The Repo Market, Collateral and Systemic Risk: In Search of Regulatory Coherence
Forthcoming, Research Handbook on Shadow Banking (eds. Chiu & MacNeil, Elgar 2018)
41 Pages Posted: 1 Nov 2016 Last revised: 20 Nov 2017
Date Written: October 26, 2016
The repo market is a major source of short-term secured funding for financial institutions. Because lending in these markets is collateralized – often by high-quality securities – the stability of the market was, until recently, taken for granted by market participants and regulators. However, in common with other forms of secured lending, repo markets may break down if concerns about collateral values become widespread, and cause participants to withdraw funding. Many contend that a run on the repo market was a central driver of the global financial crisis. And yet, direct reform of the repo market has not been prioritized. This chapter critically analyses post-crisis regulation of the repo market and argues that whilst direct reform of repo has indeed been lacking, other reforms aimed at curbing financial institutions’ reliance on short-term funding sources and capping bank balance sheets will limit the threat repo markets pose to systemic stability. Moreover, central bank monetary policy initiatives, by shrinking the supply of collateral, threaten to undermine repo market functionality and constrain market liquidity. Establishing a well-functioning repo market is dependent on addressing this paradox.
Keywords: repo, collateral, QE, monetary policy, shadow banking, financial markets, leverage, liquidity, systemic risk
JEL Classification: K00, K20, E00, E58, G20, G23
Suggested Citation: Suggested Citation