DIW Study: ECB Collateral Policy Can Strengthen Financial Markets

Changes to the European Central Bank’s (ECB) collateral framework can have a significant impact on financial markets by supporting bank stability and reducing market uncertainty, according to a new study by the German Institute for Economic Research (DIW Berlin).

While interest rate decisions receive the greatest public attention, the study highlights the ECB’s collateral policy as another important monetary policy tool. The framework determines which assets banks can use as collateral when obtaining liquidity from the central bank.

According to the research, expanding the range of eligible collateral—such as accepting lower-rated government or corporate bonds—has a positive effect on financial markets. Banks’ share prices tend to rise while their default risk declines, with the strongest impact observed among institutions with weaker credit profiles.

The study also found broader market effects. Looser collateral rules reduce overall financial market volatility and are particularly effective during periods of economic weakness, when banks face greater funding needs and increased balance sheet pressures.

Matthias Kaldorf, economist at the Bundesbank Research Centre and co-author of the study, said collateral policy is most effective during recessions because it simultaneously supports bank liquidity and eases pressure on bank balance sheets.

However, the research also identifies uneven effects across the euro area. Banks in countries such as Italy and Spain benefit more from collateral easing than those in Germany, France and the Netherlands. According to the authors, this reflects structural differences in banking systems, including lower capitalisation levels, reduced liquidity and larger holdings of domestic government bonds in some peripheral economies.

The study also found that following unexpected easing measures, government bond yield spreads decline more sharply in peripheral euro area countries than in core markets.

Pia Hüttl, economist at DIW Berlin and lead author of the report, said the unequal transmission of collateral policy represents an unintended consequence of the current euro area framework. The study argues that completing the European Banking Union—including stronger capital requirements for higher-risk sovereign debt alongside a fully integrated European deposit insurance scheme—could help ensure that ECB monetary policy has a more uniform impact across member states.