Securities Lending and Quantitative Easing

Project Start:08/2020
Researchers:Virginia Gianinazzi, Loriana Pelizzon, Marti Subrahmanyam, Davide Tomio
Category: Financial Markets
Funded by:SAFE

"In this project we aim to show that the effectiveness of central banks' interventions in lowering bond yields when engaged in Quantitative Easing (QE)-i.e., the outright purchase of securities---is hindered when central banks make securities they purchase available for borrowing.

QE is a policy tool that is especially powerful when the cost of money cannot be further decreased since it is close to the effective lower bound (Bernanke and Reinhart, 2004).. By making securities such as sovereign bonds scarce, central banks can increase their prices, further lower interest rates, inject liquidity in the economy and stimulate lending and, finally, push economic growth (see Krishnamurthy and Vissing-Jorgensen, 2011 for a rundown of the channels through which QE affects the economy).

By making the securities purchased a scarce asset, however, central banks hoard the most common assets employed in the market for collateralized lending, specifically the repurchase agreement (repo) market, and significantly inhibit a major means of funding liquidity for corporations Arrata, Nguyen, Rahmouni-Rousseau, and Vari, 2017).. To obviate this unintended consequence, central banks lend out the securities they purchase and, by doing so, they partially ``undo'' the scarcity of these securities they originally intended to create.

We lay out the trade-off that a central bank faces between the effectiveness of its purchases and the smooth functioning of collateral-based funding markets. We expect to show the real effects that securities lending has on the economy. We will also show that when the Treasury securities purchased in the context of QE are allowed to be borrowed by the financial system: 1) Bond markets are more liquid, thanks to the lower inventory risk held by bond dealers, 2) ``Fails-to-delivery'' in the context of repo transactions decrease, since the security borrower can always source the security from the central bank, and 3) Special repo transactions decrease on private platforms, as the securities lending facility (SLF) claims a lion's share of the existing repo market."