Central Banking Liquidity Provision and Segmentation of Collateral Markets

Collateral frameworks operated by central banks are at the core of financial stability and monetary policy implementation. As the lender of last resort, a central bank protects itself from excessive credit risk with eligible collateral. However, the acceptability of assets in refinancing operations can distort asset pricing and concentrate liquidity-constrained banks in the segment of pledgeable debts. The empirical analysis of these effects is hampered by difficulties in identification: shifts in collateral frameworks usually coincide with changes in the credit risks of the debt issuers. In this paper, I address these challenges and trace the outcomes of the collateral policy amendment that took place in Russia in 2015. For identification, I build a novel dataset on Russian municipal credit markets and exploit the particularities of the institutional setup where multiple potential lenders compete for the same credit contracts in English auctions. In a difference-in-difference setting, I document the pricing effect of the collateral framework: as long as their liabilities are pledgeable under the updated refinancing program, the borrowers earn, on average, an interest rate discount of 0.8pp. I then analyze a simple mechanism of bank competition that drives the price differential. I first show that in the auctions allocating collateralizable contracts, it is liquidity-constrained banks who offer lower interest. I also demonstrate that short-in-liquidity banks affect pricing indirectly by competing more frequently for eligible assets. As a consequence, financially weak institutions win competition more often when they compete for collateralizable debts. The effects are robust to a wide range of tests, including a control for unobservable heterogeneity at the level of a loan contract. These results suggest that, by changing the network of borrower-lender relationships, collateral frameworks affect the pricing of eligible assets and bank concentration risks.