What drives interbank loans? Evidence from Canada

Abstract

We identify the drivers of unsecured and collateralized loan volumes, rates and haircuts in Canada using the Bayesian model averaging approach to deal with model uncertainty. Our results suggest that the key friction driving behaviour in this market is the collateral reallocation cost faced by borrowers. Borrowers therefore adjust unsecured lending in response to changes in short-term cash needs, and use repos to finance persistent liquidity demand. We also find that lenders set rates and haircuts taking into account counterparty credit risk and collateral market price volatility.

Estimating Policy Functions in Payments Systems Using Reinforcement Learning

“…This indicates that, while the cost of liquidity in the morning is smaller than the cost of borrowing in the evening, liquidity in the morning is still costly. One potential source of this cost are collateral reallocation costs: once the collateral has been pledged to the Bank of Canada to collateralize their payments in the system, changing this portfolio of securities is cumbersome (Bulusu and Guérin 2019). This cost is smaller than the 25 basis points band between the target rate and the borrowing cost of the bank.…”