Discussion Paper Details

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

Author(s): Martina Jasova, Luc Laeven, Caterina Mendicino, JosÚ Luis Peydrˇ and Dominik Supera

Publication Date: June 2021

Keyword(s): Bank Risk Concentration, Central Bank Liquidity, Collateral, haircuts and systemic risk

Programme Area(s): Financial Economics

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 intermediaries without LOLR access, to increase bank bond holdings. Finally, LOLR revives bank bond issuance associated with higher haircut gaps.

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Bibliographic Reference

Jasova, M, Laeven, L, Mendicino, C, Peydrˇ, J and Supera, D. 2021. 'Systemic Risk and Monetary Policy: The Haircut Gap Channel of the Lender of Last Resort'. London, Centre for Economic Policy Research.