News roundup: Repo and shadow banking in the crosshairs

Repo and shadow banking have been getting a lot of attention lately. It’s rewarding that an understanding of their importance is spreading.

RepoWatch recommends the following reports, arranged within topics that are listed alphabetically:

Financial crisis

Getting up to speed on the financial crisis: A one-weekend-reader’s guide,” by Gary B. Gorton and Andrew Metrick, Yale University,  January:

The first financial crisis of the 21st century has not yet ended, but the wave of research on the crisis has already exceeded any single reader’s capacity, with the pace of new work only making this task harder. Many professional economists now find themselves answering questions from their students, friends, and relatives on topics that did not seem at all central until a few years ago, and we are collectively scrambling to catch up.

This article is intended to serve as a starting point for economists that want to get up to speed on the literature of the crisis, without having to go into a cave and read for a whole year. To this end, the reading list is restricted to 16 documents, a list that an ambitious reader could cover in one weekend or at a more leisurely pace over a few weeks.

“Short-term Wholesale Funding and Systemic Risk: A Global CoVaR Approach,” by German Lopez-Espinosa, Antonio Moreno, Antonio Rubia, and Laura Valderrama, International Monetary Fund, February:

In this paper we identify some of the main factors behind systemic risk in a set of international large-scale complex banks using the novel CoVaR approach. We find that short-term wholesale funding is a key determinant in triggering systemic risk episodes. In contrast, we find no evidence that a larger size increases systemic risk within the class of large global banks. We also show that the sensitivity of system-wide risk to an individual bank is symmetric across episodes of positive and negative asset returns. Since short-term wholesale funding emerges as the most relevant systemic factor, our results support the Basel Committee’s proposal to introduce a net stable funding ratio, penalizing excessive exposure to liquidity risk. …

Financial institutions use wholesale funding to supplement retail deposits and expand their balance sheets. These funds are typically raised on a short-term rollover basis with instruments such as large-denomination certificates of deposits, brokered deposits, central  bank funds, commercial paper and repurchase agreements. Whereas it is agreed that wholesale funding provides certain managerial advantages, the effects on systemic risk of an overreliance on these liabilities were under-recognized prior to the recent financial crisis. Banks with excessive short-term funding ratios are typically more interconnected to other banks, exposed to a large degree of maturity mismatch and more vulnerable to market conditions and liquidity risk. These features can critically increase the vulnerability of interbank markets and money market mutual funds which act as wholesale providers of liquidity and, eventually, of the whole financial system. The empirical analysis on this paper provides clear evidence on the major role played by short-term wholesale funding to spread systemic risk in global markets.

International repo

Repo market edging back towards normalisation,” ICAP Securities Ltd., February 8:

Overall euro market repo volumes are creeping back higher after sharp falls seen through the latter parts of last year.

Money market funds

“U.S. Sets Money-Market Plan,” by Andrew Ackerman and Kirsten Grind, Wall Street Journal, February 7:

Regulators are completing a controversial proposal to shore up the $2.7 trillion money-market fund industry, more than three years after the collapse of Lehman Brothers Holdings Inc. sparked a panic that threatened the savings of millions of investors and forced the federal government to intervene.

The SEC gets closer to regulating money-market funds,” by Felix Salmon, Reuters, February 7:

Banks need to be regulated. Depositors can’t be expected to do due diligence on their financials, so you need deposit insurance. And in turn, the government — which provides the deposit insurance — needs to make sure that the banks have certain minimum levels of capital. Otherwise, the insurance fund will go bust in no time.

All of this is wholly uncontroversial — until you get to the subject of money-market funds. At heart, as they exist today, MMFs are banks. They borrow money which is repayable on demand, and they lend it out for fixed terms, taking a certain amount of credit risk while doing so. If their borrowers fail to repay the money, or if their depositors all demand their money back at once, then they’ll be left needing to be bailed out.


“Asset-Backed Securities May Qualify as Liquid Buffer in EU Bank Proposal,” by Esteban Duarte, Bloomberg, January 20:

Banks may be allowed to include asset-backed securities in the liquid assets that regulators demand to defend against a credit squeeze, according to a version of the draft law published by the European Union.

