Systemic Risk and Monetary Policy: The Haircut Gap Channel of the Lender of Last Resort

Martina Jasova, Luc Laeven, Caterina Mendicino, Jose-Luis Peydro and Dominik Supera

The Review of Financial Studies, 2024, vol. 37, issue 7, 2191-2243

Abstract: We show that lender of last resort (LOLR) policy exacerbates bank interconnectedness. Using novel micro-level data, we analyze LOLR’s haircut gaps: the differences between the private market and central bank haircuts. LOLR policy incentivizes banks to increase pledging and holdings of higher haircut-gap bonds, especially those issued by domestic and systemically important banks. Effects only apply to banks, not to nonbanks without LOLR access. LOLR funding revives bank bond issuance associated with higher haircut gaps and increases the subsequent correlation between pledging and issuing banks’ bond prices, in particular during periods of low-market returns and for domestic, systemically important banks.

Keywords: E44; E52; E58; G01; G21 (search for similar items in EconPapers)
Date: 2024
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Working Paper: Systemic Risk and Monetary Policy: The Haircut Gap Channel of the Lender of Last Resort (2021)
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