A public-private partnership? Central bank funding and credit supply

We exploit the surprise announcement and subsequent amendment of a central bank funding scheme to test how public liquidity provision affects credit market outcomes. Contrary to the notion that public liquidity is primarily a substitute for private liquidity, banks that are more exposed to stress in private wholesale funding markets use less central bank funding. We rationalise this pattern by establishing an "equilibrium channel" of public liquidity. The mere availability of central bank funding reduces the cost of private wholesale funding. This stimulates lending by banks exposed to wholesale funding, regardless of whether they actually use the central bank funding. Using a surprise amendment to the design of the scheme, we show that the "strings attached" to central bank funding help to explain why it is an imperfect substitute for private funding.