Collateral Framework Research Articles

The green premium of unconventional monetary policy: Evidence from the enlarged collateral framework by the People's Bank of China

The green premium of unconventional monetary policy: Evidence from the enlarged collateral framework by the People's Bank of China

The Expansion of Central Bank Collateral and Green Innovation of Enterprises

This article takes the policy event of green bonds being included in the MLF (Medium Term Lending Facility) qualified collateral framework in June 2018 as a quasi natural experiment, and analyzes the impact of the expansion of the collateral framework of the new monetary policy on the credit spread of green bonds and the green innovation output of enterprises issuing green bonds based on a two period and multi period double difference model. The research results indicate that, firstly, the expansion of collateral by the central bank will significantly reduce the credit spread of green bonds and lower the financing costs of enterprises. Secondly, the expansion of collateral by the central bank will promote the improvement of green technology innovation capabilities of green enterprises, and alleviate their financing problems by issuing green bonds and green bonds themselves.

The Impact of MLF Collateral Expansion Policy on Total Factor Productivity of Polluting Firms

Since the reform and opening up, China's economy has developed rapidly and has become a global economic powerhouse. However, for a long time, the economic development model has been rough, resource consumption is high, and growth relies heavily on heavy industry, which is not sustainable.In 2018, China's central bank proposed to incorporate green credit into the qualified collateral framework, an initiative that has the dual function of resource allocation and environmental regulation. Considering that polluting enterprises are more susceptible to this policy, the article chooses polluting enterprises as the research object, quasi-natural experiments based on the MLF collateral expansion policy introduced in June 2018, and adopts a double difference model to analyze whether the new policy can enhance the total factor productivity of enterprises. The results of the study show that the MLF collateral expansion policy can significantly enhance the total factor productivity of heavy pollution enterprises. Finally, based on the obtained results, this paper puts forward targeted recommendations.

Collateral eligibility of corporate debt in the Eurosystem

We study the many implications of the Eurosystem collateral framework for corporate bonds. Using data on the evolving collateral eligibility list, we identify the first inclusion dates of bonds and issuers and use these events to find that the increased supply and demand for pledgeable collateral following eligibility (a) increases activity in the corporate securities lending market, (b) lowers eligible bond yields, and (c) affects bond liquidity. Thus, corporate bond lending relaxes the constraint of limited collateral supply and thereby improves market functioning.

The preferential treatment of green bonds

We study the preferential treatment of green bonds in the central bank collateral framework as a climate policy instrument within a DSGE model with climate and financial frictions. In the model, green and carbon-emitting conventional firms issue defaultable corporate bonds to banks that use them as collateral, subject to haircuts determined by the central bank. A haircut reduction induces firms to increase bond issuance, investment, leverage, and default risk. Collateral policy solves a trade-off between increasing collateral supply, adverse effects on firm risk-taking, and subsidizing green investment. Optimal collateral policy is characterized by a haircut gap of 20 percentage points, which increases the green investment share and reduces emissions. However, welfare gains fall well short of what can be achieved with optimal carbon taxes. Moreover, due to elevated risk-taking of green firms, preferential treatment is a qualitatively imperfect substitute of Pigouvian taxation on emissions: if and only if the optimal emission tax can not be implemented, optimal collateral policy features a preferential treatment of green bonds.

Collateral Framework: Liquidity Premia and Multiple Equilibria

AbstractCentral banks normally accept debt of their own governments as collateral in liquidity operations without reservations. This gives rise to a valuable liquidity premium that reduces the cost of government finance. The ECB is an interesting exception in this respect. It relies on external assessments of the creditworthiness of its member states, such as credit ratings, to determine eligibility and the haircut it imposes on such debt. We show how such features in a central bank's collateral framework can give rise to cliff effects and multiple equilibria in bond yields and increase the vulnerability of governments to external shocks. This policy can potentially induce sovereign debt crises and defaults that would not otherwise occur. The success of the ECB's temporary suspension of these features of its collateral framework during the pandemic illustrates the practical relevance of this mechanism.

Stress Testing with Multi-Faceted Liquidity: The Central Bank Collateral Framework as a Financial Stability Tool

Stress Testing with Multi-Faceted Liquidity: The Central Bank Collateral Framework as a Financial Stability Tool

The Preferential Treatment of Green Bonds

We study the preferential treatment of green bonds in the Central Bank collateral framework as an environmental policy instrument within a DSGE model with environmental and financial frictions. Green and conventional entrepreneurs issue bonds to banks that use them as collateral. The associated collateral premium induce entrepreneurs to increase bond issuance, investment, leverage, and default risk. Collateral policy solves a trade-off between increasing collateral supply, adverse effects on entrepreneur risk-taking, and subsidizing green investment. Due to these adverse side effects, optimal collateral policy is characterized by modest preferential treatment, thereby increasing the green bond share and, to a smaller extent, the green investment share, which in turn reduces pollution. The limited response of green investment is directly related to higher risk-taking of green entrepreneurs. Furthermore, we show that preferential treatment is an imperfect substitute of Pigouvian taxation on pollution: only if the optimal tax can not be implemented, optimal collateral policy features preferential treatment of green bonds.

