Restoring Regulatory Credibility and Preventing “Repo Runs”: A Cautionary Tale

Abstract

In the aftermath of the global financial crisis (‘GFC’), policy-makers and regulators have been engaged in Herculean efforts to restore their tarnished reputations. These efforts have involved jettisoning much of their flawed ideological baggage of old, rooted in a belief about the self-correcting nature of markets and the ability of financial institutions to police themselves, and, in turn, building new, more muscular regulatory and supervisory regimes. This ongoing process is explored through the lens of a high-profile facet of shadow banking, namely the regulation of sale and repurchase agreements (so-called ‘repos’). Here, regulators have set out to address a key vulnerability associated with the maturity mismatch between the short-term liabilities of the repo borrower and its longer-term assets, which has the potential to trigger a so-called ‘repo run’. Through a review of a series of highly problematic reform options, the discussion indicates that there is a danger that regulators will repeat the mistakes of the past by substituting their misplaced faith, pre-GFC, in the self-correcting power of markets, with a misguided conviction, post-crisis, in their capacities to build regulatory regimes which can contain the risks associated with modern-day financial markets. It is suggested that such over-confidence is liable to lull us into a false sense of security about how robust these regimes really are, and to cause regulators to shirk some of the more difficult questions which remain to be addressed.