“Insiders want ABS to be included in asset cushions,” by Matthew Attwood, Financial News, February 6:

Bankers and investors are calling for asset-backed securities – regarded as the scourge of the financial crisis – to be included in the asset cushion banks will need to retain against disaster under the Basel III rules.

“EU banks: Give us leeway on assets,” By David Enrich, Wall Street Journal, February 2:

LONDON—Under heavy pressure from the banking industry, European regulators are considering loosening some rules that require lenders to maintain deep pools of ultrasafe assets to protect them in a crisis, according to bankers and regulatory officials involved in the discussions….

The fight over liquidity rules involves obscure but important issues. During recent financial crises, some big banks collapsed when they lost the ability to fund themselves. Seeking to avoid such liquidity problems in the future, regulators started requiring banks to hold large piles of assets that they can easily sell if they lose access to normal funding sources like the bond market or face an exodus of deposits.

Riskier repo

“Repo Emerges from the ‘Shadow’,” by Robert Grossman, Martin Hansen, Kevin D’Albert, and Viktoria Baklanovaby, Fitch Ratings, February 3:

Despite the systemic importance of repo markets, granular information about haircut, collateral, and counterparty trends is relatively scarce. To help fill that gap, this study analyzes transaction-level trends for U.S. prime money market fund (MMF) and dealer activites in the U.S. triparty repo market since the second half of 2006 ….

Since the peak of the U.S. financial crisis, risk appetite in the triparty repo market is gradually recovering, as evident in the rising proportion of riskier forms of repo collateral (corporates, equities, and structured finance). This trend could reflect thawing in credit market conditions, money funds’ appetite for the higher yields paid on nongovernment repo, a relative scarcity of high quality collateral available for pledging, and a need by financial institutions to finance lower quality securities inventories.

Structured finance collateral disappeared from the sample during the peak of the U.S. financial crisis, but has since reverted to pre-crisis levels of roughly 20% of the overall collateral mix, a sign of improved liquidity for the sector. Almost half of this collateral is subprime and Alt-A residential mortgage-backed securities (RMBS) and collateralized debt obligations. The distressed nature of much of the structured finance collateral is reflected by the median ratio of the security value to the principal amount of 43%, a rough proxy for the current valuation of these securities.

US plan sponsors look to alternative repo – Finadium,” by Anna Reitman, Securities Lending Times, January 23:

US plan sponsors are starting to look closer at alternative repo products as a solution to the challenges they face in securities lending and collateral management programmes, according to the latest Finadium survey.

One of the key findings of the survey is that repo for equities and illiquid assets as well as term repo are slowly gaining in popularity as a way to incrementally increase collateral returns, though they are viewed as riskier.

“From deposit stashing to repo lending at UBS,” by Izabella Kaminska, FT Alphaville, Financial Times, February 7:

UBS announced lacklustre results on Tuesday, saying it expected further weakness in investment banking in the first quarter.

But the bank also provided details of some interesting underlying trends at the bank, funding wise.

What this seems to reveal is a shift away from unsecured interbank funding and into repo funding over the course of the last quarter — and within repo itself an even bigger shift away from euro-funding and into USD-funding instead.

But the trend gets even more interesting.

… while UBS has started to depend more on repo funding than interbank funding, it has also started to re-direct a lot more of the cash it has sitting on deposit at central banks into reverse repurchase agreements (i.e. collateralised lending to others, in return for what we presume is a much better yield) as well as into “trading activities” at the investment bank.

All in all something of a sign that risk appetite may be returning ….

Securities lending

Securities Lending – Under the spotlight in 2012,” by Will Duff Gordon, Data Explorers, February 1:

The debate surrounding Shadow Banking is gaining momentum amid regulators, politicians and journalists. It even has its own Wikipedia page and could soon be renamed “Spotlight Banking”. Was Oscar Wilde right that it is better to be talked about than not talked about? We will discuss the implications for Repo and collateral financing business as well as assess the main themes to emerge from a rumbustious Hong Kong Forum. We conclude by daring to make some predictions.


