Monetary Policy Transmission in Segmented Markets

Abstract

We show that dealer market power impedes the pass-through of monetary policy in the European repo market. The current literature has mostly centered around collateral scarcity, where scarce and heterogeneous collateral causes repo rates to fall below policy rates and diverge across collateral types. Using a dataset covering both inter-dealer and OTC repo trades, we find significant dispersion in repo rates that cannot be explained by collateral scarcity alone. We show that this is because most non-dealer and non-banks do not have access to e-trading on centralized exchanges. Instead, they rely on OTC-intermediated access to repo markets through dealer banks. As a result, dealers exhibit significant market power, which causes the pass-through of the ECB's policy rate to the large OTC segment of the market to be inefficient and unequal. Our model and estimates imply that a customer-facing secured funding facility like the Fed's RRP can alleviate dealer market power and improve the pass-through of monetary policy in repo markets.