This paper develops a simple analytical framework to study the impact of central bank policy-rate changes on banks’ credit supply and risk-taking incentives. Unobservable expost bank monitoring of loans creates an external-financing constraint, which determines bank leverage. Unobservable, costly ex-ante screening of borrowers determines the level of bank risk-taking. More risk-taking tightens the external-financing constraint. The policy rate affects the external-financing constraint because it affects both the return on outside investors’ alternative investments and loan rates. In a low rate environment, a policy-rate cut reduces bank funding costs less because of a zero lower bound (ZLB) on retail deposit rates. Bank risk-taking is a necessary but not sufficient for a policy-rate cut to become contractionary ("reversal"). Reversal can occur even though banks’ net-interest margins increase. Credit market competition plays an important role for the interplay of monetary policy and financing stability. When banks have market power, a policy-rate cut can increase lending and still lead to risk-taking. We use our analytical framework to discuss the literature on how monetary policy affects the credit supply of banks, with special emphasis on low and negative rates. JEL Classification: E44, E52, E58, G20, G21
{"title":"Monetary Policy in a Low Interest Rate Environment: Reversal Rate and Risk-Taking","authors":"Florian Heider, Agnese Leonello","doi":"10.2139/ssrn.3934741","DOIUrl":"https://doi.org/10.2139/ssrn.3934741","url":null,"abstract":"This paper develops a simple analytical framework to study the impact of central bank policy-rate changes on banks’ credit supply and risk-taking incentives. Unobservable expost bank monitoring of loans creates an external-financing constraint, which determines bank leverage. Unobservable, costly ex-ante screening of borrowers determines the level of bank risk-taking. More risk-taking tightens the external-financing constraint. The policy rate affects the external-financing constraint because it affects both the return on outside investors’ alternative investments and loan rates. In a low rate environment, a policy-rate cut reduces bank funding costs less because of a zero lower bound (ZLB) on retail deposit rates. Bank risk-taking is a necessary but not sufficient for a policy-rate cut to become contractionary (\"reversal\"). Reversal can occur even though banks’ net-interest margins increase. Credit market competition plays an important role for the interplay of monetary policy and financing stability. When banks have market power, a policy-rate cut can increase lending and still lead to risk-taking. We use our analytical framework to discuss the literature on how monetary policy affects the credit supply of banks, with special emphasis on low and negative rates. JEL Classification: E44, E52, E58, G20, G21","PeriodicalId":344099,"journal":{"name":"ERN: Banking & Monetary Policy (Topic)","volume":"5 1","pages":"0"},"PeriodicalIF":0.0,"publicationDate":"2021-10-01","publicationTypes":"Journal Article","fieldsOfStudy":null,"isOpenAccess":false,"openAccessPdf":"","citationCount":null,"resultStr":null,"platform":"Semanticscholar","paperid":"134619736","PeriodicalName":null,"FirstCategoryId":null,"ListUrlMain":null,"RegionNum":0,"RegionCategory":"","ArticlePicture":[],"TitleCN":null,"AbstractTextCN":null,"PMCID":"","EPubDate":null,"PubModel":null,"JCR":null,"JCRName":null,"Score":null,"Total":0}
Negative interest rate policy makes excess liquidity costly to hold for banks and this may weaken the bank-based transmission of monetary policy. We design a rule-based tiering system for excess reserve remuneration that reduces the burden of negative rates on banks while ensuring that the central bank keeps control of interbank interest rates. Using euro-area data, we show that under the proposed tiering system, the cost of holding excess liquidity when the COVID-19 monetary stimulus fully unfolds would be more than 30% lower than that under the ECB's current system.
