Central Bank Liquidity Provision, Risk-Taking and Economic Efficiency

37 Pages Posted: 19 Jun 2013

See all articles by Ulrich Bindseil

Ulrich Bindseil

European Central Bank (ECB)

Juliusz Jablecki

University of Warsaw - Faculty of Economic Sciences; National Bank of Poland

Date Written: April 19, 2013

Abstract

After the Lehman default, but also during the euro area sovereign debt crisis, central banks have tended to extend the ability of banks to take recourse to central bank credit operations through changes of the collateral framework (e.g. CGFS, 2008 – in consistence with previous narratives, such as Bagehot, 1873). We provide a simple four sector model of the economy in which we illustrate the relevant trade-offs, derive optimal central bank collateral policies, and show why in a financial crisis, in which liquidity shocks become more erratic and the total costs of defaults increase, central banks may want to allow for greater potential recourse of banks to central bank credit. The model also illustrates that the credit riskiness of counter parties and issuers is endogenous to the central bank's credit policies and related risk control framework. Finally, the model allows identifying the circumstances under which the counter intuitive case arises in which a relaxation of the central bank collateral policy may reduce its expected losses.

Keywords: central bank, risk-taking, collateral policy, economic efficiency

JEL Classification: E58, G32

Suggested Citation

Bindseil, Ulrich and Jablecki, Juliusz, Central Bank Liquidity Provision, Risk-Taking and Economic Efficiency (April 19, 2013). ECB Working Paper No. 1542, Available at SSRN: https://ssrn.com/abstract=2253845

Ulrich Bindseil (Contact Author)

European Central Bank (ECB) ( email )

Sonnemannstrasse 22
Frankfurt am Main, 60314
Germany

Juliusz Jablecki

University of Warsaw - Faculty of Economic Sciences ( email )

Dluga Street 44/50
Warsaw, 00-241
Poland

National Bank of Poland ( email )

Warsaw
Poland

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