Collateral is the new cash: The systemic risks of inhibiting collateral fluidity

Abstract

Collateral is becoming increasingly important in the post-crisis world, driven by both a need for more secured funding as well as regulatory requirements to reduce credit risk. In many ways, collateral has become the new cash, underpinning the smooth functioning of funding and capital markets, while, in turn, providing the basis for economic growth. The expected increase in demand for collateral may lead to demand-supply imbalances; however, what is more important is collateral fluidity, which allows collateral to move around the system to meet varying demand conditions across the financial markets landscape. This requires both robust and efficient settlements infrastructure (the ‘plumbing’), as well as bank funding desks that are able to source, price, manage and mobilise collateral (the ‘pump’). There exist a number of market and regulatory initiatives that may impact collateral fluidity, either positively or negatively. Some relate directly to the ability of bank funding desks to function effectively, while others affect the providers and takers of collateral. The systemic risks arising out of regulations that inhibit collateral fluidity would have broad and severe repercussions, not only for the financial markets, but also throughout the real economy. Ultimately, sound regulation is essential for the efficient and stable functioning of global funding and capital markets that support our economies. These markets are already significantly safer than before the financial crisis. As collateral becomes an increasingly important feature of the new market and regulatory landscapes, so regulation should avoid inhibiting, and ideally seek to enhance, collateral fluidity.