Managing financing costs and fostering green transition: The role of green financial policy in China

In compliance with emerging environmental imperatives, promoting sustainable development is long overdue and pivotal in today’s world. Financial policy works closely within this global discourse, but information on how it works at the micro level to achieve a green transition is still limited. Based on the environmental, social, and governance framework, we characterize the central bank eligible collateral framework as a quasi-natural experiment to determine the effect of green financial policy on firms’ bond financing costs and long-term green transition. The findings reveal a significant decline in the bond spread for green bonds and an increase in brown bonds, demonstrating the existence of the green premium. This relationship becomes pronounced when we explore the moderating effect of firms’ operational volatility and the scale of their long-term loans. We also find substantial heterogeneity in policy impacts stemming from variations in firms’ green innovation activities. Our findings thus provide insights into the role of a sound green policy in achieving green transition and sustainable growth.

Should central bank liquidity be a vehicle for fiscal disciplining?

Abstract With notable exceptions, central banking scholars typically pay little attention to collateral frameworks, and therein, to the haircuts applied to the collateral assets pledged to access central bank liquidity. One such exception, Kjell Nyborg (2017) argues that the collateral policies adopted by the European Central Bank (ECB) aggravated the sovereign debt crisis and put the survival of the euro at risk. Drawing on the money view, we argue that Nyborg’s critique of the ECB’s crisis response is misguided and that his proposal to deepen and reinforce the ECBs role in the fiscal disciplining of member states via its collateral framework would be procyclical and destabilizing. We identify core principles for collateral policies suitable to stabilise market-based financial systems: (i) countercyclical haircuts, (ii) suspension of collateral valuation practices; and should these not be sufficient to abate collateral market liquidity strains, (iii) outright purchases of collateral assets.

The politics of the ECB’s market-based approach to government debt

AbstractThe European Central Bank’s (ECB) market-based treatment of government debt was an important cause of the 2010–2012 eurozone crisis. This article analyses the political dynamics that govern the ECB’s approach to government debt from the earliest discussions on Economic and Monetary Union to the COVID-19 pandemic. The first part of the article traces the process of institutional transformation that led the ECB to introduce its strict market-based approach in 2005. I explain this development in terms of a strategy of depoliticization that brings the ECB to introduce a rigid and rule-based approach to designing its collateral framework. The article’s second part explains why the ECB stuck to the market-based approach in the eurozone crisis but not in the pandemic crisis. Although its ill-defined constitutional role led the ECB to disavow its agency earlier, in March 2020, it had become clear that this strategy had stopped working and it was quickly abandoned in the face of a new bond market panic.

Real Effects of Financial Market Integration: Evidence from an ECB Collateral Framework Change

Real Effects of Financial Market Integration: Evidence from an ECB Collateral Framework Change

Flight Abroad in the Euro Area: Evidence From a ECB Collateral Framework Change

This paper studies the effect of central bank collateral policy on bank credit supply and the real economy. In 2007, the European Central Bank replaced national collateral lists with a single list valid across the euro area. Banks holding newly eligible assets experienced a reduction in their cost of funding. Consequently, they lent more compared to banks without such assets, and they extended more loans to riskier and less productive borrowers located in other euro area countries. These borrowers in turn experienced a growth in employment and investment. The results highlight the role of financial integration in fueling cross-border credit booms.

The Interest of Being Eligible

AbstractMajor central banks accept nonmarketable assets, such as pooled individual corporate loans, as collateral in their refinancing operations with banks. Such “eligible” loans to firms may provide a liquidity service to the banks which originate them. Banks may in turn pass on a part of this benefit to their borrowers in the form of a reduced interest rate: the eligibility discount. We exploit a surprise extension of the Eurosystem's set of eligible collateral to medium‐quality corporate loans, the Additional Credit Claims (ACC) program of February 2012, to assess the eligibility discount to corporate loans spreads in France. We find that becoming eligible to the Eurosystem's collateral framework translates into a relative reduction in rates by 8 bps for new loans issued to ACC‐eligible firms , controlling for loan‐, firm‐, and bank‐level characteristics. We find that this collateral channel of monetary policy is only active for the banks which have a lower opportunity cost in pledging credit claims and which are well‐capitalized.

Toward a Central Bank Collateral Framework for ABMI

The post-global financial crisis highlighted the importance of engaging in collateralized securities financing to meet the ever-increasing market needs for liquidity and risk management. Given the heavy reliance on volatile Eurodollar system and the fragmented governance and limited cross-border usability of the collateral among ASEAN+3 countries, it is important to relax prevailing constraints on collateral and mobilize cross-border transactions. To address the imperatives for securing collateral-based cross-border financial markets in the region, Asia needs the initiatives of central banks to develop a regional collateral framework for better financial plumbing. By collaborating on common grounds for cross-border collateral utilization, some of the prevailing constraints on collateral use can be relaxed. The inclusive collateral framework that incorporates CBCA (Central Bank Collateral Arrangement) would provide strong initial market support for the ABMI, thus help achieve sustainable financial stability.

