Legal and Regulatory Aspects
Edited by Iris H.-Y. Chiu and Iain G. MacNeil
Chapter 3: The repo market, collateral and systemic risk: in search of regulatory coherence
Two of the central features of the money markets and the wider shadow banking system are securitisation – the packaging up of loans and other assets into tradable securities – and maturity transformation – the financing of longer-term assets through short-term liabilities. Traders and investors use a number of investment vehicles and financial market instruments as techniques to structure these activities. Secured financing transactions (SFTs) are one of these techniques. Repurchase agreements – or ‘repos’ as they are commonly known – are the most widely used form of SFT, and have become a key source of money market liquidity. As financial innovation has proceeded apace, repos have evolved from what was essentially a ‘back-office activity in the 1990s, [to become] integral components of the banking industry’s treasury, liquidity and assets/liabilities management disciplines [as well as] an essential transaction used by central banks for the management of open market operations’ The rapid growth of repos may be understood as one consequence of evolving legal and regulatory structures which advantaged non-bank and off-balance-sheet credit intermediation; indeed, the switch in bank business models from asset to liability balance sheet management has been heralded as ‘one raison d’être for the shadow banking system’. Higher repo volumes are a symptom of this emergence, providing liquidity for risk-averse institutions which do not have access to central bank funding or insurance, and as a source of finance for leveraged intermediaries – particularly banks and brokerdealers – in wholesale funding markets. Today, inter-dealer repo markets have largely replaced unsecured money markets as the source and use of overnight funds.
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