Repo Funding Research Articles

Market power in wholesale funding: A structural perspective from the triparty repo market

I model and structurally estimate the equilibrium rates and volume in the Triparty repo market to study imperfect competition in wholesale funding. Even in this systemically important market, where seemingly homogeneous repos trade, I document persistent rate differences paid by dealers. I characterize the Triparty market as cash-lenders allocating their portfolios among differentiated dealers who set repo rates. I find that cash-lenders’ aversion to portfolio concentration and preference for stable lending grant dealers substantial market power: between 2011 and 2017, dealers borrowed at rates that were 26 bps lower than their marginal value from intermediating the borrowed repo funds. Dealers’ market power makes the observed wholesale repo rate understate the financing rate available to market participants who rely on repo funding, and offers a novel explanation for funding spreads such as the Treasury cash-futures basis and the Treasury swap spread.

Bank Deposit Flows to Money Market Funds and ON RRP Usage during Monetary Policy Tightening

Using the historical experience from past monetary tightening cycles and the market-expected path of the federal funds rate for the current tightening cycle, we project that the flows from bank deposits to money market funds (MMFs) would be relatively small, at about $600 billion through the end of 2024, or about 3 percent of current bank deposits. Of these potential inflows to MMFs, about $100 billion are projected to flow into the overnight reverse repo (ON RRP) facility, or about 7 percent of MMFs’ recent take-up. Other factors such as the private demand for repo funding and the net supply of Treasury bills are expected to have more substantial effects on MMFs’ take-up at the ON RRP facility than the inflows from bank deposits.

Creditor Rights, Collateral Reuse, and Credit Supply

Theories linking the reuse of collateral to financial instability have been influential in macroeconomics but empirical evidence on them is limited. I utilize a change to bankruptcy treatment of repo collateral to provide causal evidence that strengthened creditor rights increase credit supply and financial instability by increasing the reuse of repo collateral. Using novel hand-collected data linking dealers’ repledgeable collateral to their lending to mortgage companies, I find that dealers exposed to the change in bankruptcy treatment increased their repledgeable collateral – consistent with a money multiplier – and their credit supply to mortgage companies during the 2000’s housing boom and bust. I establish that increased dealer credit provision drove mortgage companies to increase originations and pivot toward risky products. I estimate that the expansion in credit increased originations by 9% and accounted for 38% of defaults on mortgages originated during 2005-2006, consistent with a financial accelerator channel of repo funding. I estimate the money multiplier of private-label mortgage collateral to be 4.5 times that of Treasuries, shedding new light on the previously unknown size of this repo money multiplier.

Primary Dealers During the 2007-08 Crisis: Assessing Risks and Vulnerabilities

We study key vulnerabilities of the US Primary Dealers during the 2007-08 financial crisis. Dealers’ exposure to risky assets drives the repo run; importantly, repos become sensitive to counterparty risk only at the height of the crisis. Further, the way in which dealers use repo funding exposes them to several risks: financing illiquid assets with overnight repos exposes dealers to significant fire-sale risk; dealers are also exposed to rollover risk due to the maturity mismatch they take when intermediating credit to clients. Finally, we show how quickly illiquidity can spread across dealers, via chains of settlement fails.

Short-Term Debt and Bank Risk

The extant literature suggests that one of the main causes of the recent financial crisis was the excessive use of short-term debt by banks. Using a large sample of banks, we find that increases in repurchase agreements (repos) were recognized by external capital markets to increase bank risk in the pre-crisis period. In the crisis, we find a negative relationship between repos and risk. We attribute this result to evidence suggesting that “good” banks were able to continue funding their repos, whereas “bad” banks had to significantly decrease their repo funding.

Intraday Dynamics and Determinants of CCP and Bilateral General-Collateral Repos

We study the spread between the intraday general collateral repo rate on Italian Government bonds and the ECB deposit rate, using a novel dataset. We focus on overnight repos, both cleared by central counterparty (CCP) and traded bilaterally. We observe that collateral supply, liquidity and duration affect significantly the repo riskiness and spread, but they have a reduced impact after the ECB quantitative easing interventions. Increased margins during the European sovereign crisis (ESC) further deteriorate the repo funding costs (pro-cyclical effect). Once we control for the impact of margin costs, the CCP repo appears not be significantly cheaper than the bilateral repo. Finally, we show that bonds with lower liquidity, greater supply, longer duration, and lower specialness are more likely to be selected as collateral. However, during the ESC, CCP-repo buyers tend to provide as collaterals bonds with higher liquidity and lower duration to reduce margin and repo trading costs.

Primary Dealers' Behavior during the 2007-08 Crisis: Part I, Repo Runs

This is the first of two notes that empirically document the behavior of U.S. Primary Dealers during the 2007-08 financial crisis. In this note we show that dealers' exposure to risky assets drives the observed repo funding squeeze; moreover, as evident from Lehman's experience, we show that repos become subject to counterparty risk during periods of stress, even when collateralized by the safest assets.