{"title":"A Tiering Rule to Balance the Impact of Negative Policy Rates on Banks","authors":"M. Girotti, Benoît Nguyen, Jean‐Guillaume Sahuc","doi":"10.2139/ssrn.3900544","DOIUrl":"https://doi.org/10.2139/ssrn.3900544","url":null,"abstract":"Negative interest rate policy makes excess liquidity costly to hold for banks and this may weaken the bank-based transmission of monetary policy. We design a rule-based tiering system for excess reserve remuneration that reduces the burden of negative rates on banks while ensuring that the central bank keeps control of interbank interest rates. Using euro-area data, we show that under the proposed tiering system, the cost of holding excess liquidity when the COVID-19 monetary stimulus fully unfolds would be more than 30% lower than that under the ECB's current system.","PeriodicalId":344099,"journal":{"name":"ERN: Banking & Monetary Policy (Topic)","volume":"32 1","pages":"0"},"PeriodicalIF":0.0,"publicationDate":"2021-09-21","publicationTypes":"Journal Article","fieldsOfStudy":null,"isOpenAccess":false,"openAccessPdf":"","citationCount":null,"resultStr":null,"platform":"Semanticscholar","paperid":"132401768","PeriodicalName":null,"FirstCategoryId":null,"ListUrlMain":null,"RegionNum":0,"RegionCategory":"","ArticlePicture":[],"TitleCN":null,"AbstractTextCN":null,"PMCID":"","EPubDate":null,"PubModel":null,"JCR":null,"JCRName":null,"Score":null,"Total":0}
Long-term asset purchases carried out by central banks increase the consumption volatility of households holding long-term debt. For this reason, monetary authorities should not just aim at stabilising inflation and the output gap but also mitigate the volatility of their balance sheet. In response to negative demand shocks at the ZLB, the optimal monetary policy consists of a mix of forward guidance and mild adjustments in the balance sheet. The presence of balance-sheet policies reduces the optimal ZLB duration and significantly improves social welfare. Mitigating the effectiveness of forward guidance calls for a more substantial balance-sheet expansion and a shorter ZLB duration. If a central bank only aims to stabilise inflation and the output gap, welfare losses are significantly larger than under the optimal policy and balance-sheet policies only improve welfare if the weight on output-gap stabilisation is relatively large. Last, simple implementable policy rules can achieve welfare outcomes close to those under the optimal policy.
{"title":"Optimal Monetary Policy Mix at the Zero Lower Bound","authors":"Dario Bonciani, Joonseok Oh","doi":"10.2139/ssrn.3914833","DOIUrl":"https://doi.org/10.2139/ssrn.3914833","url":null,"abstract":"Long-term asset purchases carried out by central banks increase the consumption volatility of households holding long-term debt. For this reason, monetary authorities should not just aim at stabilising inflation and the output gap but also mitigate the volatility of their balance sheet. In response to negative demand shocks at the ZLB, the optimal monetary policy consists of a mix of forward guidance and mild adjustments in the balance sheet. The presence of balance-sheet policies reduces the optimal ZLB duration and significantly improves social welfare. Mitigating the effectiveness of forward guidance calls for a more substantial balance-sheet expansion and a shorter ZLB duration. If a central bank only aims to stabilise inflation and the output gap, welfare losses are significantly larger than under the optimal policy and balance-sheet policies only improve welfare if the weight on output-gap stabilisation is relatively large. Last, simple implementable policy rules can achieve welfare outcomes close to those under the optimal policy.","PeriodicalId":344099,"journal":{"name":"ERN: Banking & Monetary Policy (Topic)","volume":"1 1","pages":"0"},"PeriodicalIF":0.0,"publicationDate":"2021-08-31","publicationTypes":"Journal Article","fieldsOfStudy":null,"isOpenAccess":false,"openAccessPdf":"","citationCount":null,"resultStr":null,"platform":"Semanticscholar","paperid":"123131439","PeriodicalName":null,"FirstCategoryId":null,"ListUrlMain":null,"RegionNum":0,"RegionCategory":"","ArticlePicture":[],"TitleCN":null,"AbstractTextCN":null,"PMCID":"","EPubDate":null,"PubModel":null,"JCR":null,"JCRName":null,"Score":null,"Total":0}
Luiz F.S. Adão, Douglas Silveira, Regis A. Ely, D. Cajueiro
Using an agent-based model, we investigate how monetary policy affects banks' risk-taking in terms of the profile of their lending to real sector firms. Our agent-based model considers five types of agents: banks, depositors, the Central Bank, firms, and the clearinghouse. While banks and depositors are bounded-rational agents with adaptive strategies, the other players' behaviors are used as a reference to understand how these main agents respond strategically to different incentives and situations. Some of our findings recover stylized facts available in the literature: (1) when the monetary policy eases, there is an increase of real sector loans, particularly for riskier clients; (2) the interbank market plays a fundamental role in banks' liquidity management; (3) banks avoid borrowing resources from the Central Bank; (4) when the monetary policy is restrictive, banks increase the level of capital buffers and the Capital Adequacy Ratio (CAR). We also present new insights regarding the relationship between monetary policy stances and bank risk-taking, opening an avenue to investigate the banks' learning process dynamics. Finally, we show that banks tend to grow when the monetary policy stance eases.
