Central banks establish clear eligibility guidelines for assets pledged during open market operations and emergency credit facilities. These criteria protect the central bank’s balance sheet from default risk.

Central banks apply percentage discounts, known as Haircuts, to the market value of pledged securities based on their maturity, credit rating, and liquidity profile:

Adjusted Collateral Value = Market Value of Asset * (1 - Assigned Haircut Decimal)

For example, if a commercial bank seeks an overnight loan from the central bank and pledges a portfolio of corporate bonds with a market value of 10,000,000, and the eligibility guidelines apply a 12% (0.12) haircut, the plain-text calculation is:

Adjusted Collateral Value = 10,000,000 * (1 - 0.12) = 10,000,000 * 0.88 = 8,800,000

High-grade sovereign bonds receive minimal haircuts, whereas asset-backed securities or lower-rated corporate debt face steep valuation adjustments to isolate the central bank from credit exposure.