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Central banks are under increased scrutiny because of the rapid growth in, and composition of, their balance sheets. Therefore, understanding the processes that shape these balance sheets and their consequences is crucial. We contribute by studying an extensive dataset of banks’ liquidity uptake and pledged collateral in central bank repos. We document systemic arbitrage whereby banks funnel credit risk and low-quality collateral to the central bank. Weaker banks use lower quality collateral to demand disproportionately larger amounts of central bank money (liquidity). This holds both before and after the financial crisis and may contribute to financial fragility and fragmentation.
From:
Falko Fecht
Frankfurt School of Finance & Management
Kjell G. Nyborg
University of Zurich Centre for Economic Policy Research (CEPR)
Jörg Rocholl
ESMT European School of Management and Technology
Jiri Woschitz
University of Zurich
Central banks are under increased scrutiny because of the rapid growth in, and composition of, their balance sheets. Therefore, understanding the processes that shape these balance sheets and their consequences is crucial. We contribute by studying an extensive dataset of banks’ liquidity uptake and pledged collateral in central bank repos. We document systemic arbitrage whereby banks funnel credit risk and low-quality collateral to the central bank. Weaker banks use lower quality collateral to demand disproportionately larger amounts of central bank money (liquidity). This holds both before and after the financial crisis and may contribute to financial fragility and fragmentation.
From:
Falko Fecht
Frankfurt School of Finance & Management
Kjell G. Nyborg
University of Zurich Centre for Economic Policy Research (CEPR)
Jörg Rocholl
ESMT European School of Management and Technology
Jiri Woschitz
University of Zurich