Using bank loans as collateral in Europe : The role of liquidity and funding purposes

Working Paper N° 318

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Abstract

We show that illiquid assets such as bank loans are used by euro area banks both as central
bank collateral for short-term liquidity insurance purposes and for longer-term funding
purposes for issuing covered bonds or asset-backed securities. We then explore the
determinants of the choice of using bank loans for short-term liquidity insurance purposes or
long-term funding purposes focusing on the case of Belgian banks. We find that (1) loan
types are key to alleviating asymmetries of information; (2) regulatory requirements play a
major role in the choices of banks, both directly and indirectly through clientele effects and (3)
there are significant switching costs between the various uses of bank loans as collateral so
historical decisions also determine the use of bank loans as collateral.