How do central bank collateral frameworks affect non-financial firms?

The dampening effect of firm responses is associated with the debt-overhang problem that eligibility inflicts on high-rated firms: increasing leverage in periods of high profitability has little effect on their current default risk and, therefore, makes it easy for firms to increase current dividends. Ultimately, however, firms will experience periods of low profitability — for example, if their business models deteriorate or their products become unfashionable. This makes their legacy debt unsustainable, such that firms drop below the minimum rating requirement or even default. The underlying reason for these dynamics is the “stickiness of leverage” (see Gomes et al. 2016).3

Firm responses directly affect the central bank trade-off that guides the design collateral frameworks: increasing the supply of collateral ensures smooth conduct of monetary policy while the overall riskiness on the corporate bond market rises . Although our results suggest that central banks should consider firm responses when designing their collateral frameworks, we also propose a potential instrument to mitigate adverse collateral quality effects: conditioning eligibility on current leverage in addition to current ratings provides incentives to deleverage if firm profitability deteriorates and thereby softens the adverse consequences of the debt overhang. In practice, such conditioning can be implemented by rating outlooks in addition to current ratings. Our model predicts that an optimally designed eligibility covenant could have increased collateral supply by 12%, equivalent to EUR 225 billion for the euro area in 2009.

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Finally, our paper speaks to the ongoing discussion on green central banking. This policy is supposed to stimulate the investment of green firms by relaxing their financing conditions through preferential treatment in collateral frameworks. Our analysis suggests that there may be nonnegligible feedbacks from firm risk taking to collateral supply and financial stability. We explore the effectiveness of this policy instrument in detail in a related paper (Giovanardi, Kaldorf, Radke, and Wicknig 2021).


Bekkum, Sjoerd van, Marc Gabarro, and Rustom M Irani (2018). “Does a larger menu increase appetite? Collateral eligibility and credit supply.” Review of Financial Studies 31(3), 943–979.

Giovanardi, Francesco, Matthias Kaldorf, Lucas Radke, and Florian Wicknig (2021). “The Preferential Treatment of Green Bonds.” Working Paper.

Gomes, Joao, Urban Jermann, and Lukas Schmid (2016). “Sticky Leverage.” American Economic Review 106(12), 3800–3828.

Grosse-Rueschkamp, Benjamin, Sascha Steffen, and Daniel Streitz (2019). “A Capital Structure Channel of Monetary Policy.” Journal of Financial Economics 133(2), 357–378.

Kaldorf, Matthias and Florian Wicknig (2021). “Risky Financial Collateral, Firm Heterogeneity, and the Impact of Eligibility Requirements.” Working Paper.

Mesonnier, Jean-Stephane, Charles O’Donnell, and Olivier Toutain (2021). “The Interest of Being Eligible.” Journal of Money, Credit and Banking.

Pelizzon, Loriana, Max Riedel, Zorka Simon, and Marti Subrahmanyan (2020). “The Corporate Debt Supply Effects of the Eurosystem’s Collateral Framework.” Working Paper.

Todorov, Karamfil (2020). “Quantify the Quantitative Easing: Impact on Bonds and Corporate Debt Issuance.” Journal of Financial Economics 135(2), 340–358.

1 Van Bekkum et al. (2018) provide similar evidence using Dutch MBS data.
2 Our model is also applicable to other situations where eligibility induces a jump in bond demand, for example the eligibility on repo markets or for QE programs. Similar discontinuities are also induced by investment fund regulation: due to regulatory restrictions, bonds that are just rated Investment Grade (BBB-) experience large demand increases relative to those still rated High Yield (BB+).
3 Our results primarily apply to permanent changes in collateral frameworks, rather than relaxations for a short predetermined period. However, as table 1 suggests, collateral framework changes have been very persistent.
Matthias Kaldorf is a PhD Candidate at the University of Cologne. More about his research can be found here.
Florian Wicknig is a PhD Candidate at the University of Cologne. More about his research can be found here.

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