The role of collateral in supporting liquidity

Yuliya Baranova (), Zijun Liu and Joseph Noss ()
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Yuliya Baranova: Bank of England, Postal: Bank of England, Threadneedle Street, London, EC2R 8AH
Joseph Noss: Bank of England, Postal: Bank of England, Threadneedle Street, London, EC2R 8AH

No 609, Bank of England working papers from Bank of England

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 (search for similar items in EconPapers)
JEL-codes: G13 G17 G29 (search for similar items in EconPapers)
Pages: 21 pages
Date: 2016-08-16
New Economics Papers: this item is included in nep-ban
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Citations: View citations in EconPapers (6)

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