As directed by the Dodd-Frank Act, the FDIC began April 1 charging banks insurance premiums based on all of their debt, including repos, not just on their domestic deposits.
That makes repos less profitable, at least until the market adjusts to the higher costs or until financial institutions move their repos out of their FDIC-insured commercial banks.
As a result, companies that have been repo borrowers, selling securities for cash, are holding onto their securities, causing a drop in business on the repurchase market. Trading in the overnight Fed funds market, where financial institutions lend the money they have on deposit with the Federal Reserve, has also been affected.
From Dow Jones Newswires April 4:
So far, the tensions in the markets have been mild compared to the 2008 financial crisis, when the money market essentially seized up. But some market participants cautioned that inefficient functioning of the short-term lending markets, perceived widely as the oil that greases the broader economy, could hurt liquidity in the Treasury market and push up bond yields. That would raise the borrowing costs for U.S. consumers, businesses and the federal government.
The most recent report from the 20 Primary Dealers authorized to repo with the Fed shows their repo volume March 30 was down 4 1/2 percent from a week earlier, but it wasn’t clear how much of the drop was due to the new FDIC fee. Primary Dealers are thought to represent about half of the repurchase market. (Update: In June 2012 New York Fed economists said primary dealers currently represent about 90 percent of the market.)
The new fee has shut down a profit-making maneuver that has helped banks rebuild after the crisis, according to Dow Jones Newswires. Before the rule change, banks were often selling Treasury securities in an overnight repo borrowing and depositing the cash proceeds with the Federal Reserve, where the cash earned more interest than the bank had to pay on the overnight repo borrowing. But the new FDIC fee on repo debt is making that deal unprofitable, at least for now.
The tightening in the repo market also hurts financial institutions that want the securities for trading purposes, said Dow Jones. In recent days, repo lenders – who lend cash and get securities as collateral – have sometimes had to pay interest to repo borrowers, instead of the usual situation where the repo borrower pays interest to the repo lender.
Historically, the FDIC has based its premiums on the amount of deposits a bank holds, because it was mainly the depositors that the FDIC had to repay when a bank failed. But in the financial crisis of 2007-2008, the FDIC also had to repay repo and other shadow lenders.
The new premiums are an effort to make sure the banks that use the riskier funding have to bear their fair share of the FDIC insurance costs.
Banks will continue to get a favorable adjustment on long-term unsecured debt, which reduces FDIC loss if the bank fails, the FDIC said.
The total amount collected by the FDIC is not expected to change much, as the FDIC is making other adjustments to offset premium increases, said the FDIC. In general, banks that fund themselves from the shadow banking sector, with debt like repurchase agreements, foreign deposits and commercial paper, will pay higher premiums than those that fund themselves with domestic deposits.
Banks do not disclose the dollar amount of their FDIC premium. An expert interviewed by the American Banker estimated FDIC annual premiums for mega-banks under the new rules at $30 million to $1.4 billion.