Liquidity, Collateral Quality and Interest Rate

Jung-Hyun Ahn, Vincent Bignon (), Régis Breton () and Antoine Martin ()
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Vincent Bignon: DGSEI DPEM - Banque de France, Direction générale des Statistiques, des Études et de l'International, CEPR - Center for Economic Policy Research, AMSE - Aix-Marseille Sciences Economiques - EHESS - École des hautes études en sciences sociales - AMU - Aix Marseille Université - ECM - École Centrale de Marseille - CNRS - Centre National de la Recherche Scientifique
Régis Breton: Centre de recherche de la Banque de France - Banque de France
Antoine Martin: Sentier Ergonomie

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Abstract: This paper analyzes how collateral quality shocks affect banks' liquidity management and the risk-free rate. We develop a model where banks manage liquidity through near-cash assets and marketable securities subject to idiosyncratic and/or aggregate shocks. Collateral quality deterioration leads to non-monotonic changes in liquidity holdings: moderate declines reduce cash holdings via lower market returns, while severe declines cause precautionary hoarding and market freezes. Reduced collateral quality depresses the risk-free rate. Policy interventions, including liquidity regulation and negative interest rate policies can mitigate these effects. Our findings highlight the risks of collateral quality shocks and the importance of policy complementarities in addressing liquidity issues.

Keywords: interbank market; risk-free rate; collateral; liquidity regulation; negative interest rate; cash-hoarding (search for similar items in EconPapers)
Date: 2025-01-16
Note: View the original document on HAL open archive server: https://hal.science/hal-04901384v1
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Working Paper: Liquidity, Collateral Quality and Interest Rate (2025)
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