Asset Encumbrance, Bank Funding and Financial Fragility

36 Pages Posted: 21 Jun 2016

See all articles by Toni Ahnert

Toni Ahnert

European Central Bank, Financial Research Division; Centre for Economic Policy Research (CEPR)

Kartik Anand

Deutsche Bundesbank

Prasanna Gai

University of Auckland Business School; Australian National University (ANU); Bank of England

James T. E. Chapman

Government of Canada - Bank of Canada

Date Written: 2016

Abstract

How does asset encumbrance affect the fragility of intermediaries subject to rollover risk? We offer a model in which a bank issues covered bonds backed by a pool of assets that is bankruptcy remote and replenished following losses. Encumbering assets allows a bank to raise cheap secured debt and expand profitable investment, but it also concentrates risk on unsecured debt and thus exacerbates fragility and raises unsecured funding costs. Deposit insurance or wholesale funding guarantees induce excessive encumbrance and fragility. To mitigate such risk shifting, we study prudential regulatory tools, including limits on encumbrance, minimum capital requirements and surcharges for encumbrance.

Keywords: asset encumbrance, covered bonds, financial fragility, guarantees, rollover risk, wholesale funding

JEL Classification: D82, G01, G21, G28

Suggested Citation

Ahnert, Toni and Anand, Kartik and Gai, Prasanna and Chapman, James T. E., Asset Encumbrance, Bank Funding and Financial Fragility (2016). Bundesbank Discussion Paper No. 17/2016, Available at SSRN: https://ssrn.com/abstract=2798535 or http://dx.doi.org/10.2139/ssrn.2798535

Toni Ahnert (Contact Author)

European Central Bank, Financial Research Division ( email )

ECB Tower
Sonnemannstraße 20
Frankfurt am Main

HOME PAGE: http://toniahnert.com

Centre for Economic Policy Research (CEPR)

London
United Kingdom

Kartik Anand

Deutsche Bundesbank ( email )

Wilhelm-Epstein-Str. 14
Frankfurt/Main, 60431
Germany

HOME PAGE: http://www.bundesbank.de/research_kartik_anand

Prasanna Gai

University of Auckland Business School ( email )

12 Grafton Rd
Private Bag 92019
Auckland, 1010
New Zealand

Australian National University (ANU) ( email )

Canberra, Australian Capital Territory 2601
Australia

Bank of England ( email )

Threadneedle Street
London, EC2R 8AH
United Kingdom
+020 7601 3583 (Phone)

James T. E. Chapman

Government of Canada - Bank of Canada ( email )

234 Wellington Street
Ontario, Ottawa K1A 0G9
Canada

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