BofE working paper: Liquidity transformation, collateral assets and counterparties

We investigate how counterparties’ characteristics, and the collateral they use, interact with their demand for liquidity in the Bank of England’s (BoE) operations. Between 2010 and 2016 there was regular usage of two BoE facilities: Indexed Long-Term Repos (ILTR) and the Funding for Lending Scheme (FLS). Using BoE proprietary data, we show that participation in ILTR is not skewed towards riskier counterparties, and is instead consistent with safe counterparties using the facilities to meet their liquidity needs. Collateral assets used for FLS are less liquid, since almost all assets are loan portfolios. Riskier and larger institutions are more likely to pre-position collateral in the FLS, but these counterparties do not subsequently draw upon FLS more than others do. Overall, our study points to no systemic misincentives; rather banks react to incentives in the manner intended by the policy objectives. Our results support the view that the central bank can provide market liquidity without absorbing undue risks onto its balance sheet.