{"title":"The Impacts of Monetary Policy on Banks' Loan Portfolio Risk-taking","authors":"Luiz F.S. Adão, Douglas Silveira, Regis A. Ely, D. Cajueiro","doi":"10.2139/ssrn.3898624","DOIUrl":"https://doi.org/10.2139/ssrn.3898624","url":null,"abstract":"Using an agent-based model, we investigate how monetary policy affects banks' risk-taking in terms of the profile of their lending to real sector firms. Our agent-based model considers five types of agents: banks, depositors, the Central Bank, firms, and the clearinghouse. While banks and depositors are bounded-rational agents with adaptive strategies, the other players' behaviors are used as a reference to understand how these main agents respond strategically to different incentives and situations. Some of our findings recover stylized facts available in the literature: (1) when the monetary policy eases, there is an increase of real sector loans, particularly for riskier clients; (2) the interbank market plays a fundamental role in banks' liquidity management; (3) banks avoid borrowing resources from the Central Bank; (4) when the monetary policy is restrictive, banks increase the level of capital buffers and the Capital Adequacy Ratio (CAR). We also present new insights regarding the relationship between monetary policy stances and bank risk-taking, opening an avenue to investigate the banks' learning process dynamics. Finally, we show that banks tend to grow when the monetary policy stance eases.","PeriodicalId":344099,"journal":{"name":"ERN: Banking & Monetary Policy (Topic)","volume":"100 1","pages":"0"},"PeriodicalIF":0.0,"publicationDate":"2021-08-03","publicationTypes":"Journal Article","fieldsOfStudy":null,"isOpenAccess":false,"openAccessPdf":"","citationCount":null,"resultStr":null,"platform":"Semanticscholar","paperid":"123321900","PeriodicalName":null,"FirstCategoryId":null,"ListUrlMain":null,"RegionNum":0,"RegionCategory":"","ArticlePicture":[],"TitleCN":null,"AbstractTextCN":null,"PMCID":"","EPubDate":null,"PubModel":null,"JCR":null,"JCRName":null,"Score":null,"Total":0}
In recorded financial history, there are almost no occasions, other than the present, where a significant portion of the global bond markets has been trading at negative nominal yields. Is this an anomaly or what will be the normal state of the financial markets in years to come? This monograph investigates the ongoing debate between the pros and cons of negative nominal yields and the economic rationale(s) that are used to justify or criticize underlying policies. Even in academic circles, few agree on the costs and benefits of negative yields. Surveying the global bond markets of the day, I find the impact of negative yields in almost all regions and sectors, though sovereign bond markets, which are closest to monetary policy, are the dominant category of bonds with negative yields. I next look at the participants in the negatively yielding bond market and at the motivations that justify their actions. The conclusion is that although different participants might have different reasons to buy negatively yielding bonds, their collective action is certainly responsible for creating a local equilibrium in which these markets clear. Central bank policy is the next focus in this monograph, and I discuss in depth the economic rationale as propounded by one such bank, the European Central Bank. I conclude with a discussion of the blurring lines between monetary and fiscal policy, which are likely to become centerpieces in future years as global sovereign debt levels rise. Next, I look at the influence of negative yields on other asset markets, such as equities, and especially derivatives markets, such as the demand for options. A discussion of potential risks then follows. The monograph concludes with a review of the impact of negative yields on nonfinancial aspects of society. Although the forecast is anything but crystal clear, the evolution of markets and economics in the years to come will undoubtedly be influenced by this massive economic experiment of negative yields.
