Central Bank Liquidity Provision and Collateral Quality

45 Pages Posted: 14 May 2013 Last revised: 24 Oct 2014

Date Written: September 1, 2014

Abstract

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.

Keywords: collateral policy, asset encumbrance, repo, haircuts

JEL Classification: E58, G01, G20

Suggested Citation

Koulischer, Francois and Struyven, Daan, Central Bank Liquidity Provision and Collateral Quality (September 1, 2014). Journal of Banking and Finance, Vol. 49, No. 12, 2014. Available at SSRN: https://ssrn.com/abstract=2213690 or http://dx.doi.org/10.2139/ssrn.2213690

Francois Koulischer (Contact Author)

Luxembourg School of Finance ( email )

6, rue Richard Coudenhove-Kalergi
Luxembourg, L-1359
Luxembourg

HOME PAGE: http://https://sites.google.com/site/francoiskoulischer/

Daan Struyven

Goldman Sachs ( email )

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