Liquidity, Collateral Quality, and Negative Interest Rate

Ahn, Jung-Hyun; Bignon, Vincent; Breton, Régis; Martin, Antoine

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Liquidity, Collateral Quality, and Negative Interest Rate

Abstract: We analyze how banks manage liquidity between cash and marketable securities and its impact on the refinancing of projects subject to a liquidity shock. Securities can be pledged as collateral to acquire additional cash but are an imperfect hedge because their quality is uncertain. We show that banks may hold too much or too little cash in equilibrium compared to the first-best level, depending on the dispersion of securities value. Furthermore, the equilibrium relationship between the dispersion and banks cash holding is non-monotonous. We use this framework to assess the impact of liquidity regulation and negative interest rate policy.

Keywords: money markets; liquidity regulations; negative interest rates; cash; hoarding; cash-in-the-market pricing;

JEL Classification: E58; G21; G28;