Edited by Matthias Haentjens and Bob Wessels
Chapter 2: Central banks, systemic lending and collateral markets
This chapter examines the evolving role that central banks play in funding private banks and, increasingly, a wider range of non-bank financial intermediaries. In particular, the central bank serves as lender of last resort to solvent banks temporarily locked out of the private funding markets in which they manage their liquidity. The central bank does this by lending to these banks as well as by entering into outright purchases and sales of financial assets and engaging in repurchase agreements. In these operations, the central bank acts through the price mechanism (buying at the ask and selling at the bid) rather than through regulatory coercion. During periods of financial stability, the central bank may provide last resort funding to an individual bank suffering a temporary liquidity shortage due to factors specific to that bank. During a financial crisis in which it is not individual banks but, rather, a sector of the funding market that becomes illiquid, the central bank will also engage in systemic lending to help stabilize an entire sector of the financial market. Traditionally, access to the central bank’s last resort liquidity was available only to depository banks with a pre-existing relationship to the central bank and with collateral that met strict guidelines. This chapter analyzes how the traditional approach to central bank funding has changed.
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