Liquidity is not neutral

This article is part of In conversation about sustainable finance & emission reduction systems, a new series by Diego Balverde. You're reading volume three of the The collateral crisis series. Here is volume two

Liquidity has always been treated as a technical tool, something central banks could expand or contract to stabilize the system, but that assumption no longer holds because liquidity is now conditioned by the quality of the assets behind it, in a world of structurally higher energy prices, persistent inflation and growing carbon constraints, money stops being neutral and becomes selective, tensions in the Persian Gulf (a key artery for global energy supply) are no longer just geopolitical events, they directly impact the stability of the assets that support credit, and when the quality of those assets changes the flow of liquidity across the system changes with it.

Liquidity depends on collateral quality

Banks do not create money freely, they create credit based on the assets they can pledge as collateral (guarantees used to access funding), when those assets lose value or become riskier the capacity to generate credit declines, the European Central Bank is already integrating climate risk into its collateral framework (deciding which assets are acceptable to obtain liquidity), this means that assets exposed to emissions or transition risks may receive larger haircuts (valuation discounts applied by central banks) or become ineligible altogether, once an asset is no longer eligible it cannot be used to generate liquidity, this is not a marginal adjustment, it directly reduces the amount of money that can circulate in the system.

The invisible tightening of credit

Interest rates are the visible signal of financial tightening, but the real tightening happens beneath the surface through collateral quality and risk perception, a company can still face higher rates, but the critical moment is when it loses access to credit entirely, this is increasingly visible in energy-intensive sectors where banks are limiting exposure, credit spreads (the extra cost charged depending on perceived risk) are widening, which in practical terms means less money available and at a higher price, this process does not affect all sectors equally, it creates fragmentation, some sectors continue receiving liquidity while others are progressively excluded.

Fragmentation of the financial system

Liquidity no longer flows evenly across the system, it concentrates in assets perceived as safe and withdraws from those considered risky, institutional investors managing more than 100 trillion dollars are reallocating capital based on energy exposure and climate risk, insurers are reducing coverage in areas exposed to physical risk, banks are recalibrating lending models using emissions data, the result is a segmented system where liquidity is not disappearing but concentrating, and that concentration amplifies differences between sectors, regions and business models, some operate with abundant capital while others face tightening constraints.

When liquidity withdraws, systems contract fast 

Financial history shows that crises are not triggered only by losses but by the inability to convert assets into cash, when liquidity disappears the system enters stress, in the current environment this risk is amplified because multiple factors are degrading collateral quality at the same time, energy costs remain elevated, inflation persists, interest rates stay high and climate risk is being priced in simultaneously, if enough assets lose their ability to function as reliable collateral the system’s capacity to generate credit contracts, this contraction does not occur gradually, it can accelerate rapidly once confidence weakens, and at that point the financial system shifts from expansion to contraction. 

Analysis — money is no longer neutral

The concept of neutral money assumed that liquidity could be distributed without discrimination across sectors, that assumption is breaking down, liquidity is now conditional, it depends on the nature of the asset, its exposure to energy costs, its emissions profile and its regulatory risk, this introduces a filter that did not exist before, not all assets can access the same level of financing, not all sectors can sustain the same growth trajectory, this shift is structural, not cyclical.

Conclusion — liquidity is now a filter

Liquidity is no longer just a stabilizing force, it has become a selection mechanism, it determines which sectors receive financing and which are excluded, it defines which business models remain viable and which are pushed out of the system, the key question is no longer how much liquidity exists but who can access it, because in this new environment liquidity is not a given, it is conditional, and that condition is already reshaping the global economy.