European Central Bank working paper links banks’ securities losses to reduced repo funding and weaker corporate lending

The European Central Bank published a working paper that finds valuation losses on banks’ securities portfolios can materially amplify monetary tightening by eroding the value of pledgeable collateral used to raise liquidity. Even when banks remain well capitalised and regulatory capital is not directly affected by accounting treatment, securities losses are associated with impaired secured interbank market access and a subsequent contraction in illiquid corporate lending. Using granular euro area data on banks’ securities holdings, interbank transactions and firm-bank credit relationships, the authors report that a one-standard-deviation increase in securities losses is associated with a 3.76% decline in interbank credit and a 2.5% decline in corporate lending, alongside higher interest rates on new loans and shorter maturities. The effect is concentrated in secured funding: losses on ECB-eligible (pledgeable) securities reduce repo borrowing while unsecured interbank borrowing is largely unaffected, and losses on held-to-maturity securities also matter, supporting a collateral constraint mechanism rather than a pure regulatory-capital channel. Internal capital markets within banking groups partly offset the shock for subsidiaries located in the same country as the group headquarters, but foreign subsidiaries in the euro area receive less intra-group liquidity support and cut lending similarly to stand-alone banks, pointing to nationally segmented liquidity pools.