Mini-panic hits repos backed by Irish bonds

LCH.Clearnet, a London-based clearinghouse for financial transactions, said November 10 that borrowers on the repurchase market who used Irish bonds as collateral would have to deposit an extra 15 percent of the transaction in cash to protect the clearinghouse from default, the Financial Times reported.

The move reflects concern over economic conditions in Ireland, where the banking crisis has not yet been resolved. It prompted a panic, as investors and financial institutions rushed to sell bonds and raise cash to meet the new requirements or to buy other bonds less expensive to repo, the Financial Times said.

In a mini-repeat of the run on repo in 2007 and 2008, the panic sales drove down the value of the bonds and drove up the cost of borrowing. The scare was a reminder that the repurchase market has not been reformed since the financial crisis and is still vulnerable to the type of panic that erupted three years ago.

Some traders expect futher impact may be limited, in part because repo traders can move from LCH.Clearnet to the European Central Bank, where the extra cost of repoing Irish bonds is only 5 percent, according to the Times.

From the Financial Times:

The repurchase, or repo, markets allow banks to access cash quickly and is fundamental to the way the banking system operates.

In this market, banks sell their holdings of bonds to other banks in exchange for cash and a commitment to buy the bonds back for a marginally higher price at a determined point in the future.

At times of stress, banks can find themselves shunned by their peers because of fears over their solvency or else fears over the riskiness of the bonds that are being sold and repurchased.