Central Bank Liquidity Provision and Collateral Quality
45 Pages Posted: 14 May 2013 Last revised: 24 Oct 2014
Date Written: September 1, 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.
Keywords: collateral policy, asset encumbrance, repo, haircuts
JEL Classification: E58, G01, G20
Suggested Citation: Suggested Citation