Toward A Central Bank Collateral Framework for ABMI

The post-global financial crisis highlighted the importance of engaging in collateralized securities financing to meet the ever-increasing market needs for liquidity and risk management. Given the heavy reliance on volatile Eurodollar system and the fragmented governance and limited cross-border usability of the collateral among ASEAN+3 countries, it is important to relax prevailing constraints on collateral and mobilize cross-border transactions. To address the imperatives for securing collateral-based cross-border financial markets in the region, Asia needs the initiatives of central banks to develop a regional collateral framework for better financial plumbing. By collaborating on common grounds for cross-border collateral utilization, some of the prevailing constraints on collateral use can be relaxed. The inclusive collateral framework that incorporates CBCA (Central Bank Collateral Arrangement) would provide strong initial market support for the ABMI, thus help achieve sustainable financial stability.

Climate-related Risks and Central Banks’ Collateral Policy: A Methodological Experiment

Central banks increasingly acknowledge that climate change is a source of financial risks, which is likely to also impact their conduct of monetary policy. Against this backdrop, the aim of this paper is to explore one potential approach to factoring climate-related transition risks into a central bank’s collateral framework. Given the radical uncertainty associated with measuring such risks, this approach relies on so-called climate “alignment” methodologies, which enable to assess the consistency of eligible and pledged marketable assets with specific climate targets. Moreover, this paper proposes a “climate-hedging portfolio approach”: instead of seeking to “align” the collateral on an asset-by-asset basis, central banks could aim for “alignment”, in aggregate, of the collateral pools pledged by their counterparties with a given climate target. The rationale for this choice is that assessing climate-related risk at the pool level avoids the Eurosystem having to decide on which assets/issuers in the pools should be excluded or capped, and is therefore more compatible with a market neutrality approach. The numerical experiment using Eurosystem marketable criteria data suggests that, in aggregate, neither the Eurosystem eligible collateral universe nor the collateral pledged is “aligned” with the climate targets of the European Union. From this perspective, the Eurosystem marketable collateral can be considered to be exposed to climate-related transition risks. We discuss the potential practical implications of aiming to “align” collateral pools, and suggest avenues for further work

Greening monetary policy

ABSTRACT While there is increasing interest in decarbonizing or greening monetary policy, central banks are keen to maintain market neutrality. However, there is evidence that the market has a bias towards carbon-intensive companies. The paper develops a method to tilt the European Central Bank’s (ECB) asset and collateral framework towards low-carbon assets. We find that a medium tilting approach reduces carbon emissions in the ECB’s corporate and bank bond portfolio by over 50%. We show that a low carbon allocation can be done without undue interference with the transmission mechanism of monetary policy. Key policy insights The ECB’s asset and collateral portfolio for monetary policy operations is overweight in high carbon companies. A medium tilting approach towards low-carbon companies reduces carbon emissions by 55% in the ECB's portfolio. It also reduces the cost of capital for low carbon companies. This is an incentive for high carbon companies to reform and adopt low carbon technologies.

Collateral Framework: Liquidity Premia and Multiple Equilibria

Central banks normally accept debt of their own governments as collateral in liquidity operations without reservations. This gives rise to a valuable liquidity premium that reduces the cost of government finance. The ECB is an interesting exception in this respect. It relies on external assessments of the creditworthiness of its member states, such as credit ratings, to determine eligibility and the haircut it imposes on such debt. We show how such features in a central bank's collateral framework can give rise to cliff effects and multiple equilibria in bond yields and increase the vulnerability of governments to external shocks. This can potentially induce sovereign debt crises and defaults that would not otherwise arise.

The Preferential Treatment of Green Bonds

We study the preferential treatment of green bonds in the Central Bank collateral framework as an environmental policy instrument within a DSGE model with environmental and financial frictions. Green and conventional entrepreneurs issue bonds to banks that use them as collateral. The associated collateral premium induce entrepreneurs to increase bond issuance, investment, leverage, and default risk. Collateral policy solves a trade-off between increasing collateral supply, adverse effects on entrepreneur risk-taking, and subsidizing green investment. Due to these adverse side effects, optimal collateral policy is characterized by modest preferential treatment, thereby increasing the green bond share and, to a smaller extent, the green investment share, which in turn reduces pollution. The limited response of green investment is directly related to higher risk-taking of green entrepreneurs. Furthermore, we show that preferential treatment is an imperfect substitute of Pigouvian taxation on pollution: only if the optimal tax can not be implemented, optimal collateral policy features preferential treatment of green bonds.