The European Central Bank has published a paper on the liquidation value of collateral. The abstract is shown below; the full paper may be accessed here.
We show that the liquidation value of collateral depends on who is pledging it. Using transaction-level data on all overnight repurchase agreements (repo) of 47 large European banks, we find that a loan collateralized by a sovereign bond carries a 3.0 bps rate premium if the borrower is of the same country as the collateral issuer. The main driver of this premium is the decrease in liquidation value which occurs when borrower default risk is negatively correlated with collateral value. Accordingly, we show that repo rates increase in the correlation between the borrower’s and the collateral issuer’s CDS premia, and are high when the borrower is also the collateral issuer. Our results imply that lenders monitor the correlation between borrower default risk and collateral value, and uncover a channel through which the sovereign-bank nexus impacts funding costs.