{"title":"The Incredible Upside-Down Fixed-Income Market - Negative Interest Rates and Their Implications","authors":"V. Bhansali","doi":"10.2139/ssrn.3893898","DOIUrl":"https://doi.org/10.2139/ssrn.3893898","url":null,"abstract":"In recorded financial history, there are almost no occasions, other than the present, where a significant portion of the global bond markets has been trading at negative nominal yields. Is this an anomaly or what will be the normal state of the financial markets in years to come? This monograph investigates the ongoing debate between the pros and cons of negative nominal yields and the economic rationale(s) that are used to justify or criticize underlying policies. Even in academic circles, few agree on the costs and benefits of negative yields. Surveying the global bond markets of the day, I find the impact of negative yields in almost all regions and sectors, though sovereign bond markets, which are closest to monetary policy, are the dominant category of bonds with negative yields. I next look at the participants in the negatively yielding bond market and at the motivations that justify their actions. The conclusion is that although different participants might have different reasons to buy negatively yielding bonds, their collective action is certainly responsible for creating a local equilibrium in which these markets clear. Central bank policy is the next focus in this monograph, and I discuss in depth the economic rationale as propounded by one such bank, the European Central Bank. I conclude with a discussion of the blurring lines between monetary and fiscal policy, which are likely to become centerpieces in future years as global sovereign debt levels rise. Next, I look at the influence of negative yields on other asset markets, such as equities, and especially derivatives markets, such as the demand for options. A discussion of potential risks then follows. The monograph concludes with a review of the impact of negative yields on nonfinancial aspects of society. Although the forecast is anything but crystal clear, the evolution of markets and economics in the years to come will undoubtedly be influenced by this massive economic experiment of negative yields.","PeriodicalId":344099,"journal":{"name":"ERN: Banking & Monetary Policy (Topic)","volume":"43 1","pages":"0"},"PeriodicalIF":0.0,"publicationDate":"2021-07-26","publicationTypes":"Journal Article","fieldsOfStudy":null,"isOpenAccess":false,"openAccessPdf":"","citationCount":null,"resultStr":null,"platform":"Semanticscholar","paperid":"133803490","PeriodicalName":null,"FirstCategoryId":null,"ListUrlMain":null,"RegionNum":0,"RegionCategory":"","ArticlePicture":[],"TitleCN":null,"AbstractTextCN":null,"PMCID":"","EPubDate":null,"PubModel":null,"JCR":null,"JCRName":null,"Score":null,"Total":0}
The paper develops an early warning system to identify banks that could face liquidity crises. To obtain a robust system for measuring banks’ liquidity vulnerabilities, we compare the predictive performance of three models – logistic LASSO, random forest and Extreme Gradient Boosting – and of their combination. Using a comprehensive dataset of liquidity crisis events between December 2014 and January 2020, our early warning models’ signals are calibrated according to the policymaker's preferences between type I and II errors. Unlike most of the literature, which focuses on default risk and typically proposes a forecast horizon ranging from 4 to 6 quarters, we analyse liquidity risk and we consider a 3-month forecast horizon. The key finding is that combining different estimation procedures improves model performance and yields accurate out-of-sample predictions. The results show that the combined models achieve an extremely low percentage of false negatives, lower than the values usually reported in the literature, while at the same time limiting the number of false positives.
