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Central Bank Haircut Policy

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  • James Chapman
  • Jonathan Chiu
  • Miguel Molico

Abstract

We present a model of central bank collateralized lending to study the optimal choice of the haircut policy. We show that a lending facility provides a bundle of two types of insurance: insurance against liquidity risk as well as insurance against downside risk of the collateral. Setting a haircut therefore involves balancing the trade-off between relaxing the liquidity constraints of agents on one hand, and increasing potential inflation risk and distorting the portfolio choices of agents on the other. We argue that the optimal haircut is higher when the central bank is unable to lend exclusively to agents who actually need liquidity. Finally, for an unexpected drop in the haircut, the central bank can be more aggressive than when setting a permanent level of the haircut.

Suggested Citation

  • James Chapman & Jonathan Chiu & Miguel Molico, 2010. "Central Bank Haircut Policy," Staff Working Papers 10-23, Bank of Canada.
    • Handle: RePEc:bca:bocawp:10-23
    DOI: 10.34989/swp-2010-23
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    References listed on IDEAS

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    2. Martin, Antoine & Monnet, Cyril, 2011. "Monetary Policy Implementation Frameworks: A Comparative Analysis," Macroeconomic Dynamics, Cambridge University Press, vol. 15(S1), pages 145-189, April.
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    5. Koeppl, Thorsten & Monnet, Cyril & Temzelides, Ted, 2006. "A Dynamic Model of Settlement," Queen's Economics Department Working Papers 273529, Queen's University - Department of Economics.
    6. Koeppl, Thorsten & Monnet, Cyril & Temzelides, Ted, 2008. "A dynamic model of settlement," Journal of Economic Theory, Elsevier, vol. 142(1), pages 233-246, September.
    7. Berentsen, Aleksander & Monnet, Cyril, 2008. "Monetary policy in a channel system," Journal of Monetary Economics, Elsevier, vol. 55(6), pages 1067-1080, September.
    8. José Suárez-Lledó, "undated". "Monetary Policy with Heterogeneous Collateralized Borrowing," Working Papers 374, Barcelona School of Economics.
    9. Jeffrey Lacker, 2001. "Collateralized Debt as the Optimal Contract," Review of Economic Dynamics, Elsevier for the Society for Economic Dynamics, vol. 4(4), pages 842-859, October.
    10. James T.E. Chapman & Antoine Martin, 2013. "Rediscounting under Aggregate Risk with Moral Hazard," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 45(4), pages 651-674, June.
    11. ANTOINE MARTIN & JAMES McANDREWS, 2010. "Should There Be Intraday Money Markets?," Contemporary Economic Policy, Western Economic Association International, vol. 28(1), pages 110-122, January.
    12. Alejandro García & Ramazan Gençay, 2006. "Risk-Cost Frontier and Collateral Valuation in Securities Settlement Systems for Extreme Market Events," Staff Working Papers 06-17, Bank of Canada.
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    Citations

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    Cited by:

    1. Matthias Kaldorf & Florian Wicknig, 2021. "Risky Financial Collateral, Firm Heterogeneity, and the Impact of Eligibility Requirements," ECONtribute Discussion Papers Series 123, University of Bonn and University of Cologne, Germany.
    2. Ulrich Bindseil & Edoardo Lanari, 2020. "Fire Sales, the LOLR and Bank Runs with Continuous Asset Liquidity," Papers 2010.11030, arXiv.org.
    3. Nyborg, Kjell G., 2017. "Central bank collateral frameworks," Journal of Banking & Finance, Elsevier, vol. 76(C), pages 198-214.
    4. Fuhrer, Lucas Marc & Müller, Benjamin & Steiner, Luzian, 2017. "The Liquidity Coverage Ratio and security prices," Journal of Banking & Finance, Elsevier, vol. 75(C), pages 292-311.
    5. Hüttl, Pia & Kaldorf, Matthias, 2024. "The transmission of bank liquidity shocks: Evidence from the Eurosystem collateral framework," Discussion Papers 04/2024, Deutsche Bundesbank.
    6. Lanari, Edoardo, 2022. "Fire Sales, the LOLR, and Bank Runs with Continuous Asset Liquidity," Journal of Financial Crises, Yale Program on Financial Stability (YPFS), vol. 4(4), pages 77-102, April.
    7. Wolski, Marcin & van de Leur, Michiel, 2016. "Interbank loans, collateral and modern monetary policy," Journal of Economic Dynamics and Control, Elsevier, vol. 73(C), pages 388-416.
    8. Nyborg, Kjell G., 2017. "Reprint of: Central bank collateral frameworks," Journal of Banking & Finance, Elsevier, vol. 83(C), pages 232-248.
    9. Matsuoka, Tarishi, 2022. "Asset prices and standing facilities in a monetary economy," Journal of Economic Dynamics and Control, Elsevier, vol. 135(C).
    10. 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.
    11. Sever, Can, 2014. "Systemic Liquidity Crisis with Dynamic Haircuts," MPRA Paper 55602, University Library of Munich, Germany.
    12. Rocheteau, Guillaume & Wright, Randall & Xiaolin Xiao, Sylvia, 2018. "Open market operations," Journal of Monetary Economics, Elsevier, vol. 98(C), pages 114-128.
    13. Aleksander Berentsen & Alessandro Marchesiani & Christopher Waller, 2014. "Floor Systems for Implementing Monetary Policy: Some Unpleasant Fiscal Arithmetic," Review of Economic Dynamics, Elsevier for the Society for Economic Dynamics, vol. 17(3), pages 523-542, July.
    14. Nguyen, Minh, 2020. "Collateral haircuts and bond yields in the European government bond markets," International Review of Financial Analysis, Elsevier, vol. 69(C).
    15. Enchuan Shao & Kwabena Bediako, 2020. "The Impact Of Return On Collateral In A Channel System," Economic Inquiry, Western Economic Association International, vol. 58(3), pages 1314-1341, July.
    16. Jakob Vestergaard & Daniela Gabor, 2021. "Central Banks Caught Between Market Liquidity and Fiscal Disciplining: A Money View Perspective on Collateral Policy," Working Papers Series inetwp170, Institute for New Economic Thinking.
    17. Bindseil, Ulrich & Jablecki, Juliusz, 2023. "Zombification and Central Bank Risk-Taking: The Lender of Last Resort as a Signal Extraction Problem," Journal of Financial Crises, Yale Program on Financial Stability (YPFS), vol. 5(3), pages 1-22, July.
    18. Bindseil, Ulrich & Jabłecki, Juliusz, 2013. "Central bank liquidity provision, risk-taking and economic efficiency," Working Paper Series 1542, European Central Bank.

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    JEL classification:

    • E40 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - General
    • E50 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - General

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