PrefBlog

For reasons that will become clear to Assiduous Readers in the near future, I’m doing a little reading on the “Eligibility Premium”.

This was defined, in ECB Occasional Paper #49, BindSeil & Papadia, August 2006 as:

the interest rate differential between eligible [as collateral for central bank loans] and ineligible assets, dubbed the “eligibility premium”.

… with the conclusion …

The three estimates above consistently indicate that the eligibility premium deriving from being eligible as collateral for Eurosystem operations is, as a maximum, in the order of magnitude of a few basis points only. However, again, the following caveats to these estimates should be highlighted: In times of financial tensions, the eligibility premium will be much higher. One may view ample collateral availability as an insurance against the consequences of financial instability.

• In times of financial tensions, the eligibility premium will be much higher. One may view ample collateral availability as an insurance against the consequences of financial instability.
• For lower-rated banks (e.g. banks with a BBB rating), the value of the eligibility feature is likely to be systematically higher.
• The low eligibility premium in the euro area is also the result of the ample availability of collateral. If availability were to decrease or demand increase, the premium would increase as well.

As remarked by Michael Reuther of Commerzbank in June 2008:

In a liquidity stress situation only central bank eligible collateral can be seen as really liquid.

It was to capture a suddenly much larger eligibility premium that Congress pressured the Fed to add Student Loans to the eligibility list – and the Fed responded on May 2. It’s hard to say how much the eligibility premium was in this case, but 35bp is a possibility:

The Lincoln, Nebraska-based student-loan provider issued three-year bonds rated AAA that priced to yield 70 basis points more than the three-month London interbank offered rate, said a person familiar with today’s sale, who declined to be identified because the terms aren’t public. That’s a narrower spread than the 105 basis points Nelnet was charged last month, and the 100 basis points the company offered on March 31.

I seem to remember – but cannot find – a Bloomberg story specifically mentioning that spreads between eligible and non-eligible assets had skyrocketted at the height of the crisis.

All this is related to the matter of the Real Bills Doctrine.

This entry was posted on Monday, July 7th, 2008 at 6:58 pm and is filed under Interesting External Papers. You can follow any responses to this entry through the RSS 2.0 feed. You can leave a response, or trackback from your own site.