The first book-length study of the importance of collateral frameworks in monetary policy, focusing on the Eurozone and euro crisis.

Central bank collateral policies came under pressure with the 2007-08 financial market crisis. This paper addresses the rationale for and constraints in taking collateral, and recent practices in different collateral frameworks. It then considers the risks of adverse selection. The paper concludes that (i) the collateral framework needs to include market incentives; (ii) central banks face trade-offs between risk and counterparty access; (iii) emerging markets may see pressure on collateral policies in coming years; and (iv) further work is required to develop pricing incentives and the structure of central bank facilities, both during normal times and in periods of market stress.

This paper seeks to inform about a feature of monetary policy that is largely overlooked, yet occupies a central role in modern monetary and financial systems, namely central bank collateral frameworks. Their importance can be understood by the observation that the money at the core of these systems, central bank money, is injected into the economy on terms, not defined in a market, but by the collateral frameworks and interest rate policies of central banks. Using the collateral framework of the Eurosystem as a basis of illustration and case study, the paper brings to light the functioning, reach, and impact of collateral frameworks. A theme that emerges is that collateral frameworks may have distortive effects on financial markets and the wider economy. They can, for example, bias the private provision of real liquidity and thereby also the allocation of resources in the economy as well as contribute to financial instability. Evidence is presented that the collateral framework in the euro area promotes risky and illiquid collateral and, more generally, impairs market forces and discipline. The paper also emphasizes the important role of ratings and government guarantees in the Eurosystem's collateral framework.

The Eurosystem collateral framework (ESCF) has played a key role in the ECB monetary policy implementation since 1999. Moreover, the financial and sovereign debt crisis and with it the increased reliance of banks on central bank credit have underlined the importance of central bank collateral frameworks. Broad collateral frameworks have helped prevent large-scale liquidity-driven defaults of financial institutions in all major advanced economies. More recently, they have allowed central banks to provide a large amount of - at times targeted - longer-term credit. Nevertheless, a number of authors have argued that the ESCF is too forthcoming or broad and that it does not afford the central bank sufficient protection. This paper first explains and justifies the logic of collateral frameworks in general and that of the ESCF in particular. It then reviews the main critical comments. It concludes that the ESCF has been effective (i) in providing an adequate level of elasticity for Eurosystem credit, and (ii) in protecting the Eurosystem from financial losses despite the severity of the financial and sovereign debt crisis and the large amounts of longer-term credit provided by the Eurosystem.

Since 2007, central banks of industrialized countries have counteracted financial instability, recession, and deflationary risks with unprecedented monetary policy operations. While generally regarded as successful, these measures also led to an exceptional increase in the size of central bank balance sheets. The book first introduces the subject by explaining monetary policy operations in normal times, including the key instruments (open market operations, standing facilities, reserve requirements, and the collateral framework). Second, the book reviews the basic mechanics of financial crises as they have hit economies many times. The book then explains what central banks need to do to when financial markets and banks are impaired to fulfil their monetary policy and financial stability mandates. Besides demonstrating the need for non-conventional monetary policy measures, the book also highlights their dangers, such as moral hazard and increased central bank risk taking. The book draws a number of lessons from the crisis on non-conventional monetary policy operations, assessing what measures have worked well, and how a framework should be designed in future normal times such as to contribute to make financial crises less likely. Central bank monetary policy operations have traditionally been considered as a matter of practice, while the macroeconomic modelling of the transmission mechanism of monetary policy is regarded as a discipline relying on substantial theory ('monetary economics'). However, monetary policy operations can equally benefit from a theory, and from a normative framework to guide policy choices. The limited interest that monetary policy operations have found for many decades in academic economics may well have contributed to the many misunderstandings on central bank actions over recent years. This book provides a basis for a better theoretical understanding of real-world monetary policy operations.

Most readers, especially those with car loans or home mortgages, know about "collateral"--property that the lender can take away from the borrower in the event that the borrower defaults. In low/middle income countries, it is understood that conservative lenders exclude firms from credit markets with their excessive collateral requirements. Usually, this is because only some property is acceptable as collateral: large holdings of urban real estate and, sometimes, new motor vehicles. Microenterprises, SMEs, and the poor have little of this property but they do have an array of productive assets that could easily be harnessed to serve as collateral. It is only the legal framework which prevents firms from using these assets to secure loans. In countries with reformed laws governing collateral, property such as equipment, inventory, accounts receivable, livestock are considered excellent collateral. This book aims to better equip project managers to implement reforms to the legal and institutional framework for collateral (secured transactions). It discusses the importance of movable property as a source of collateral for firms, the relationship between the legal framework governing movable assets and the financial sector consequences for firms (better loan terms, increased access, more competitive financial sector), and how reforms can be put in place to change the lending environment.