{"title":"A Liquidity Risk Early Warning Indicator for Italian Banks: A Machine Learning Approach","authors":"Stefano Nobili, Maria Ludovica Drudi","doi":"10.2139/ssrn.3891566","DOIUrl":"https://doi.org/10.2139/ssrn.3891566","url":null,"abstract":"The paper develops an early warning system to identify banks that could face liquidity crises. To obtain a robust system for measuring banks’ liquidity vulnerabilities, we compare the predictive performance of three models – logistic LASSO, random forest and Extreme Gradient Boosting – and of their combination. Using a comprehensive dataset of liquidity crisis events between December 2014 and January 2020, our early warning models’ signals are calibrated according to the policymaker's preferences between type I and II errors. Unlike most of the literature, which focuses on default risk and typically proposes a forecast horizon ranging from 4 to 6 quarters, we analyse liquidity risk and we consider a 3-month forecast horizon. The key finding is that combining different estimation procedures improves model performance and yields accurate out-of-sample predictions. The results show that the combined models achieve an extremely low percentage of false negatives, lower than the values usually reported in the literature, while at the same time limiting the number of false positives.","PeriodicalId":344099,"journal":{"name":"ERN: Banking & Monetary Policy (Topic)","volume":"27 1","pages":"0"},"PeriodicalIF":0.0,"publicationDate":"2021-06-22","publicationTypes":"Journal Article","fieldsOfStudy":null,"isOpenAccess":false,"openAccessPdf":"","citationCount":null,"resultStr":null,"platform":"Semanticscholar","paperid":"124628777","PeriodicalName":null,"FirstCategoryId":null,"ListUrlMain":null,"RegionNum":0,"RegionCategory":"","ArticlePicture":[],"TitleCN":null,"AbstractTextCN":null,"PMCID":"","EPubDate":null,"PubModel":null,"JCR":null,"JCRName":null,"Score":null,"Total":0}
This paper aims to evaluate an inference of bank internal PDs (Default Probabilities) on subsequent prepayments of variable rate institutional loans. Since variable rate loans hardly present an economic motivation for early prepayments in that they would not o er a cheaper re nancing alternative, we test the conjecture of a correlation between improvements in obligors´creditworthiness (as re ected by negative changes in Bank Internal PDs) and subsequent loan prepayments, as obligors might be tempted to renegotiate more advantageous terms (lower credit spreads) with their lenders. The analysis is purported to serve as an early warning mechanism for banks pursuing the Basel III IRB (internal rating based) approach for unexpected in ows of liquidity in the near future. We use Machine Learning (ML) ensemble methods to forecast potential prepayments and perform a conditional prepayment analysis to make an inference on the prepayment amounts and the prepayment timing distributions while controlling for macroeconomic and corporate idiosyncratic characteristics.
{"title":"On the Modeling of Prepayments for Variable Rate Institutional Loans - Ascertaining the Inference of Bank Internal Default Probabilities on Subsequent Prepayments","authors":"Andre Horovitz","doi":"10.2139/ssrn.3893837","DOIUrl":"https://doi.org/10.2139/ssrn.3893837","url":null,"abstract":"This paper aims to evaluate an inference of bank internal PDs (Default Probabilities) on subsequent prepayments of variable rate institutional loans. Since variable rate loans hardly present an economic motivation for early prepayments in that they would not o er a cheaper re nancing alternative, we test the conjecture of a correlation between improvements in obligors´creditworthiness (as re ected by negative changes in Bank Internal PDs) and subsequent loan prepayments, as obligors might be tempted to renegotiate more advantageous terms (lower credit spreads) with their lenders. The analysis is purported to serve as an early warning mechanism for banks pursuing the Basel III IRB (internal rating based) approach for unexpected in ows of liquidity in the near future. We use Machine Learning (ML) ensemble methods to forecast potential prepayments and perform a conditional prepayment analysis to make an inference on the prepayment amounts and the prepayment timing distributions while controlling for macroeconomic and corporate idiosyncratic characteristics.","PeriodicalId":344099,"journal":{"name":"ERN: Banking & Monetary Policy (Topic)","volume":"90 1","pages":"0"},"PeriodicalIF":0.0,"publicationDate":"2021-05-30","publicationTypes":"Journal Article","fieldsOfStudy":null,"isOpenAccess":false,"openAccessPdf":"","citationCount":null,"resultStr":null,"platform":"Semanticscholar","paperid":"115245290","PeriodicalName":null,"FirstCategoryId":null,"ListUrlMain":null,"RegionNum":0,"RegionCategory":"","ArticlePicture":[],"TitleCN":null,"AbstractTextCN":null,"PMCID":"","EPubDate":null,"PubModel":null,"JCR":null,"JCRName":null,"Score":null,"Total":0}
This study investigates the determinants of banks’ profitability on a sample of 169 commercial banks located in 7 countries of South-Eastern Europe. Specifically, the study employs dynamic panel data analysis based on the generalized method of moments over a period spanning from 2003–2012. Using alternative profitability measures, such as ROA and ROE, suggests that total assets and loan loss provision usually have more pronounced effects on banks' profitability than other variables and that macroeconomic variables are usually statistically significant, therefore highlighting their importance. Splitting the sample into small and large banks, we found that the determinants of profitability on small banks have a larger effect in comparison to large banks irrespective of the profitability measures used in the analysis; the opposite is the case on macroeconomic variables.
