Monetary policy, illiquid collateral and bank lending during the European sovereign debt crisis

Abstract

This paper assesses the effect on banks’ lending activity of accepting illiquid collateral at the central bank refinancing facility in times of wholesale funding stress. We exploit original data on the loans granted by the 177 largest euro area banks between 2011m1 and 2014m12 and on the composition of their pool of collateral pledged with the Eurosystem. During this period, two-thirds of the banks in our sample experienced a sizable loss of wholesale funding. Panel regression estimates show that the banks that pledged more illiquid collateral with the Eurosystem reduced their lending to non-financial firms and households less: a one standard deviation increase in the volume of illiquid collateral pledged corresponded to a 1.1% increase in loans to the economy. This result holds for banks that were and were not run. Our finding thus suggests that the broad range of collateral eligible in the euro area may have helped to mitigate the credit crunch during the euro debt crisis.