The Bank of England has published a staff working paper examining why returns differ when the same security is lent against cash or securities collateral. The research finds that the gap widens with security risk, illiquidity, dealer balance sheet constraints and collateral reusability. Greater participation in both segments by institutions outside the dealer sector is associated with narrower gaps. The analysis covers approximately 16.5 million equity lending transactions denominated in USD between April 2022 and December 2025, each involving at least one UK counterparty. Lending returns increase with the risk and illiquidity of the security in both segments, while dealers pass the cost of scarce balance sheet capacity to clients. Permission to reuse securities collateral is associated with lower lending fees when dealer constraints are weak, reflecting the collateral’s economic value. That discount diminishes as constraints tighten because contracts permitting reuse consume more balance sheet capacity. Costly legal agreements and persistent counterparty relationships limit movement between collateral regimes. Although many securities are lent in both segments, most counterparties operate in only one. Institutions active in both can compare terms and redirect transactions, helping align prices. The return gap does not necessarily represent a pure arbitrage opportunity, since it also reflects differences in collateral value and intermediation costs.
Bank of England research links dealer constraints and market segmentation to securities lending price gaps
A Bank of England staff working paper finds that security risk, illiquidity and dealer balance sheet constraints are associated with wider return gaps between lending the same security against cash or securities collateral. Participation in both segments by institutions outside the dealer sector helps narrow those gaps. Collateral reuse rights reduce lending fees when dealer constraints are weak, but the discount shrinks as capacity becomes scarcer.