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Collateral Management in the LVTS by Canadian Financial Institutions

Authors
Disciplines
  • Economics

Abstract

This article examines the incentives for banks to hold various assets on their balance sheets for use as collateral when the opportunity cost of doing so can be high. Focusing on the five-year period (2002-07) that preceded the financial crisis, it examines the choices made by financial institutions among the assets that are pledged as collateral in Canada's Large Value Transfer System. This serves as a baseline for collateral-management practices during relatively normal times. The results of this study are important for policy-makers, especially the Bank of Canada, which is concerned both about the efficient functioning of fixed-income markets and about the credit risk it ultimately bears in insuring LVTS settlement. The results suggest that relative market liquidity and market-making capacity are important factors in the choice of securities pledged as collateral in the LVTS.

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