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The role of collateral requirements in the crisis: one tool for two objectives?

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  • Paolo Fegatelli

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    Abstract

    The implications of central bank collateral requirements for the monetary policy transmission mechanism and the working of the money market have often been neglected. Such implications, however, have clearly manifested during the course of the 2007-2009 crisis. As liquidity was vanishing in the interbank market, banks used (and abused of) central bank funding more intensively, in order to cover their financing needs. As a result, central bank collateral eligibility criteria have become even more critical than the policy rate as a factor of monetary policy transmission as well as a driver of liquidity in the interbank market. Thus, in the light of a retrospective analysis of some major events affecting monetary policy in the Euro area in the last two years, this study intends to properly reformulate the problem related to the choice of ?optimal? collateral requirements, by illustrating their interrelations with other central bank policy tools and targets. Ultimately, this approach allows us to derive a non-exhaustive set of recommendations for collateral and interest rate policies, as well as for central banks? exit strategies from the current unconventional measures.

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    File URL: http://www.bcl.lu/fr/publications/cahiers_etudes/44/BCLWP044.pdf
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    Bibliographic Info

    Paper provided by Central Bank of Luxembourg in its series BCL working papers with number 44.

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    Length: 84 pages
    Date of creation: Feb 2010
    Date of revision:
    Handle: RePEc:bcl:bclwop:bclwp044

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    Web page: http://www.bcl.lu/

    Related research

    Keywords: Collateral; Monetary policy; Central bank; Interbank market; Financial stability;

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    References

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    1. Marie Hoerova & Cornelia Holthausen & Florian Heider, 2009. "Liquidity hoarding and interbank market spreads: the role of counterparty risk," 2009 Meeting Papers 929, Society for Economic Dynamics.
    2. Eisenschmidt, Jens & Tapking, Jens, 2009. "Liquidity risk premia in unsecured interbank money markets," Working Paper Series 1025, European Central Bank.
    3. Paolo Angelini & Andrea Nobili & Cristina Picillo, 2011. "The Interbank Market after August 2007: What Has Changed, and Why?," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 43(5), pages 923-958, 08.
    4. Eisenschmidt, Jens & Hirsch, Astrid & Linzert, Tobias, 2009. "Bidding behaviour in the ECB’s main refinancing operations during the financial crisis," Working Paper Series 1052, European Central Bank.
    5. Lavoie, M, 1995. "Horizontalism, Structuralism, Liquidity Preference and the Principle of Increasing Risk," Working Papers 9513e, University of Ottawa, Department of Economics.
    6. Celso Brunetti & Mario di Filippo & Jeffrey H. Harris, 2011. "Effects of Central Bank Intervention on the Interbank Market During the Subprime Crisis," Review of Financial Studies, Society for Financial Studies, vol. 24(6), pages 2053-2083.
    7. Ewerhart, Christian & Tapking, Jens, 2008. "Repo markets, counterparty risk and the 2007/2008 liquidity crisis," Working Paper Series 0909, European Central Bank.
    8. Thomas I. Palley, 2008. "Endogenous Money: Implications for the Money Supply Process, Interest Rates, and Macroeconomics," Working Papers wp178, Political Economy Research Institute, University of Massachusetts at Amherst.
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    Cited by:
    1. Gary B. Gorton & Andrew Metrick, 2009. "Securitized Banking and the Run on Repo," NBER Working Papers 15223, National Bureau of Economic Research, Inc.

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