The Committee on Payment and Settlement Systems (CPSS) has long given attention to liquidity issues arising from commercial banks' use of payment systems. And because collateral plays an important role in securing the credit extended by a central bank, these liquidity issues are deeply interrelated with policies stipulating the terms and conditions under which a central bank accepts collateral. During the past few years, with the globalisation of financial markets and the increasing use of collateral to mitigate counterparty risks in financial market transactions, the banking community has discussed the potential to use collateral in one country or currency to obtain liquidity in another.
In this context, and under the leadership of its former chairman, Tommaso Padoa-Schioppa, the Committee established a working group to investigate: (i) calls for central banks to accept collateral denominated in a foreign currency or located in a foreign jurisdiction in order to support intraday or overnight credit, either routinely or in extraordinary situations; (ii) the existing institutional arrangements through which central banks accept foreign collateral; and (iii) alternative models for the acceptance of foreign collateral. As part of this effort, the working group conducted a series of interviews with selected internationally active banks.
The report notes that large internationally active banks must manage their collateral and liquidity in multiple currencies and jurisdictions, and, as a result, they are developing new techniques to conserve collateral and liquidity. Accordingly, accepting foreign assets as collateral, either routinely or only in extraordinary circumstances, is an option that central banks could take in order to address commercial banks' intraday liquidity requirements.
At the same time, the diversity and complexity of domestic financial markets, liquidity usage, and the operational structure of G10 central banks suggest a wide range of approaches regarding whether, and, if so, under what circumstances, it would be appropriate for an individual central bank to take cross-border collateral. Thus, the G10 central banks agreed on adopting an "à la carte approach", under which it is left to each central bank at this stage to decide independently its policies on foreign collateral. Hence, this report is intended to serve as a guide for central banks as they review the potential costs and benefits associated with accepting cross-border collateral in the context of their financial markets. In addition, the report recognises that some forms of coordination and cooperation among central banks may increase the effectiveness of an individual central bank's policies and actions, or may aid the private sector in developing more advanced tools for managing collateral and liquidity.
The CPSS is very grateful to Tommaso Padoa-Schioppa for supporting this project, and to the members of the working group, its chair, Koenraad De Geest (until December 2004) and Daniela Russo (from January 2005), both from the European Central Bank, and the CPSS secretariat at the BIS for their excellent work in preparing this report.
Timothy F Geithner, Chairman
Committee on Payment and Settlement Systems