Securities losses impact monetary policy transmission through bank collateral
A new ECB working paper demonstrates that losses on banks' securities portfolios significantly impact monetary policy transmission. These losses impair banks' ability to access interbank liquidity, leading to reduced corporate lending, even without financial stability concerns.
Collateral erosion curbs corporate credit
The paper reveals that when monetary policy tightens, the market value of banks' pledgeable securities declines, particularly for longer-duration instruments.
This reduction in collateral value weakens banks' ability to raise liquidity in the interbank market, especially through secured borrowing like repurchase agreements.
Anticipating future liquidity shocks, banks respond by reducing their exposure to illiquid assets, most notably corporate loans.
This mechanism operates even when banks remain well-capitalised and regulatory capital is not directly affected, highlighting a collateral-based bank lending channel.
A one-standard-deviation increase in securities losses is associated with a 3.76 percent decline in interbank credit and a 2.5 percent decline in corporate lending.
National borders limit group liquidity
Internal capital markets within banking groups offer partial mitigation for domestic subsidiaries, allowing them to draw liquidity without pledging collateral.
This cushions the impact of securities losses on their funding and lending.
However, this support is uneven: foreign subsidiaries within the euro area do not benefit similarly and reduce lending like stand-alone banks.
This segmentation highlights the continued importance of national boundaries, reflecting national deposit insurance and local liquidity requirements, suggesting incomplete banking integration across the Eurozone.
Beyond capital: a new policy lens
This research significantly expands the understanding of monetary policy transmission beyond traditional capital constraints.
It underscores the critical role of liquidity management and collateral values in shaping credit conditions, even for well-capitalized banks.
Policymakers must consider these collateral-based channels and the implications of incomplete banking integration for effective euro area monetary policy.