Stabilising Virtues of Central Banks: (Re)Matching Bank Liquidity

Abstract

The liquidity of financial system plays a central role in systemic crises. In this paper, we show that the ECB haircut policies provided an important liquidity support to distressed financial institutions during the euro area sovereign debt turmoil. Using novel, micro data on the pool of collateral eligible to ECB open market operations, we construct a “public” liquidity mismatch indicator (LMI) for the French aggregate banking sector based on the ECB haircuts. We then compare it to the “private” LMI based on the haircuts in private repo markets in a spirit of Bai et al. (2018). The difference between the two indicators represents a new measure of the ECB liquidity support. Our results suggest that the ECB haircut policies have indeed helped French banks to reduce the liquidity mismatch.