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Covered bonds, core markets, and financial stability

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  • Kartik Anand
  • James Chapman
  • Prasanna Gai

Abstract

We examine the financial stability implications of covered bonds. Banks issue covered bonds by encumbering assets on their balance sheet and placing them within a dynamic ring fence. As more assets are encumbered, jittery unsecured creditors may run, leading to a banking crisis. We provide conditions for such a crisis to occur. We examine how different over-the-counter market network structures influence the liquidity of secured funding markets and crisis dynamics. We draw on the framework to consider several policy measures aimed at mitigating systemic risk, including caps on asset encumbrance, global legal entity identifiers, and swaps of good for bad collateral by central banks.

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File URL: http://sfb649.wiwi.hu-berlin.de/papers/pdf/SFB649DP2012-065.pdf
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Bibliographic Info

Paper provided by Sonderforschungsbereich 649, Humboldt University, Berlin, Germany in its series SFB 649 Discussion Papers with number SFB649DP2012-065.

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Length: 30 pages
Date of creation: Oct 2012
Date of revision:
Handle: RePEc:hum:wpaper:sfb649dp2012-065

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Keywords: covered bonds; over-the-counter markets; systemic risk; asset encumbrance; legal entity identifiers; velocity of collateral;

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References

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  1. Rochet, Jean-Charles & Vives, Xavier, 2004. "Coordination Failures and the Lender of Last Resort : Was Bagehot Right After All?," IDEI Working Papers, Institut d'Économie Industrielle (IDEI), Toulouse 294, Institut d'Économie Industrielle (IDEI), Toulouse.
  2. Manmohan Singh & Peter Stella, 2012. "Money and Collateral," IMF Working Papers 12/95, International Monetary Fund.
  3. Darrell Duffie & Nicolae Gârleanu & Lasse Heje Pedersen, 2007. "Valuation in Over-the-Counter Markets," Review of Financial Studies, Society for Financial Studies, Society for Financial Studies, vol. 20(6), pages 1865-1900, November.
  4. Holmström, Bengt, 2013. "Inside and Outside Liquidity," MIT Press Books, The MIT Press, edition 1, volume 1, number 0262518536, December.
  5. Ricardo Lagos & Guillaume Rocheteau & Pierre-Olivier Weill, 2009. "Crises and Liquidity in Over-the-Counter Markets," NBER Working Papers 15414, National Bureau of Economic Research, Inc.
  6. Beirne, John & Dalitz, Lars & Ejsing, Jacob & Grothe, Magdalena & Manganelli, Simone & Monar, Fernando & Sahel, Benjamin & Sušec, Matjaž & Tapking, Jens & Vong, Tana, 2011. "The impact of the Eurosystem's covered bond purchase programme on the primary and secondary markets," Occasional Paper Series 122, European Central Bank.
  7. Gai, Prasanna & Shin, Hyun Song, 2004. "Debt maturity structure with pre-emptive creditors," Economics Letters, Elsevier, Elsevier, vol. 85(2), pages 195-200, November.
  8. Brock,W.A. & Durlauf,S.N., 2000. "Discrete choice with social interactions," Working papers, Wisconsin Madison - Social Systems 7, Wisconsin Madison - Social Systems.
  9. Blume Lawrence E., 1993. "The Statistical Mechanics of Strategic Interaction," Games and Economic Behavior, Elsevier, Elsevier, vol. 5(3), pages 387-424, July.
  10. Vincent Glode & Richard C. Green & Richard Lowery, 2012. "Financial Expertise as an Arms Race," Journal of Finance, American Finance Association, American Finance Association, vol. 67(5), pages 1723-1759, October.
  11. Manmohan Singh, 2011. "Velocity of Pledged Collateral," IMF Working Papers 11/256, International Monetary Fund.
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Cited by:
  1. Prasanna Gai & Andrew G Haldane & Sujit Kapadia & Benjamin Nelson, 2013. "Bank Funding and Financial Stability," RBA Annual Conference Volume, in: Alexandra Heath & Matthew Lilley & Mark Manning (ed.), Liquidity and Funding Markets Reserve Bank of Australia.
  2. Alexandra Heath & Gerard Kelly & Mark Manning, 2013. "OTC Derivatives Reform: Netting and Networks," RBA Annual Conference Volume, in: Alexandra Heath & Matthew Lilley & Mark Manning (ed.), Liquidity and Funding Markets Reserve Bank of Australia.

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