February 2017

The (Unintended?) Consequences of the Largest Liquidity Injection Ever

Matteo Crosignani, Miguel Faria-e-Castro, and Luis Fonseca


We study the design of lender of last resort interventions and show that the provision of long-term liquidity incentivizes purchases of high-yield short-term securities by banks. Using a unique security-level data set, we find that the European Central Bank's three-year Long-Term Refinancing Operation incentivized Portuguese banks to purchase short-term domestic government bonds that could be pledged to obtain central bank liquidity. This "collateral trade" effect is large, as banks purchased short-term bonds equivalent to 8.4% of amount outstanding. The resumption of public debt issuance is consistent with a strategic reaction of the debt agency to the observed yield curve steepening.

Accessible materials (.zip)

Keywords: Lender of Last Resort, Sovereign Debt, Unconventional Monetary Policy

DOI: https://doi.org/10.17016/FEDS.2017.011

PDF: Full Paper

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Last Update: January 09, 2020