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Collateral Scarcity: An Approach to Preventing Market Stress from Becoming Contagion

Since the financial crisis of 2007 and 2008, regulators around the world have been working diligently to strengthen policies to stabilize the global financial system and prevent or mitigate future crises. Policymakers are focused on several items to ensure regulatory changes attain their fundamental objectives:

• The underlying factors that lead to crisis
• Changing macroeconomic and financial market conditions
• The secondary impacts of enacted or pending policy changes

One specific secondary impact demands further exploration: the availability and use of various forms of acceptable collateral in capital market activities and other financial applications. That is the subject of this paper written by Treasury Strategies, Inc.

New regulations around the globe call for increased use of collateral, higher required collateral levels and larger haircuts for certain collateral instruments. Under stressed or rapidly changing market conditions, increased collateral demands could strain the very financial markets they are meant to stabilize.

It is useful to examine the amount of collateral that may be required under new regulations, the amount that may be available, and factors that may prevent collateral from being readily accessed. As this paper shows, there is compelling evidence to conclude that collateral scarcity may in fact arise during times of market stress.

Having demonstrated this, the paper considers one avenue to address such a potentially de-stabilizing factor: adjusting the policies for the types of collateral that are acceptable. Specifically, by treating Treasury-Only Money Market Mutual Funds (TMMFs) as functionally equivalent to Treasury Bills (T-Bills) for collateral purposes, regulators can reduce systemic risks associated with heightened global demand for high-quality collateral.

Treasury Strategies

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