The Role of Collateral in Supporting Liquidity

21 Pages Posted: 23 Aug 2016

See all articles by Zijun Liu

Zijun Liu

Bank of England

Joseph Noss

Bank of England

Yuliya Baranova

Bank of England

Date Written: August 16, 2016

Abstract

Collateral plays an important role in supporting a vast range of transactions that help ensure the efficient functioning of the financial system. But collateral markets also have the potential to exacerbate risks to financial stability, not least given that during periods of market stress demand for high-quality collateral may increase, whilst collateral availability may fall. This paper offers a means to estimate how this potential imbalance between collateral supply and demand is likely to vary as a function of market stress. In doing so, it offers an estimate of the increase in market volatility sufficient to cause a dislocation in the market for collateral and a subsequent deterioration in market functioning. It suggests that — from the perspective of financial stability — the implications of an imbalance between the supply and demand of collateral are likely to be comparatively benign, but that the implications of a reduction in the willingness and/or ability of market participants to act as intermediaries in collateral markets are likely to have more serious consequences for market functioning. This work also provides a framework through which policymakers might be able to investigate how regulations might affect the proximity of these risks.

Keywords: Collateral, securities financing transactions, derivatives, regulation, liquidity

JEL Classification: G13, G17, G29

Suggested Citation

Liu, Zijun and Noss, Joseph and Baranova, Yuliya, The Role of Collateral in Supporting Liquidity (August 16, 2016). Bank of England Working Paper No. 609, Available at SSRN: https://ssrn.com/abstract=2827526 or http://dx.doi.org/10.2139/ssrn.2827526

Zijun Liu (Contact Author)

Bank of England ( email )

Threadneedle Street
London, EC2R 8AH
United Kingdom

Joseph Noss

Bank of England ( email )

Threadneedle Street
London, EC2R 8AH
United Kingdom

Yuliya Baranova

Bank of England ( email )

Threadneedle Street
London, EC2R 8AH
United Kingdom

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