IMF urges repo reforms

As part of its twice-a-year Global Financial Stability Report, the International Monetary Fund has issued a separate study of ways to reduce systemic risk in financial institutions and markets, including the repurchase market.

“The repo market is used by large institutional investors to lend short-term cash, while banks and broker-dealers and others use it to borrow by offering collateral in return for cash. The market was at the epicenter of the global funding crisis,” the IMF report says.

The IMF study advocates greater use of central counterparties, standardised rules, central posting of collateral and netting exposures, summarizes a Financial Times editorial that supports the IMF recommendations. The editorial states:

The failure of banks to roll over or obtain new short-term funds brought the global financial system to the verge of collapse in the autumn of 2008…. The IMF does not want to shut down repo markets, which remain an important source of liquidity for banks. Instead, it wants to make them more resilient…. True, the cost of funding would rise. But that would be a price worth paying.

From the IMF study:

The inability of multiple financial institutions to roll over or obtain new short-term funding was one of the defining characteristics of the crisis. …

A key aspect of the crisis was the increased use by banks of short-term wholesale funding and the risks that it posed when these short-term markets dried up. …

A well-functioning repurchase market is now a cornerstone of the wholesale funding market. In the run-up to the crisis, however, the market—in particular the triparty repo market—had features that increased systemic risks: poor collateral valuation and margining policies, a lack of due diligence about the counterparties’ credit risk, and fragmented or nontransparent methods of clearing and settlement. Hence part of the solution will be requiring better internal controls on collateral valuation and margining policies, more transparency about counterparties, including through triparty relationships, and greater use of central counterparties for clearing and collateral management.