Collateralised borrowing spiked amid financial stress: RBA

To reach its findings in its paper, The Role of Collateral in Borrowing, the authors focused on Australia’s short-term interbank markets during the global financial crisis (GFC) in September 2008, which was a period of extreme financial system stress.

The paper’s authors found that the presence of collateral does indeed affect reactions to stress, and the reactions differ depending on the characteristics of the borrower.

They noted that collateralised and uncollateralised interbank markets reacted differently when the Lehman Brothers collapsed in mid-September 2008 and caused sudden global financial turmoil.

“Collateralised borrowing rose, particularly by borrowers that already held large amounts of collateral prior to the stress,” the authors said.

“Uncollateralised borrowing did not increase overall, and for riskier borrowers (i.e., those with more non-performing loans (NPL) on their balance sheet), it decreased.”

The authors discovered that different types of borrowers (i.e., high NPL and low NPL borrowers with low collateral and high collateral) reacted differently in the collateralised (repo) market, and uncollateralised (unsecured) market.

“The combined outcome of these reactions was that riskier borrowers that held sufficient quantities of collateral switched from uncollateralised to collateralised borrowing,” the authors said.

According to the study, after the Lehman shock, riskier low doc (ex-ante) borrowers shifted from the unsecured to the repo market.

“This effect has a significant interaction with ex ante high-quality collateral holdings, such that the strongest shifts are by risky borrowers with large holdings of high-quality collateral,” the authors said.

“These patterns occur in the intensive and extensive margins. Overall, our results indicate that riskier borrowers are rationed from uncollateralised borrowing, while those with sufficient collateral can switch to collateralised borrowing.”

The authors also found that collateralised borrowing became relatively easy if the collateral contained assets that were in high demand throughout the financial system, and referred to previous work which revealed that there was a global spike in demand to hold the safest types of investments in late 2008.

“In Australia these are Australian Government Securities (AGS), which are frequently used as collateral in interbank markets,” the authors outlined. 

“We show that this spike in demand meant that lenders became willing to provide cash to borrowers at very low interest rates if the borrower provided AGS as collateral to the lender in return.”

“We also present evidence of broad-based excess demand for high-quality collateral, as the repo market collateralised against second-best collateral (i.e., semis) expands, while interest rates against first-best collateral (i.e., Australian Government securities (AGS)) fall noticeably – over 100 basis points in our sample.,” the authors said.

According to the authors, this is an indication of a lack of the most liquid safe assets.

“Patterns across lenders and collateral types indicate that this demand to hold liquid/safe assets facilitates credit flows, resembling the opposite of cash hoarding.”

The researchers observed that after the financial shock, uncollateralised borrowing by ex-ante riskier borrowers declined, while collateralised borrowing by banks with ex-ante more high-quality collateral rose, and riskier borrowers with sufficient high-quality collateral shifted from uncollateralised to collateralised borrowing.

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