions, among which the London clearing

banks are the most

Until recently it has been the policy of the Bank not-

to open any new accounts for private customers and to gradually liquidate

those going back to the time when it engaged in commercial

banking business.

Recently, however, the Bank has invited certain

city firms, among them some leading jobbers (dealers) in gilt-edged
securities, to open accounts with it.
The discount ("Bank") rate is established by the Court of the
Bank of England with approval of the Chancellor of the Exchequer.
Changes in Bank rate, as the discount rate is called, are traditionally announced on Thursdays, shortly before noontime, and

from this tradition

has occurred in crisis situations

Changes in the central bank discount rate are made either

to increase the authorities' room

to maneuver in their day-to-day

management of the money market, or to giye a lead to the financial
community on general economic policy, or both.
The Bank of England discount rate establishes the pattern of
rates over the entire spectrum of the money market and for bank loans
and deposits.

This pattern of rates is implemented in part through

formal agreements.

For example, the London clearing banks, by agree-

ment, currently pay 2 percentage points below Bank rate on deposit

accounts 1 and generally charge l/2 to 1 point above Bank rate on
prime loans, but no less than 5 per cent.

Nonclearing banks, finance

houses and local authorities normally pay close to the Bank rate for
3-month time deposits, although during periods of stringency the rate
on such deposits has exceeded the Bank rate by about 1 per cent or
The central bank rate establishes the minimum cost to the discount
market of call loans from the clearing banks (normally 1 5/8 points
below the Bank rate).

It also establishes a ceiling for the Treasury

bill rate and, by convention, a lower range within which the discount
market may bid for Treasury bills at the weekly tender and at the same
time expect official open-market operations to keep the money market
on an even keel.*

In the recent past, for instance, the authorities

have usually been willing to see the Treasury bill rate within a margin of l/2 to 3/4 of a point below Bank rate.

At the same time, such

a spread has given the discount market enough maneuvering room at the
weekly tender to garner an amount of bills sufficient to enable it to
meet the liquid asset needs of its main customers, the clearing banks.
Open-market operations in the money market are then designed to
keep short-term rates within the desired range.

In the long-term

1. Accounts not directly subject to check, but callable at 7 days
notice.. The clearing banks dp not offer any longer maturities.
2. At least once in the recent past the Bank of England has acted
to move*the Treasury bill rate unprecedently close to the current central bank, rediscount rate in order to keep short-term interest rates
internationally competitive. On one other occasion it used the exceptional technique of lending above the central bank discount rate to
produce this result. Earlier, the Bank of England had used similar
devices in its rediscount procedures in order to achieve specific

market, apart from the secondary effects of operations on short-term rates,
the authorities have considerable influence on longer-term interest
rates, given the existing debt management arrangements. The Bank of
England has control over the supply and terms of sale of medium- and
long-term government securities, some of which are almost always
available to the public from the securities held in the Issue
Department. Moreover, debt management operations are a continuous
process; large maturing issues are usually purchased in advance of
maturity by the Bank of England, and sales of long-term issues are
made whenever possible. However, the authorities1 desire to avoid
sharp swings in long-term interest rates has been an important
limiting factor in their open-market operations.
Official funding operations operate, whenever conditions permit,
to help keep total short-term liquidity within desired limits. In
implementing debt management policies the authorities automatically
offset the effects of flows of foreign currency based liquidity.
Official purchases or sales of sterling through the Exchange
Equalization Account are reflected in reduced or increased issuance
of Treasury bills, respectively, which is integrated into the Bank
of England's daily management of the money market, thus returning
to or absorbing from the market the cash element of the foreignexchange flow.
The banking structure
The banking structure of the United Kingdom is quite complex.
It was formed when Great Britain was the most advanced industrial
country of the world, the center of world trade, the leading financial
power and the center of the British Commonwealth, and when London was

the most important and active financial market in the world.


the banking structure of the United Kingdom is characterized bynumerous traditional influences, it has been quite responsive to new
challenges, and there have been numerous innovations since World
War II.

Since the Bank of England does not provide credit to com-

mercial banks directly but only through the intermediation of a
special group of institutions described in the following section, it
may suffice to give a very broad view of the banking system.
The London clearing banks form the core of the banking system.
In 1967 their number was reduced through mergers from 11 to 8.


of them have extensive networks of domestic branches and most of them
own foreign branches, agencies or subsidiaries as well.


banks hold about 85 per cent of domestically owned (but only about
5 per cent of foreign currency) deposits and extend about two-thirds
of domestic loans.

