Central banks never provide funding lines or participate in repo transactions unsecured. Every transaction requires counterparties to pledge eligible securities to isolate the central bank from credit and market losses.

To account for asset price volatility and market liquidity risks, central banks apply percentage-based valuation discounts, known as Haircuts, to all pledged collateral. The plain-text mathematical relationship requires:

Adjusted_Collateral_Value = Market_Value_Of_Asset * (1 - Assigned_Haircut_Decimal)

For example, if a primary dealer seeks an overnight cash injection and pledges a package of high-grade corporate bonds with a market value of 50,000,000, and the eligibility guidelines apply a 12% (0.12) haircut, the plain-text calculation is:

Adjusted_Collateral_Value = 50,000,000 * (1 - 0.12) = 50,000,000 * 0.88 = 44,000,000

High-quality, highly liquid assets like short-term sovereign treasury bills receive minimal haircuts, whereas long-term or complex structured debt faces steep adjustments to protect the central bank’s balance sheet.