The effect of central bank operations on collateral markets is becoming increasingly more important, as the regulatory landscape evolves and market practices change, according to a study conducted by the Committee on the Global Financial System and the Markets Committee.
The report, titled Central Bank Operating Frameworks and Collateral Markets, suggests that many banks have left a footprint in markets for assets that also serve as collateral, following large-scale asset purchases, and other unconventional policy tools over recent years. This has coincided with increasing demand for collateral assets.
It argues that operations could have a significant effect on the assets market. Whether the effects are material or not depends on the size of the operations in relation to the market for collateral assets, and on whether financial market participants are constrained by the collateral available.
Effects can also depend on the various design choices at a central bank’s disposal, such as the supply or pledgeability of assets, as well as policies, haircuts and counterparty access policies.
These options can be used to support collateral markets, and the report pointed out that they have been used in this way during the euro sovereign debt crisis and by the US Federal Reserve throughout the financial crisis.
A number of tools and metrics are available for assessing how markets for collateral assets are affected by operational choices, the report says.
It adds that there are two main channels of impact, scarcity effects and structural effects, and suggests that there should be a broad and conceptual framework in place for analysing the differences.
The report also distinguishes between effects during ‘normal’ times versus times of stress. In normal times, the report found that the effects of operations choices to be minimal.
Crisis times, however, are generally associated with greater scarcity of collateral in the financial system, when declined confidence in the market leads to a shift from unsecured to secured financing. In these cases, central banks could operate on a larger scale, which will, in turn, have negative, unintended side effects on collateral markets.
In times of crisis, banks will also be more likely to try to directly influence functioning of collateral markets, for example, by introducing facilities that allow banks to post illiquid collateral assets in place of liquid securities.
Finally, the report suggests that some aspects of operational frameworks should be examined to assess their preparedness for a crisis response. Any effects on collateral markets should be carefully monitored, especially in connection with unconventional monetary policies and exit from policies.
The study draws on case studies, surveys and interviews with market participants, and aims to facilitate discussion among central banks about their operational frameworks and potential effects of them.
