Introduction

Chapter 7 has presented a theoretical approach for deducing the optimal collateral framework of the central bank based on a cost–benefit analysis. The analysis was based on the assumption that the central bank needs to cover exogenously determined refinancing needs of the banking system vis-à-vis the central bank without exposing itself to risks beyond a certain level deemed acceptable. Furthermore, the central bank will always try to do so in the most cost-efficient way. Therefore, it will rank assets that are potentially eligible for collateral according to handling costs and the cost of the risk mitigation tools that would be needed to reduce the risk of these assets to the level set as acceptable by the central bank. These will then be included in the list of eligible assets in order of increasing cost until the aggregate outstanding volume of the eligible assets covers the corresponding needs of the system in cash.

Applying this basic framework in different central banks that act mainly as liquidity providers would normally lead to the implementation of collateral frameworks that are similar in their core features. Indeed when comparing the frameworks of the leading central banks, these exhibit many similarities. At the same time important differences also exist. This is also a result of the simplicity of the model described in Chapter 7 that does not fully capture the diversity of ‘liquidity needs’ in practice. These differences between central banks can be attributed to any of the following factors:

• Amount of liquidity deficit covered by collateralized lending: Generally speaking, the higher the amounts covered by such operations, the more extensive the range of collateral accepted would tend to be.

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