RDP 2021-01: The Role of Collateral in Borrowing 6. Conclusion

The credit contractions that occur during financial crises have lasting adverse consequences. These contractions have been studied in detail (e.g. Schularick and Taylor 2012), and the presence of collateral has been put forward as an important determinant (e.g. Lian and Ma forthcoming). However, the effect of collateral on credit is difficult to identify, in part because retail credit markets tend to have illiquid and idiosyncratic collateral that is correlated with other borrower characteristics. To identify the role of collateral during crises, we focus on Australian interbank markets around the Lehman Brothers default. In this setting, the collateral is liquid and homogenous across borrowers, the shock is large and exogenous (unlike in regions where banks failed), and, with loan-level data, we can control for endogenous borrower-lender matching.

Our regulatory dataset includes loan-level collateralised and uncollateralised interbank borrowing, and the collateral held by each counterparty. With these data, we examine how banks' ex ante risk and collateral-holding characteristics determine how their borrowing reacts to the Lehman Brothers default. We control for endogenous borrower-lender matching by adopting fixed effects at the lender*time level or higher. Our study is also a contribution to the interbank markets literature. As far as we know, we are the first loan-level examination of collateralised and uncollateralised interbank markets that operate side by side without intermediation by a central counterparty.

We show that after the shock, uncollateralised borrowing by ex ante riskier borrowers declines, collateralised borrowing by banks with ex ante more high-quality collateral rises, and riskier borrowers with sufficient high-quality collateral substitute from uncollateralised to collateralised borrowing. We also find evidence of broad-based excess demand for safe collateral, as the repo market collateralised against second-best collateral expands, while rates on the safest collateral fall heavily (over 100 basis points in our sample). Patterns across lenders and collateral types indicate that this demand to hold liquid/safe assets facilitates credit flows, resembling the opposite of cash hoarding. Overall, our estimated effects are statistically and quantitatively significant, and do not appear in placebo regressions using 2006 data (i.e. normal times).