Conference Agenda

We quantify the cost of pledging collateral for small businesses using a revealed preference approach. We exploit a regulatory quirk in which firms are exempt from posting collateral if their loan size is below a threshold. Firms bunch their loans below the threshold, and the resulting distortion in the loan size distribution reveals the magnitude of the collateral cost. The collateral cost is substantial and varies across collateral types, business sectors, and collateral laws in ways consistent with flexibility-based theories. Finally, we introduce the collateral cost into a standard macro-finance model and show that it has important implications for macroeconomic fluctuations.

Using supervisory data from UK central counterparties (CCPs), our paper uncovers persistent collateral cycles in which cash goes back and forth from financial markets to CCPs. In the onward phase of the cycle, clearing members provide cash to CCPs to meet margin requirements. This pattern is procyclical as the pledged collateral increases with market volatility and places upward pressure on repurchase agreement (repo) rates. In the backward phase, CCPs return the cash to the financial markets via reverse repos and bond purchases, in compliance with regulation that requires CCPs to invest their cash holdings in safe assets. The cash given back by CCPs generates downward pressure on repo rates in a countercyclical manner.

The information banks have about borrowers drives their lending decisions and macroeconomic outcomes, but this information is inherently difficult to analyze because it is private. We construct a novel measure of bank information quality from confidential regulatory data that include banks' private risk assessments for US corporate loans. Information quality improves as local economic conditions deteriorate, particularly for newly originated loans and loans with larger potential losses. Our results provide empirical support for theories of countercyclical information production in credit markets.