Central Bank Collateral, Asset Fire Sales, Regulation and Liquidity

35 Pages Posted: 30 Nov 2013

Date Written: November 6, 2013

Abstract

This paper analyses the potential roles of bank asset fire sales and recourse to central bank credit to ensure banks' funding liquidity and solvency. Both asset liquidity and central bank haircuts are modelled as power functions within the unit interval. Funding stability is captured as strategic bank run game in pure strategies between depositors. Asset liquidity, the central bank collateral framework and regulation determine jointly the ability of the banking system to deliver maturity transformation and financial stability. The model also explains why banks tend to use the least liquid eligible assets as central bank collateral and why a sudden non-anticipated reduction of asset liquidity, or a tightening of the collateral framework, can destabilize short term liabilities of banks. Finally, the model allows discussing how the collateral framework can be understood, beyond its essential aim to protect the central bank, as financial stability and non-conventional monetary policy instrument.

Keywords: asset liquidity, liquidity regulation, bank run, central bank collateral framework, unconventional monetary policy

JEL Classification: E42, G21

Suggested Citation

Bindseil, Ulrich, Central Bank Collateral, Asset Fire Sales, Regulation and Liquidity (November 6, 2013). ECB Working Paper No. 1610, Available at SSRN: https://ssrn.com/abstract=2350657

Ulrich Bindseil (Contact Author)

European Central Bank (ECB) ( email )

Sonnemannstrasse 22
Frankfurt am Main, 60314
Germany

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