Working Paper: CEPR ID: DP16240
Authors: Martina Jasova; Luc Laeven; Caterina Mendicino; Jos Luis Peydro; Dominik Supera
Abstract: We show that lender of the last resort (LOLR) policy contributes to higher bank interconnectedness and associated systemic risk. Using novel micro-level data, we analyze the haircut gap channel of LOLR--the difference between the private market and central bank haircuts. LOLR increases interconnectedness by incentivizing banks to pledge higher haircut gap bonds, especially issued by similar banks and by systemically important banks. LOLR also exacerbates cross-pledging of bank bonds. Higher haircut gaps only incentivize banks, not other intermediarieswithout LOLR access, to increase bank bond holdings. Finally, LOLR revives bank bond issuance associated with higher haircut gaps.
Keywords: central bank liquidity; haircuts; collateral; bank risk concentration; systemic risk
JEL Codes: E44; E52; E58; F30; G01; G21
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| LOLR policy (G33) | bank interconnectedness (F65) |
| higher haircut gaps (I24) | more pledging of securities (G24) |
| higher haircut gaps (I24) | cross-pledging of bank bonds (G21) |
| LOLR policy (G33) | cross-pledging of bank bonds (G21) |
| higher haircut gaps (I24) | issuance of bank bonds (G21) |
| cross-pledging of bank bonds (G21) | systemic risk (E44) |
| higher haircut gaps (I24) | systemic risk at the margin (E44) |