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Collateral management in central bank policy operations

Author

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  • Garreth Rule

Abstract

In order to achieve their monetary policy goals central banks must interact with wider financial markets through money market operations. Operations where the central bank provides reserves to the market through the means of a loan potentially leaves the central bank exposed to the risk of loss should the counterparty be unable to repay. As losses can lead to the central bank's reputation and independence being compromised, it is important that central banks undertake steps to protect themselves. Risk management in central bank operations is therefore crucial to the central bank's ability to effectively implement its policy goals. In this handbook we outline how a central bank can limit its exposure to the risk of loss when conducting money market operations. We review the need for operations, discuss the form of such operations and distinguish the contrasting challenges facing countries with surpluses or shortages of liquidity. We then discuss the channels through which the central bank is exposed to the risk of loss and look at the role of capital on a central bank's balance sheet. We introduce the concept of collateralised lending and detail the means through which a central bank chooses the types of collateral it is willing to accept. Subsequently we examine how the central bank manages the collateral it has accepted in its operations, introducing the concepts of valuation, haircuts and margin calls. The recent financial market crisis has let central banks to consider whether or not they should change their collateral policies in the face of market stress, we look at both the advantages and risks of such a move.Â

Suggested Citation

  • Garreth Rule, 2012. "Collateral management in central bank policy operations," Handbooks, Centre for Central Banking Studies, Bank of England, edition 1, number 31.
  • Handle: RePEc:ccb:hbooks:31
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    File URL: http://www.bankofengland.co.uk/education/ccbs/handbooks/pdf/ccbshb31.pdf
    File Function: English version
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    References listed on IDEAS

    as
    1. Blake, Andrew P. & Zampolli, Fabrizio, 2011. "Optimal policy in Markov-switching rational expectations models," Journal of Economic Dynamics and Control, Elsevier, vol. 35(10), pages 1626-1651, October.
    2. Blake, Andy & Gondat-Larralde, Celine, 2010. "Chief Economists' Workshop: state-of-the-art modelling for central banks," Bank of England Quarterly Bulletin, Bank of England, vol. 50(3), pages 214-218.
    3. Andrew P. Blake & Tatiana Kirsanova, 2011. "Inflation Conservatism and Monetary-Fiscal Policy Interactions," International Journal of Central Banking, International Journal of Central Banking, vol. 7(2), pages 41-83, June.
    4. Joyce, Michael & Lasaosa, Ana & Stevens , Ibrahim & Tong, Matthew, 2010. "The financial market impact of quantitative easing," Bank of England working papers 393, Bank of England.
    5. Blake, Andy & Kirsanova, Tatiana & Yates, Tony, 2011. "The gains from delegation revisited: price-level targeting, speed-limit and interest rate smoothing policies," Bank of England working papers 415, Bank of England.
    6. Liu, Philip & Mumtaz, Haroon, 2010. "Evolving macroeconomic dynamics in a small open economy: an estimated Markov-switching DSGE model for the United Kingdom," Bank of England working papers 397, Bank of England.
    7. Garreth Rule, 2011. "Issuing central bank securities," Handbooks, Centre for Central Banking Studies, Bank of England, edition 1, number 30.
    8. Baumeister, Christiane & Liu, Philip & Mumtaz, Haroon, 2010. "Changes in the transmission of monetary policy: evidence from a time-varying factor-augmented VAR," Bank of England working papers 401, Bank of England.
    Full references (including those not matched with items on IDEAS)

    Citations

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    Cited by:

    1. Jakob Korbinian Eberl, 2016. "The Collateral Framework of the Eurosystem and Its Fiscal Implications," ifo Beiträge zur Wirtschaftsforschung, ifo Institute - Leibniz Institute for Economic Research at the University of Munich, number 69, November.
    2. Garreth Rule, 2015. "Understanding the central bank balance sheet," Handbooks, Centre for Central Banking Studies, Bank of England, edition 1, number 32.

    More about this item

    Keywords

    Collateral management in central bank policy operations;

    JEL classification:

    • G18 - Financial Economics - - General Financial Markets - - - Government Policy and Regulation
    • G20 - Financial Economics - - Financial Institutions and Services - - - General

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