He said that there is evidence from recent significant sales of Treasuries by emerging market central banks that the market can absorb sales of assets currently locked away in silos.

“Central bank balance sheet unwinding gives space and helps the dealer community accommodate a lot more transactions that they are not willing to do right now.”

There has of course been an expansion of AAA securities “but much of these securities has been silo-ed” on central bank balance sheets so “they have no velocity”. This is a problem because “AAA lubricates the other collateral to move” in the collateral upgrade chain.

“There is a disconnect now between the dealer balance sheet at what is happening outside dealer balance sheets. Until recently they were the fulcrum… now central banks have taken a lot of good securities.”

He noted that the levels of pledged collateral (reusable, with title transfer) in the 15 largest banks has decreased since the financial crisis and remains much lower for half a decade, from around $10trn to $5.65trn in 2015 and, at the moment, “they are not bouncing back”. 

“Less AAA leads to less efficiency and ease of pricing” of all other types of collateral. “Once collateral is with the market, it moves.”

Since a seminal Reserve Bank of Australia paper investigating the velocity, or reuse, of collateral there has been many studies into its significance for the functioning of markets. A recent CGFS paper identified that collateral reuse and rehypothecation is decreasing.

Singh said velocity had decreased from three at the time of the Lehman crisis to below two now. “Collateral is coming in – but it is not being circulated in the way it used to be.” 

When it ends up at the central bank “it’s a closed loop”.“The money printed takes balance sheet space – trillions of space. If that space is unclogged, you would have space at the banks which would allow them to do other activities.”

“Whether those securities come out and what it means for securities lending is huge.”

Central clearing

However, the central clearing of OTC derivatives provides an avenue for the central bank to accumulate more deposits that could become silo-ed. BIS figures, he says, suggest that a huge new wave of collateral is set to reach central bank balance sheets.

“If CCPs do their jobs, where will all these deposits go? Where will the $2-3trn go? CCPs are allowed to deposit at central banks at privileged rate, in the US 75bps at the Fed.”

“If trillions bypasses the plumbing and goes directly to the Fed, where is the money to price the plumbing? I believe it is better done at the market level… The more that goes to the balance sheet of the public sector the rustier the plumbing becomes – the signals are not as deep and liquid.”