US banks snap up bundled mortgage products,” by Tracy Alloway, Financial Times, February 7:

Banks have been responding to low interest rates by snapping up billions of dollars of bundled mortgage products that resemble the sliced-and-diced debt some blame for the financial crisis. The products, known as “collateralised mortgage obligations,” or CMOs, group together securities backed by mortgage loans.

Shadow banking

Watchdogs to drag shadow banks into the light,” by Douwe Miedema, Reuters, February 7:

Beyond the reach of regulators, and about half the size of the world’s banking industry, a thriving breed of “shadow banks” is emerging that could trigger the next chapter in the global financial crisis.

Q+A – What is shadow banking and why does it matter?” by Michelle Martin, Reuters, February 7:

The shadow banking system makes up 25 to 30 percent of the total financial system, according to the Financial Stability Board (FSB), a regulatory task force for the world’s group of top 20 economies (G20).

FSB official outlines shadow banking concerns,” Reuters, February 7:

The Financial Stability Board (FSB) will develop policy recommendations for the world’s shadow banking sector by the end of 2012, according to a senior Bank of Canada official who also chairs a key FSB committee.

“Global watchdog official says banking reforms must proceed,” By Jennifer Kwan, Reuters, February 7:

The underperforming global economy should not be allowed to delay financial system reforms, a senior official at the Financial Stability Board (FSB), a global watchdog set up by the Group of 20 nations, said on Tuesday, adding that the FSB will propose new rules on so-called shadow banking by year-end.

“The need to shine light into those dark corners,” by Gillian Tett, Financial Times, February 9:

Being a financial journalist often feels akin to chasing bars of soap in the bath. On occasion, we hear fascinating rumours, and peer into dark corners of finance, aware that something odd is going on. Yet, all too often the “story” quarry slips away for lack of evidence or of quotable sources – or because powerful financial public relations officials are waving libel laws in our face.

Interbank borrowing rates such as Libor are a case in point….As the current probe gathers pace, pressure for more radical change may grow, not least because there are signs that financial players have been trying to reduce their reliance on Libor in recent years, due to credibility concerns.

That is to be welcomed, in much the same way that it is good news that back office procedures for ETFs are – belatedly – being overhauled, or that people such as Gary Gensler of the Commodity Futures Trading Commission, are now pushing for more transparency in the OTC swaps world. But the sad fact is that there is still much further to go, in terms of injecting sunlight. Do we really know what is happening in, say, the weeds of the “repo” world? In inter-broker OTC swaps practices? What about the clubby traditions used to set some commodity benchmarks prices, or other dark financial corners? Tips about where to grope in the next five years, as a journalist, would be heartily welcome; even better, with tangible leads.

Tri-party repo

“Tri-party repo taskforce to disband without delivering key reform,” by Mark Pengelly, Risk Magazine, February 7:

Market participants will explain why they have not been able to make key changes to the tri-party repo market in a report due later this month, setting up a showdown with the Federal Reserve Bank of New York, which has been pushing for reform.

“Repo market reform delayed despite Fed push -sources,” by Karen Brettell and Jonathan Spicer, Reuters, February 9:

An industry committee formed by the New York Federal Reserve to devise ways to reduce systemic risks in the $1.67 trillion repurchase agreement market is set to announce another delay in revamping the market, a disappointment for regulators.

The task force’s final report is expected as early as Wednesday, a source said on Thursday. But the task force failed to show how to apply a cap on credit exposures at clearing banks or fully implement effective risk management procedures, nor did it set a plan for the orderly liquidation of collateral in a time of crisis, said two people familiar with the matter.

Repos are a prime source of bank funding and are backed by assets such as Treasuries.

The task force is, however, expected to set out a new timetable for the main clearing banks in the tri-party repo market – JPMorgan Chase & Co and Bank of New York Mellon Corp – to reduce credit exposures to trading partners, a key cause of the 2008 financial crisis. In tri-party trades JPMorgan or BNY Mellon stand between trades and arrange for the settlement of the loans and manage the collateral behind them.


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