Asset Liquidity, Central Bank Collateral, and Banks’ Liability Structure

Abstract

This paper analyses the roles of bank asset fire sales and recourse to the central bank as lender of last resort for the equilibrium debt structure of banks and the spread between bank lending rates and the central bank policy rate (the short term risk free rate). The asset side of banks is modelled in three variants, including without previously applied constraints on the functional form of asset liquidity and central bank collateral haircuts. The model allows capturing how asset liquidity and the central bank collateral framework interact and determine funding market access of banks and the ability of banks to undertake liquidity and term transformation, which impacts also on monetary conditions. Moreover, the paper provides a cross-section analysis of liquidity properties and central bank collateral haircuts of the euro area fixed income universe.

Keywords: Asset Liquidity, LOLR, Bank Run, Central Bank Collateral Framework, Unconventional Monetary Policy

JEL Classification: E42, G58, G33