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Liquidity Provision and Collateral Haircuts in Payments Systems

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Abstract

Central banks play a pivotal role in well-functioning payments systems by providing liquidity via collateralized lending. This article discusses the role of collateral and haircut policy in central bank lending, as well as the distinguishing features of the central bank’s policy relative to private sector practices. It presents a model that explicitly incorporates the unique role of central banks in the payments system and argues that central banks must consider how their haircut policies affect the relative price and liquidity of assets, the market’s asset allocation, and the likelihood of participants to default. Furthermore, under extraordinary circumstances, there is a rationale for the central bank to temporarily reduce haircuts or broaden the list of eligible collateral to mitigate the shortage of liquidity in the market.

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  • James Chapman & Jonathan Chiu & Miguel Molico, 2011. "Liquidity Provision and Collateral Haircuts in Payments Systems," Bank of Canada Review, Bank of Canada, vol. 2011(Autumn), pages 13-20.
  • Handle: RePEc:bca:bcarev:v:2011:y:2011:i:autumn11:p:13-20
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    3. Anna Nordstrom & Scott Roger & Mark R. Stone & Seiichi Shimizu & Turgut Kisinbay & Jorge Restrepo, 2009. "The Role of the Exchange Rate in Inflation-Targeting Emerging Economies; Targeting Emerging Economies," IMF Occasional Papers 267, International Monetary Fund.
    4. Carl E. Walsh, 2009. "Inflation Targeting: What Have We Learned?," International Finance, Wiley Blackwell, vol. 12(2), pages 195-233, August.
    5. de Carvalho Filho Irineu E, 2011. "28 Months Later: How Inflation Targeters Outperformed Their Peers in the Great Recession," The B.E. Journal of Macroeconomics, De Gruyter, vol. 11(1), pages 1-46, July.
    6. Schmidt-Hebbel, Klaus & Tapia, Matias, 2002. "Inflation targeting in Chile," The North American Journal of Economics and Finance, Elsevier, vol. 13(2), pages 125-146, August.
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