Collateral eligibility policy is neglected, says BIS paper

A working paper, published by the Bank for International Settlements on November 9, says collateral eligibility is a neglected aspect of monetary policy theory, and the easing of collateral standards by the European Central Bank (ECB) is exposing the eurozone to greater risk.

The authors, William Allen and Richhild Moessner, analyse the liquidity effects of the euro area sovereign debt crisis on intra-euro area financial flows, international liquidity, and the supply of and demand for collateral.

The eurozone, the authors say, has expanded the range of eligible collateral so as not to aggravate a ‘collateral squeeze' that is developing as anxiety about bank solvency increases. The amount of eligible assets at the ECB was increased by 62% between 2006 and the second quarter of 2012. This has exposed the eurozone to greater credit risk, as has the central bank's outright monetary transactions (OMTs), the paper says.

The paper says eligibility policy has been a "neglected aspect" in monetary policy theory, and analysis of how these polices impact the relative price of assets is needed.

Click here to read the paper.