Wot about repo? November 19, 2012 at 2:18 pm

Like many, I am reading the FSB report on shadow banking. The most important issue here is the fifth workstream, securities lending and repo — yet the proposals seem, well, a little bland. Here are the suggestions in brief:

  1. Improving regulatory reporting
  2. Improving market transparency
  3. Improving corporate disclosures
  4. Improving reporting by fund managers to end-investors
  5. Introducing minimum standards for haircut practices
  6. Limiting risks associated with cash collateral reinvestment
  7. Addressing risks associated with re-hypothecation of client assets
  8. Strengthening collateral valuation and management practices
  9. Evaluating the establishment or wider-use of central clearing where appropriate
  10. Changing bankruptcy law treatment of repo and securities lending transactions

All good stuff, but if a money market fund requires something like capital because it is bank-like, shouldn’t there be capital requirements for all repo rather than Basel II’s safe harbour (zero capital for certain qualifying transactions)? And, if not, on what basis is liquidity risk being `traded off’ against systemic and credit risks? Just askin’.

3 Responses to “Wot about repo?”

  1. I might have misunderstood something, but don’t the minimum haircuts create a kind of capital requirement?

    After all, if you consider a balance sheet whose assets have all been repo’d, the liabilities corresponding to these repos must be smaller than the asset side, leaving a gap that can only be filled by equity or at least more subordinated unsecured lending.

  2. It depends on what risk you are trying to cover, JH. Haircuts are equity like on credit risk for the obligator, but the possibility of a haircut increase creates liquidity risk for them. In order words:

    The lender needs protection to cover gap risk on the borrower, and this is the haircut; and

    The borrower needs protection to cover the risk of haircut increases (and value decreases) on the collateral.

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