Journal of Financial Market Infrastructures

This special issue of The Journal of Financial Market Infrastructures on collateral provides a collection of papers that are not fully in sync with traditional thinking in policy and academic circles (such as collateral reuse rate), or are under-researched. My hope is that this special issue will provide some food for thought for policy makers and academics as the financial markets and central banks, as well as forthcoming regulations, continue to change the demand for and supply of available collateral.

The issue's first paper, by Yuliya Baranova, Zijun Liu and Joseph Noss from the Bank of England, finds that a reduction in the willingness of market participants to act as intermediaries in collateral markets will likely lead to adverse consequences for market functioning and financial stability.

Our second paper is from the Reserve Bank of Australia and is one of the first to estimate the collateral reuse rate in Australia via a survey on collateral activity. The authors, Belinda Cheung, Mark Manning and Angus Moore, find that the reuse rate is lower now, in 2016, than it was in 2014.

The third paper in the issue, from Alexander Müller, Jan Paulick, Jan Fichtner and Hubert Wittenmayer from Deutsche Bundesbank, provides a snapshot of collateral submitted from 2008 to 2016 via different mobilization channels, and summarizes how submission of collateral shifted during times of crisis and then again due to monetary policy decisions.

The issue's fourth paper, from Manmohan Singh, reiterates that collateral does not flow through a vacuum; it needs (on- or off-) balance sheet space to move within the financial system, and ad hoc allocation of balance sheet space by central banks is not conducive to monetary policy transmission.

In the past few years, in several dissertations (including job market papers) and policy papers, researchers have tried to provide macro-foundations for the financial plumbing of the market. An example is our fifth paper by Ameya Muley from the MIT economics department (it forms part of his dissertation) and it provides the theory behind the plumbing, concluding that when central banks remove good collateral from the market this leads to lower investment and lower aggregate output in the economy. Thus, from a policy perspective, exhausting policy rates first (including below-zero rates) may be more effective than siloing good collateral when scarce.

The issue's final paper is from Charles M. Kahn and Hyejin Park from the University of Illinois at Urbana-Champaign. The authors model the asymmetry between collateral values to the parties in the collateral chain: a reason why hedge funds resort to rehypothecation of their assets with their prime broker rather than an outright sale in the market to fund their positions. In this more analytical paper it is highlighted that collateral reuse can be socially beneficial if the costs of misallocation are not significant.

I hope the readers of The Journal of Financial Market Infrastructures will attempt to journey into uncharted waters, especially since global financial markets are currently truly at a crossroads.

Manmohan Singh