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Scarce Collateral and Bank Reserves

  • Miquel Faig
  • Gregory Gagnon

If collateral for bank loans is scarce and as a result access to secured loans is restricted, the allocation of resources is inefficient. Anticipating future borrowing constraints, individuals over-invest in collateralized types of capital, whereas consumption and investment expenditures are inefficiently low while individuals are borrowing constrained. The dual counterpart of this misallocation of resources is inefficiently low interest rates. In this situation, bank reserves play a positive welfare role by increasing not only bank lending rates, but also, paradoxically, bank deposit rates. As a result, in economies with scarce collateral the optimal reserves requirement ratio is positive.

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Paper provided by University of Toronto, Department of Economics in its series Working Papers with number faig-03-01.

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Length: 22 pages
Date of creation: 11 Jul 2003
Date of revision:
Handle: RePEc:tor:tecipa:faig-03-01
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  1. Javier Diaz-Gimenez & Edward C. Prescott & Terry Fitzgerald & Fernando Alvarez, 1992. "Banking in computable general equilibrium economies," Staff Report 153, Federal Reserve Bank of Minneapolis.
  2. D. K. Foley & M. F. Hellwig, 1973. "Asset Management with Trading Uncertainty," Working papers 108, Massachusetts Institute of Technology (MIT), Department of Economics.
  3. Bewley, Truman, 1983. "A Difficulty with the Optimum Quantity of Money," Econometrica, Econometric Society, vol. 51(5), pages 1485-504, September.
  4. Faig, Miquel, 2000. "Money with Idiosyncratic Uninsurable Returns to Capital," Journal of Economic Theory, Elsevier, vol. 94(2), pages 218-240, October.
  5. Diamond, Douglas W & Dybvig, Philip H, 1983. "Bank Runs, Deposit Insurance, and Liquidity," Journal of Political Economy, University of Chicago Press, vol. 91(3), pages 401-19, June.
  6. Miquel Faig, 1999. "The Optimal structure of Liquidity Provided by a Self Financed Central Bank," Working Papers faig-99-01, University of Toronto, Department of Economics.
  7. Bengt Holmstrom & Jean Tirole, 1998. "Private and Public Supply of Liquidity," Journal of Political Economy, University of Chicago Press, vol. 106(1), pages 1-40, February.
  8. S. Rao Aiyagari, 1993. "Uninsured idiosyncratic risk and aggregate saving," Working Papers 502, Federal Reserve Bank of Minneapolis.
  9. Woodford, Michael, 1990. "Public Debt as Private Liquidity," American Economic Review, American Economic Association, vol. 80(2), pages 382-88, May.
  10. Williamson, Stephen D, 1987. "Financial Intermediation, Business Failures, and Real Business Cycles," Journal of Political Economy, University of Chicago Press, vol. 95(6), pages 1196-1216, December.
  11. Huggett, Mark, 1993. "The risk-free rate in heterogeneous-agent incomplete-insurance economies," Journal of Economic Dynamics and Control, Elsevier, vol. 17(5-6), pages 953-969.
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