XXV Edition

1-2 December 2016"

Funding Risk and Collateralized Lending

Koenig Philipp, German Institute for Economic Research (DIW Berlin)
Daniels Tijmen , Dutch Central Bank

This paper uses a stylized 3-action global game banking model to compare the effects of secured and unsecured lending. We establish the following key results. First, the availability of secured wholesale debt exerts a catalytic effect on lending in equilibrium and lowers the bank's funding risk. This leads to an increase in welfare. Second, however, secured financiers may finance inefficient banks. This may lead to a reduction in welfare. Third, we show under which conditions the overall effect from introducing secured debt on expected welfare is positive. Fourth, our model predicts tiering: Sound banks with good fundamentals are more likely to refinancer using unsecured debt, while unsound banks are more likely to issue secured debt.

Area: Financial Stability

Keywords: funding risk, coordination failure, global games, secured debt, collateral

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