A Market for Intra-day Funds: Does it Have Implications for Monetary Policy?

The UK is due to move to a system of real-time gross settlement (RTGS) later this year. Although the decision to move to RTGS was based on prudential concerns, this paper considers whether it has any implications for the implementation of monetary policy. In particular, the move could, in theory, lead to the development of an intra-day funds market which in turn would imply the existence of intra-day interest rates. Although the paper argues that such a market is unlikely to develop in the near term, it continues by developing a simple theoretical framework to analyse the intra-day funds market and the intra-day yield curve. The paper derives two main results from this model. First, intra-day interest rates of a given duration could be highly volatile, even in the absence of shocks, since rates will vary depending on how close to the end of the trading day the loan is taken out. Second, the provision of intra-day liquidity does not effect a central bank's ability to control one-day (or longer) interest rates. As long as intra-day loans have to be repaid at some point during the day, the Bank will retain control over the one-day interest rate. As a result, extending the opening hours of the intra-day market (i.e. the period over which the discount window is open) could help reduce Herstatt risk without unduly influencing monetary control.