The Collateral Trap

Frédéric Boissay and Russell Cooper

No 565, BIS Working Papers from Bank for International Settlements

Abstract: Active wholesale financial markets help reallocate deposits across heterogeneous banks. Because of incentive problems, these flows are constrained and collateral is needed. Both the volume, the value, and the composition of collateral matter. We make a distinction between "outside collateral" and "inside collateral". The use of inside assets, such as loans, creates a "collateral pyramid", in that cash flows from one loan can be pledged to secure another. Through collateral pyramids the financial sector creates safe assets, but at the cost of exposing the economy to systemic panics. Outside collateral, such as treasuries, serves as foundation of, and stabilises, the pyramid. There is a threshold for the volume of treasuries, below which investors panic, the pyramid collapses, and there is not enough safe assets to support wholesale market activity; a situation that we call "collateral trap".

Keywords: Banking crisis; collateral composition (search for similar items in EconPapers)
Pages: 39 pages
Date: 2016-06
New Economics Papers: this item is included in nep-ban
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Citations: View citations in EconPapers (1)

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Related works:
Working Paper: The Collateral Trap (2014)
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