J.P. Morgan Chase will accept physical gold as collateral for tri-party repurchase transactions, the banking giant said Monday.
It will also let traders use gold as collateral in securities lending transactions.
Bonds and stocks have traditionally been the collateral used for repos and securities lending, respectively, because they’re considered easier to buy and sell than commodities.
J.P. Morgan said it decided to accept gold because many of its clients are holding gold as an inflation hedge. It plans to accept “additional precious metals and commodities” as collateral later in the year.
This move could allow expansion of the repurchase market, which has relied since 2008 on more reliable collateral such as U.S. Treasuries and mortgage securities guaranteed by federal agencies like Fannie Mae and Freddie Mac.
It also could increase the demand for gold, as it adds repos as a way to finance gold purchases and lets gold holders raise cash to reinvest without having to sell their holdings. Until now, one downside of holding gold has been that it doesn’t earn interest.
The volatility of gold prices adds another level of risk in the repurchase market. If gold values fall, repo lenders could call their loans, in a replay of the financial crisis of 2007 and 2008. That panic grew out of lenders’ concerns over the quality of mortgage securities being used as collateral. Since the panic, repo lenders have demanded more conservative collateral, which they believe could be more easily sold in a crisis, but that limits expansion of the market.
“This initiative enables clients to mobilize collateral inventories across multiple geographies and trading activities, regardless of the underlying obligation, to extract maximum value and manage risk,” J.P. Morgan said in its announcement, underscoring the international and systemic nature of the decision.
In the tri-party repurchase market, which is thought to represent about 25 percent of repo activity, J.P. Morgan and Bank of New York Mellon act as clearing banks for the transactions. Other repo agreements are negotiated bilaterally, between two parties, with no middleman. All negotiations are confidential.
Securities lending is a smaller cousin to the repo market, where financial institutions lend their stock holdings, usually in return for cash.
A Wall Street Journal story on the implications of the J.P. Morgan announcement does not mention the repurchase market or securities lending.