The (Unintended?) Consequences of the Largest Liquidity Injection Ever

46 Pages Posted: 28 Nov 2017 Last revised: 21 Feb 2019

See all articles by Matteo Crosignani

Matteo Crosignani

University of Michigan at Ann Arbor - Finance

Miguel Faria-e-Castro

Federal Reserve Bank of St. Louis

Luís Fonseca

London Business School - Department of Economics

Multiple version iconThere are 3 versions of this paper

Date Written: 2017-11-01

Abstract

The design of lender-of-last-resort interventions can exacerbate the bank-sovereign nexus. During sovereign crises, central bank provision of long-term liquidity incentivizes banks to purchase high yield eligible collateral securities matching the maturity of the central bank loans. Using unique security level data, we find that the European Central Bank’s 3-year Long-Term Refinancing Operation caused Portuguese banks to purchase short-term domestic government bonds, equivalent to 10.6% of amounts outstanding, and pledge them to obtain central bank liquidity. The steepening of Eurozone peripheral sovereign yield curves right after the policy announcement is consistent with the equilibrium effects of this “collateral trade.�

Keywords: Lender of Last Resort, Bank-Sovereign Nexus, Collateral, Sovereign Debt, Eurozone Crisis

JEL Classification: E58, G21, G28, H63

Suggested Citation

Crosignani, Matteo and Faria-e-Castro, Miguel and Fonseca, Luís, The (Unintended?) Consequences of the Largest Liquidity Injection Ever (2017-11-01). FRB St. Louis Working Paper No. 2017-39. Available at SSRN: https://ssrn.com/abstract=3078599 or http://dx.doi.org/10.20955/wp.2017.039

Matteo Crosignani (Contact Author)

University of Michigan at Ann Arbor - Finance ( email )

701 Tappan Street
Ann Arbor, MI 48109-1234
United States

Miguel Faria-e-Castro

Federal Reserve Bank of St. Louis ( email )

411 Locust St
Saint Louis, MO 63011
United States

Luís Fonseca

London Business School - Department of Economics ( email )

Sussex Place
Regent's Park
London NW1 4SA
United Kingdom

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