February 19, 2019

BIS published a working paper that studies how securities lending affects over-the-counter market (OTC) liquidity. The study identifies and quantifies the importance of securities lending of corporate bonds to market liquidity in the OTC corporate bond market. The findings highlight the importance of shadow banking system as a potentially fragile determinant of market efficiency.

The paper first provides an overview of the market for corporate bond securities lending and the experience of insurance companies during the financial crisis. The study combines micro-data on corporate bond market trades with securities lending transactions and individual corporate bond holdings by U.S. insurance companies. The theoretical literature on OTC markets suggests that natural frictions in these markets prevent fully efficient trading. The study shows that securities lending markets can help dealers to mitigate those frictions. Applying a difference-in-differences empirical strategy, the authors show that the shutdown of AIG’s securities lending program in 2008 caused a statistically and economically significant reduction in the market liquidity of corporate bonds predominantly held by AIG. They also show that an important mechanism behind the decrease in corporate bond liquidity was a shift toward relatively small trades among a greater number of dealers in the inter-dealer market. 

 

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Keywords: International, Securities, Securities Lending, Corporate Bonds, Insurance, Shadow Banking, BIS

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