The shadow costs of repos and bank liability structure

Making use of a structural model that allows for optimal liquidity management, we study the role that repos play in a bank׳s financing structure. In our model the bank׳s assets consist of illiquid loans and liquid reserves and are financed by a combination of repos, long-term debt, deposits and equity. Repos are a cheap source of funding, but they are subject to an exogenous rollover risk. We show that the use of repos inflicts two types of indirect (“shadow”) costs on the bank׳s shareholders: first, it induces the bank to maintain higher liquid reserves in order to alleviate the additional default risk; second, it adds to the cost of long-term debt financing. These shadow costs limit the bank׳s appetite for cheap but unstable repo funding. This effect is, however, weakened under poor returns on risky assets, access to deposit funding and the depositor preference rule. We also analyze the impact of a liquidity coverage ratio, payout restrictions and a leverage ratio on the bank׳s financing choices and show that all these tools are able to curb the bank׳s reliance on repos.

Macroprudential regulation under repo funding

The use of collateral has become one of the most widespread risk mitigation techniques. While it brings stabilizing effects to the individual cash lender, it may exacerbate systemic risk by accelerating bank deleveraging under funding stress. We show how a liquidity shock to the cash lender may propagate as a solvency shock via liquidity hoarding even if the cash lender remains solvent in all states of nature. Albeit a privately optimal response of the cash lender to a liquidity shock, bank deleveraging may lead to excessive bankruptcy among its borrowing counterparties while, at the same time, triggering contagion across asset classes. To buttress financial system resilience, we lay out a menu of macroprudential policies that deactivate this channel of financial contagion.

Short Term Debt and Bank Liability Structure

Making use of a structural model that allows for optimal liquidity management, we study the role that repos play in a bank’s financing structure. In our model the bank’s assets consist of illiquid loans and liquid reserves and are financed by a combination of repos, long–term debt, deposits and equity. Repos are a cheap source of funding, but they are subject to an exogenous rollover risk. We show that the use of repos inflicts two types of indirect (“shadow”) costs on the bank’s shareholders: first, it induces the bank to maintain higher liquid reserves in order to alleviate the additional default risk; second, it adds to the cost of long–term debt financing. These shadow costs limit the bank’s appetite for cheap but unstable repo funding. This effect is, however, weakened under poor returns on risky assets, access to deposit funding and the depositor preference rule. We also analyze the impact of a liquidity coverage ratio, payout restrictions and a leverage ratio on the bank’s financing choices and show that all these tools are able to curb the bank’s reliance on repos.

Repo Runs: Evidence from the Tri‐Party Repo Market

ABSTRACTThe repo market has been viewed as a potential source of financial instability since the 2007 to 2009 financial crisis, based in part on findings that margins increased sharply in a segment of this market. This paper provides evidence suggesting that there was no system‐wide run on repo. Using confidential data on tri‐party repo, a major segment of this market, we show that, the level of margins and the amount of funding were surprisingly stable for most borrowers during the crisis. However, we also document a sharp decline in the tri‐party repo funding of Lehman in September 2008.

Repo Funding and Internal Capital Markets in the Financial Crisis

This paper examines how the exposure of German parent banks to the disruptions on sale and repurchase markets (repo markets) during the financial crisis has affected their provision of funds to their foreign branches and subsidiaries via bank-internal capital markets. The collapse of the subprime market, the rescue of Bear Stearns and the bankruptcy of Lehman Brothers are analyzed with regard to their role as amplifiers of uncertainty about the value of collateral used in repo transactions and mistrust among market participants. The results show that parent banks which were more exposed to these disruptions were more likely to withdraw bank-internal funds from their branches and subsidiaries located abroad. Among the three events, the rescue of Bear Stearns triggered the largest contraction on internal capital markets from the part of the parent bank, possibly because this event demonstrated for the first time the fragility of even very large financial institutions. After the subprime market collapse, branches were briefly more protected as core investment locations, while subsidiaries were used as core funding locations up to the Lehman Brothers bankruptcy. All in all, funding via repo markets is found to be one channel that transmitted shocks primarily related to the US financial system abroad.

The US Dollar Funding Premium of Global Banks

Following the financial crisis of 2007, many global financial firms faced difficulties in borrowing U.S. dollars (USD). We estimate the premium global banks paid to obtain USD (the “USD basis”) by the rate banks pay to swap euros into USD in the foreign exchange (FX) market, while fully hedging the FX risk, relative to the interbank rate for borrowing USD. We find that the bank basis is higher the day following increases in CDS prices and in asymmetric information measures. Controlling for fundamental risk, the basis is lower the day after successful borrowing at the Fed’s dollar liquidity facilities and it is higher for European banks following an unanticipated decrease in repo funding amounts, implying that USD funding constraints were binding for European banks during the crisis. Our results show that increased asymmetric information and “repo runs” (through unanticipated withdrawals of repo funding) combined to increase bank funding costs during the crisis.

Macroprudential Regulation under Repo Funding

The use of collateral has become one of the most widespread risk mitigation techniques. While it brings stabilizing effects to the individual lender we argue that it may exacerbate systemic risk through margin call activation. We show how a liquidity shock to the cash lender may propagate as a solvency shock via liquidity hoarding even if the cash lender remains solvent in all states of nature. Albeit a cost-effective response of the cash lender to a liquidity shock, liquidity hoarding may lead to the bankruptcy of its repo counterparties triggering contagion across asset classes. To buttress the resilience of the financial system, we lay out a menu of macroprudential policies that deactivate this channel of financial contagion.

Macroprudential Regulation Under Repo Funding

Macroprudential Regulation Under Repo Funding