The Scottish banks and the banks in Northern

Ireland mainly serve.local needs, although they do place significant
amounts of cash at short call in the London money market.

There are

also a large number of other "nonelearing" banks, including merchant
banks and a diverse group of banks whose main activities are overseas,
and banks of overseas origin.

Many of these institutions—of which there

are 200--are active in taking foreign-currency deposits (mainly dollars, but other convertible currencies also) and relending them abroad
or swapping them into sterling assets.

They are also important in

providing credit through the acceptance of domestic and international
sterling bills of exchange.

In aggregate, their deposits (including

those denominated in foreign currencies) are less than half those of
the clearing banks, but they account for over 90 per cent of lending
to nonresidents.

The structure of commercial banks1 liquid assets
The London clearing banks, by long-established tradition, maintain
minimum cash and liquidity ratios. These ratios were originally adopted,
and still are maintained, for prudential purposes, but they also have become a means of implementing monetary policy.

Indeed, the Bank of England

expects the clearing banks to adhere to ratios which have evolved as a
matter of custom.

The clearing banks keep 8 per cent of their total

deposits in the form of cash--i.e., coin, notes and balances with the
central bank, as closely as possible on a day-to-day basis.

In addition

to their required cash reserves, the clearing banks currently must keep
an additional 20 per cent of their total deposits in the form of specified
liquid assets--i.e., money at call and short notice (loans to the money market and loans to others with maturities up to 28 days), United Kingdom Treasury
bills, commercial bills, or specified refinanceable export credits. The
Bank of England has varied the liquidity ratio only once--in 1963—and
banks themselves determine in what proportion to hold each type of these
assets, depending on the type of business they are engaged in. No other
category of banking institution is required to keep balances on deposit
at the central bank, although most nonelearing banks do maintain very
small balances for convenience. When the Cash Deposit Scheme proposed
in 1968 comes into operation, all banks concerned will have special
accounts at the Bank of England to meet its requirements.
The standards of liquidity which the Bank of England expects the
Scottish and Northern Irish banks to maintain are similar to, though
somewhat more flexible and less explicit than, those which apply to
the clearing banks. This distinction in part reflects the greater
emphasis on time deposits by the Scottish banks. No formal liquidity

regulations are applied by the Bank of England to the discount houses,
the merchant banks, or the overseas and foreign banks; but most of these
institutions (especially those whose bills are bought by the Bank) submit to central bank judgment as to the adequacy of their capital resources, liquidity, and general standing.


The discount market
The 12 members -of the London Discount Market Association, to which
access to the Bank of England's discount window is limited, are a key
element in the rediscount mechanism.

As specialists in dealing in

short-term money, they do business mainly with the banking community
and to a small extent with nonbank institutions, but hardly at all
with the general public. Their principal activities may be summarized
as follows:
(1) The discount houses undertake to underwrite the weekly tender
of United Kingdom Treasury bills.

With the concurrence of the author-

ities, they submit a syndicated bid which puts a floor under the market
price at the tender.

This bid must be carefully priced because the

discount houses cannot afford to go without Treasury bills; at the
same time, they face competition from outside tenders, particularly
from nonclearing banks and bill brokers outside the Discount Market
Association tendering on their own account and from banks tendering
for insurance companies, nonfinancial corporations and overseas and
other customers.
(2) The discount houses borrow the clearing banks1 excess cash,
on a secured basis, providing the banks with a highly liquid asset in
the form of money taken at call.

About two-thirds of the discount

houses1 liquid resources are provided in this manner.

The remainder

comes largely from other banks operating in the London money market
and such "outside money" is borrowed on terms that fluctuate with
money market conditions but which generally are slightly higher than
the cost of funds obtained from the clearing banks.

The clearing

banks, which never borrow reserves from each other, normally recall
from the market on any one day sufficient cash balances to meet their
daily cash reserve requirements.
(3) The discount market, on its part, invests whatever funds are
available to it in liquid asset.s—e.g., mainly Treasury bills, prime
commercial bills and government securities of maturities up to five

Market holdings of Treasury bills are primarily designed to

meet anticipated purchases by the clearing banks; the latter do not
tender for Treasury bills for their own account.
Discount houses make a market in Treasury bills, bank bills and
trade bills as well as government bonds of up to five years1 maturity.
These instruments are also employed as collateral for short-term loans
obtained by the discount houses from the clearing banks and the rest
of the money market.

In recent years, the discount houses' commercial

bill holdings have grown rapidly relative to their other assets, thus
reversing a long-term trend.

