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Stress testing with multi-faceted liquidity: the central bank collateral framework as a financial stability tool

Author

Listed:
  • Cuzzola, Angelo
  • Barbieri, Claudio
  • Bindseil, Ulrich
Abstract
The paper studies the central bank collateral framework and its impact on banks’ liquidity under an adverse stress test scenario. We construct a stress test model that accounts for a granular and multi-faceted representation of the liquidity of marketable and non-marketable assets. In particular, the model analyses banks’ strategic decisions to mobilise assets through four funding channels: unsecured loans, asset sales, private repurchase agreements, or Central Bank lending. We test three scenarios: the EBA regulatory stress test exercise, a shock to Russia and the Eastern European countries, and a shock to the Southern European countries. Results show that illiquidity can trigger insolvency and that liquidity adjustment can last significantly after the initial shock. We find evidence of a threshold in the benefits of expanding the collateral framework and highlight the heterogeneous effects across different jurisdictions and financial institutions. We find that bank equity losses are reduced in aggregate up to 17% at the tail of the loss distribution and on average by around 5% when financial institutions can rely on the collateral framework channel. JEL Classification: C63, E52, G01, G28

Suggested Citation

  • Cuzzola, Angelo & Barbieri, Claudio & Bindseil, Ulrich, 2023. "Stress testing with multi-faceted liquidity: the central bank collateral framework as a financial stability tool," Working Paper Series 2814, European Central Bank.
    • Handle: RePEc:ecb:ecbwps:20232814
    Note: 327704
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    File URL: https://www.ecb.europa.eu//pub/pdf/scpwps/ecb.wp2814~142d4a795f.en.pdf
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    Citations

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    Cited by:

    1. Michele Azzone & Roberto Baviera & Pietro Manzoni, 2024. "The puzzle of Carbon Allowance spread," Papers 2405.12982, arXiv.org.

    More about this item

    Keywords

    Asset liquidity; Central Bank Collateral Framework; Collateral; Lender-Of-Last Resort; Stress test;
    All these keywords.

    JEL classification:

    • C63 - Mathematical and Quantitative Methods - - Mathematical Methods; Programming Models; Mathematical and Simulation Modeling - - - Computational Techniques
    • E52 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Monetary Policy
    • G01 - Financial Economics - - General - - - Financial Crises
    • G28 - Financial Economics - - Financial Institutions and Services - - - Government Policy and Regulation

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