Safe asset shortage

The collateral reuse channel

An increasing global demand for high quality assets as well as large-scale purchases of sovereign debt by central banks have contributed to a scarcity of safe assets. Market participants have adjusted to this limited availability of safe assets as collateral by reusing received collateral in other transactions.

In this paper, Jank et al. use a unique proprietary dataset to study this largely ignored “collateral reuse channel.”  They use Bundesbank’s Securities Holdings Statistics (SHS) which provides security-level data on German banks’ portfolios at quarter and month ends. This dataset also includes for each security the amount of incoming and outgoing collateral from securities lending and repo transactions. The authors focus on sovereign bonds issued by euro area countries with a remaining maturity between 1 and 30 years and denominated in Euro and which are actively used by German dealers as collateral. Their results highlight the trade-off between shock absorption and shock amplification effects of collateral reuse.

First, we document that banks substantially increase collateral reuse in response to scarcity induced by Eurosystem asset purchases. Second, we show that reuse mitigates scarcity premia when it is low but amplifies them when reuse is already high. Finally, we document that elevated levels of reuse are associated with a higher prevalence of failures to deliver in the repo market and an increased volatility of repo rates.

Safe asset shortage and collateral reuse
Authors: Stephan Jank, Emanuel Moench, Michael Schneider
From: Deutsche Bundesbank, Frankfurt School of Finance and Management

Eurobonds as safe assets

In this paper Bletzinger et al. explain why issuance of Eurobonds could alleviate the safe asset scarcity in the Eurosystem. They base their argument on the following empirical findings:

(i) EU bonds are widely considered by market participants as low in default risk, even though rating agencies have disagreed somewhat on the extent to which EU bonds are entirely default risk free. (ii) EU-Bund yield spreads remained contained during the Covid-19 pandemic recession, suggesting robustness to market downturns. (iii) Before the issuance of new (SURE) bonds in October 2020, EU bonds were subject to much lower market liquidity (i.e., wider bid-ask spreads) than large euro area member states’ sovereign bonds. Bid-ask spreads have decreased since then. (iv) “Tapping” previously-issued EU bonds increased these bonds’ secondary market liquidity, and thus appears to be an expedient way to raise EU funding in the future. (v) Changes in EU yields over time are most closely correlated with those of highly rated but less liquid German KfW bonds, suggesting that liquidity risk premia are an important component of EU yields. (vi) EU yield spreads over ten-year German benchmark bonds (Bunds) have decreased notably following recent, Covid-19-related SURE and NGEU bond issuances, suggesting that investors recognized the improved liquidity conditions. Finally, (vii) Eurosystem purchases and lagged holdings of EU bonds did not raise their bid-ask spreads, suggesting that the market is already sufficiently liquid to accommodate these operations.