1. Nonclearing banks similarly may recall needed cash balances;
in the last few years, however, an active interbank market has developed
among the nonclearing banks. These banks, which keep accounts with and
make settlements through the clearing banks, can adjust their cash
positions by borrowing or lending sterling deposits among themselves
on an unsecured basis, in addition to using the discount market.

Technique and practice of central bank lending
The discount houses can either rediscount bills or borrow on
collateral, normally at the Bank rate.

In either case rediscountable

paper or acceptable loan collateral consists of Treasury bills,
government securities within five years of maturity, bills issued by
local authorities which comply with Bank of England requirements,
and commercial bills carrying the names of two established British
institutions (one of which must be the primary acceptor)--usually a
British bank and a discount house. To reinforce the penal nature of
the borrowing, Bank of England regulations require that rediscounts
must have an average maturity of 21 days, and until 1966, advances had
normally been given for a minimum of 7 days (see below).


discount houses typically require assistance for a period very much
shorter than 21 days.

Consequently, they are normally eager to

obtain loans with the-shortest possible maturity in order to minimize
the total interest cost of central bank assistance which is given at
a uniform rate (usually the Bank of England discount rate) regardless
of the maturity involved.

In general practice, therefore, the discount

houses borrow by means of advances, usually secured by "short" government securities (bonds within 5 years of maturity).
In order to avoid adding to or creating unwanted market shortages
seven days ahead, the authorities may allocate some 8 to 9 days'
maturities to each borrower or equal amounts of six-and eight-day
money in which case average maturity is, in effect, seven days.


bills are offered for rediscount, the Bank of England insists that no
bill in the parcel have less than 15 days1 maturity and, as noted above,
requires an average life of 21 days for the aggregation of the bills involved

in each transaction.

Rediscounts are treated "by the discount houses

in their balance sheets as sales of assets, and there is no counterpart to repurchase agreements as practiced in the United States.
On June 30, 1966, the Bank informed the discount houses that it
was prepared on occasions of its own choosing, and for purely technical money-market purposes, to assist them overnight, thus reducing
the actual cost of borrowing.

In part, at least, the new arrangement

became desirable because contraction in the available supply of.
Treasury bills tended to inhibit open-market operations.

Such over-

night lending has so far taken place when there was an acute shortage
of money on one day and a large surplus was expected the next day.
With the new type of accommodation, the Bank did not have to buy bills
one day and sell bills the. next.

Overnight lending has also been used

to push forward a shortage from day-to-day and thereby ensure the
opportunity of taking penal action the following day, if so desired.
So far, such overnight lending has been at a rate below the Bank rate,
and usually at the highest effective market rate.

The authorities

reserve, however, the right to charge for overnight accommodation
whatever rate seems appropriate in the light of current policy objectives .








ing a rate above the regular discount rate when it seems unadvisable,
for domestic reasons, to raise the discount rate.

Thus, in early

1963, along with a reduction in the discount rate, the Bank of England
announced that it might from time to time lend to the discount houses
at a higher rate.

But, the superpenalty rate was brought into play

only once, in March 1963.

Technically, there is no ceiling on the amount that a discount
house may borrow at rates determined by the Bank, provided that
acceptable collateral is presented.

Nor are there explicit limits

on the total rediscounting of bills, although the Bank of England
does observe internal limits on individual acceptors and drawers. In
circumstances of relative stringency, no special emphasis is placed
on having an individual discount house borrow at the Bank of England
for any shorter period than the borrowing by the market as a whole.
Moreover, during such periods, as for example during the early part of
1965 when total borrowings tended to be exceptionally large, the number
of days on which such borrowings occurred increased, and the period in
which loans were outstanding also showed a rise. This use of central
bank credit reflected the pressures imposed on the discount market by
the Bank of England through its day-to-day open-market operations.
The discount houses, however, do not normally make it a practice
to borrow or rediscount in excess of their short-term needs, for they
cannot profitably finance investments in prime short-term assets on
funds borrowed at a penalty rate. Excessive acquisitions of highyield

paper with considerable risk exposure would surely incur Bank

of England disapproval.

Moreover, such assets would not prove accept-

able to the clearing banks as collateral for money-market loans because a
high proportion of such collateral must be eligible security at the
Bank of England. Still, some leeway exists for "speculative" operations
in "short" government securities. For instance, if the market anticipates that over the near term interest rates will decline (as for
example, after a stringent official credit policy has been in force
for some time and the market has reason to expect an easing of policy),
it will increase its holdings of these types of assets.

Federal Reserve Bank of St. Louis, One Federal Reserve Bank Plaza, St. Louis, MO 63102