Prior to the global financial crisis starting in 2007, the Eurosystem’s operational framework for implementing monetary policy used to be a corridor system. This involved the ECB Governing Council setting three interest rates, which usually had the same distance from each other. The rates of the deposit facility and the marginal lending facility formed the lower and upper bounds of the corridor, respectively. The relevant key interest rate on the main refinancing operations was the middle of the interest rate corridor. This system aimed to steer short-term money market rates close to the main refinancing operations rate.

It was through its main refinancing operations – the primary instrument in the interest rate steering toolkit – that the Eurosystem made central bank liquidity available to euro area banks. These operations were executed in the form of weekly auctions, known as variable rate tenders, in which banks had the opportunity to offer an interest rate that they were willing to pay on the amount of central bank reserves they wished to obtain. However, the total amount of liquidity to be allotted in the auctions was limited from the outset, meaning that not every bid was (fully) satisfied. The Eurosystem’s objective was to set this total amount so that the marginal allotment rate (the lowest rate at which central bank reserves were still allocated) was close to the main refinancing operations rate. The total amount to be allotted was derived from the liquidity estimate, which combined any changes to the so-called autonomous factors (e.g. banknotes in circulation or government deposits), the reserve ratio and other input parameters to form an aggregate liquidity need of the banking sector.

Liquidity was usually distributed between individual euro area banks by means of unsecured transactions in the interbank market. Banks with excess reserves lent these to banks with a deficit. Alternatively, any excess liquidity could also be placed overnight with the Eurosystem’s central banks in the deposit facility. Deficits run up by individual banks could also be covered overnight with funds from the Eurosystem’s marginal lending facility. However, as banks could make deposits and borrow at more favourable conditions on the interbank market, the use of central bank facilities was associated with opportunity costs and was therefore rare. In order to stabilise demand for central bank liquidity and avoid excessive interest rate fluctuations, banks were required to maintain a minimum reserve that only needed to be met on average over a certain period of time.

In the event of short-term fluctuations in the aggregate liquidity needs of euro area banks, the ECB Governing Council reserved the right to intervene by conducting fine-tuning operations. To this end, central bank liquidity could be provided or absorbed at short notice by means of reverse transactions.

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