Macroprudential Regulation Under Repo Funding

38 Pages Posted: 1 Feb 2011

See all articles by Laura Valderrama

Laura Valderrama

International Monetary Fund - Monetary and Capital Markets Department

Date Written: September 2010

Abstract

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.

Keywords: Bank regulations, Bankruptcy, Capital, Economic models, Financial institutions, Financial risk, International financial system, Liquidity

Suggested Citation

Valderrama, Laura, Macroprudential Regulation Under Repo Funding (September 2010). IMF Working Papers, Vol. , pp. 1-37, 2010. Available at SSRN: https://ssrn.com/abstract=1750708

Laura Valderrama (Contact Author)

International Monetary Fund - Monetary and Capital Markets Department ( email )

700 19th Street NW
Washington, DC 20431
United States

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