{"title":"The Determinants of Commercial Bank’ Profitability in the South-Eastern Europe Region: A System GMM Approach","authors":"Michael Enowbi Batuo, Francesco Guidi","doi":"10.2139/ssrn.3857948","DOIUrl":"https://doi.org/10.2139/ssrn.3857948","url":null,"abstract":"This study investigates the determinants of banks’ profitability on a sample of 169 commercial banks located in 7 countries of South-Eastern Europe. Specifically, the study employs dynamic panel data analysis based on the generalized method of moments over a period spanning from 2003–2012. Using alternative profitability measures, such as ROA and ROE, suggests that total assets and loan loss provision usually have more pronounced effects on banks' profitability than other variables and that macroeconomic variables are usually statistically significant, therefore highlighting their importance. Splitting the sample into small and large banks, we found that the determinants of profitability on small banks have a larger effect in comparison to large banks irrespective of the profitability measures used in the analysis; the opposite is the case on macroeconomic variables.","PeriodicalId":344099,"journal":{"name":"ERN: Banking & Monetary Policy (Topic)","volume":"1 1","pages":"0"},"PeriodicalIF":0.0,"publicationDate":"2021-05-10","publicationTypes":"Journal Article","fieldsOfStudy":null,"isOpenAccess":false,"openAccessPdf":"","citationCount":null,"resultStr":null,"platform":"Semanticscholar","paperid":"129638718","PeriodicalName":null,"FirstCategoryId":null,"ListUrlMain":null,"RegionNum":0,"RegionCategory":"","ArticlePicture":[],"TitleCN":null,"AbstractTextCN":null,"PMCID":"","EPubDate":null,"PubModel":null,"JCR":null,"JCRName":null,"Score":null,"Total":0}
We consider a general tractable model for default contagion and systemic risk in a heterogeneous financial network, subject to an exogenous macroeconomic shock. We show that, under some regularity assumptions, the default cascade model could be transferred to a death process problem represented by balls-and-bins model. We also reduce the dimension of the problem by classifying banks according to different types, in an appropriate type space. These types may be calibrated to real-world data by using machine learning techniques. We then state various limit theorems regarding the final size of default cascade over different types. In particular, under suitable assumptions on the degree and threshold distributions, we show that the final size of default cascade has asymptotically Gaussian fluctuations. We next state limit theorems for different system-wide wealth aggregation functions and show how the systemic risk measure, in a given stress test scenario, could be related to the structure and heterogeneity of financial networks. We finally show how these results could be used by a social planner to optimally target interventions during a financial crisis, with a budget constraint and under partial information of the financial network.
