Central Bank Liquidity Provision and Collateral Quality
Banque de France; ECARES, Universite Libre de Bruxelles
Massachusetts Institute of Technology (MIT), Department of Economics, Students
September 1, 2014
Journal of Banking and Finance, Vol. 49, No. 12, 2014
Should central banks lend against low quality collateral? We characterize efficient central bank collateral policy in a model where a bank borrows from the interbank market or the central bank. Collateral has favorable incentive effects but is costly to transfer to lenders who value the collateral less because of imperfect collateral quality. We show that a fall in the quantity or the quality of the bank's collateral can increase interest rates in the economy even with a constant policy rate. A looser central bank collateral policy can reduce the spread, alleviate the credit crunch and increase output.
Number of Pages in PDF File: 45
Keywords: collateral policy, asset encumbrance, repo, haircuts
JEL Classification: E58, G01, G20
Date posted: May 14, 2013 ; Last revised: October 24, 2014
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