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Putting repo lenders’ skin in the game

A congressional proposal to force lenders to have more “skin in the game” could make repo lenders less willing to lend, writes Reuters columnist Agnes T. Crane November 23.

Representatives Brad Miller of North Carolina and Dennis Moore of Kansas are proposing that when a bank fails, the receiver gets to keep up to 20 percent of the collateral on a repo loan made to the bank. Currently repo collateral is not included in bankruptcy assets. A repo lender walks away with all the collateral.

From the column:

The repurchase agreement, or repo, market is a critical source of financing for dealers, hedge funds and others who use leverage to finance short-term trading positions. It’s a source of extra income for those holding virtually risk-free securities since they can squeeze out extra return by lending them out.

Such financing makes for a deeper and more liquid market that gives investors confidence that if they buy a Treasury note, for example, they can quickly sell it if they want to.

Making repo lenders share in bankruptcy losses could also trigger earlier runs on weak banks, because repo lenders would be more likely to flee at the first hint of trouble, writes Crane.

From the column:

If lawmakers want to make the financial system stable when trouble strikes again, they should start with the basics — require bigger capital cushions at banks that need to be much smaller. Then let markets sort out the minutiae. If they still want to tinker, take up a hobby instead.

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