Safe Asset Shortages: Evidence from the European Government Bond Lending Market

Reena Aggarwal, Jennie Bai, and Luc Laeven

We identify the unique role of the government bond lending market in collateral transformation during periods of market stress. Using a novel database, we provide evidence that safe assets in the lending market have higher demand, higher borrowing cost, and higher usage of non-cash collateral relative to non-safe assets during stressed market conditions. Moreover, we find that market participants are able to obtain safe assets using relatively low-quality non-cash collateral, allowing for collateral transformation. We show that policy interventions by central banks can help reduce safe asset shortages by returning sought-after safe assets to the market.