{"title":"Limit Theorems for Default Contagion and Systemic Risk","authors":"H. Amini, Zhong Cao, A. Sulem","doi":"10.2139/ssrn.3811107","DOIUrl":"https://doi.org/10.2139/ssrn.3811107","url":null,"abstract":"We consider a general tractable model for default contagion and systemic risk in a heterogeneous financial network, subject to an exogenous macroeconomic shock. We show that, under some regularity assumptions, the default cascade model could be transferred to a death process problem represented by balls-and-bins model. We also reduce the dimension of the problem by classifying banks according to different types, in an appropriate type space. These types may be calibrated to real-world data by using machine learning techniques. We then state various limit theorems regarding the final size of default cascade over different types. In particular, under suitable assumptions on the degree and threshold distributions, we show that the final size of default cascade has asymptotically Gaussian fluctuations. We next state limit theorems for different system-wide wealth aggregation functions and show how the systemic risk measure, in a given stress test scenario, could be related to the structure and heterogeneity of financial networks. We finally show how these results could be used by a social planner to optimally target interventions during a financial crisis, with a budget constraint and under partial information of the financial network.","PeriodicalId":344099,"journal":{"name":"ERN: Banking & Monetary Policy (Topic)","volume":"20 1","pages":"0"},"PeriodicalIF":0.0,"publicationDate":"2021-03-24","publicationTypes":"Journal Article","fieldsOfStudy":null,"isOpenAccess":false,"openAccessPdf":"","citationCount":null,"resultStr":null,"platform":"Semanticscholar","paperid":"132065961","PeriodicalName":null,"FirstCategoryId":null,"ListUrlMain":null,"RegionNum":0,"RegionCategory":"","ArticlePicture":[],"TitleCN":null,"AbstractTextCN":null,"PMCID":"","EPubDate":null,"PubModel":null,"JCR":null,"JCRName":null,"Score":null,"Total":0}
This paper studies how Central Bank eligibility requirements affect the supply and quality of bonds issued by non-financial firms. Banks increase demand for eligible bonds, to which firms respond by increasing their debt issuance and, therefore, default risk. We characterize firm responses and aggregate collateral supply in a heterogeneous firm model with endogenous default and eligibility premia. Using a calibration to euro area data, we study the impact collateral easing, consistent with the ECB's policy in the 2008 financial crisis and evaluate the quantitative relevance of firm responses. We find that firm responses substantially deteriorate collateral quality and dampen the total increase in collateral supply to a quantitatively relevant degree. Moreover, our analysis suggests that collateral easing is accompanied by sizeable adverse side effects on the corporate bond market.
{"title":"Risky Financial Collateral, Firm Heterogeneity, and the Impact of Eligibility Requirements","authors":"Matthias Kaldorf, Florian Wicknig","doi":"10.2139/ssrn.3800024","DOIUrl":"https://doi.org/10.2139/ssrn.3800024","url":null,"abstract":"This paper studies how Central Bank eligibility requirements affect the supply and quality of bonds issued by non-financial firms. Banks increase demand for eligible bonds, to which firms respond by increasing their debt issuance and, therefore, default risk. We characterize firm responses and aggregate collateral supply in a heterogeneous firm model with endogenous default and eligibility premia. Using a calibration to euro area data, we study the impact collateral easing, consistent with the ECB's policy in the 2008 financial crisis and evaluate the quantitative relevance of firm responses. We find that firm responses substantially deteriorate collateral quality and dampen the total increase in collateral supply to a quantitatively relevant degree. Moreover, our analysis suggests that collateral easing is accompanied by sizeable adverse side effects on the corporate bond market.","PeriodicalId":344099,"journal":{"name":"ERN: Banking & Monetary Policy (Topic)","volume":"13 1","pages":"0"},"PeriodicalIF":0.0,"publicationDate":"2021-03-12","publicationTypes":"Journal Article","fieldsOfStudy":null,"isOpenAccess":false,"openAccessPdf":"","citationCount":null,"resultStr":null,"platform":"Semanticscholar","paperid":"125613194","PeriodicalName":null,"FirstCategoryId":null,"ListUrlMain":null,"RegionNum":0,"RegionCategory":"","ArticlePicture":[],"TitleCN":null,"AbstractTextCN":null,"PMCID":"","EPubDate":null,"PubModel":null,"JCR":null,"JCRName":null,"Score":null,"Total":0}
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