What Drives Repo Haircuts? Evidence from the UK Market

Abstract

Using a unique transaction-level data, we document that only 60% of bilateral repos held by UK banks are backed by high quality collateral. Banks intermediate repo liquidity among different counterparties and use CCPs to reallocate high-quality collaterals among themselves. Furthermore, maturity, collateral rating and asset liq- uidity have important effects on repo liquidity via haircuts. Counterparty types also matter: non-hedge funds, large borrowers, and borrowers with repeated bilateral rela- tionships receive lower (or zero) haircuts. The evidence supports an adverse selection explanation of haircuts, but does not find significant roles for mechanisms related to lenders’ liquidity position or default probabilities.

Keywords: repurchase agreement, systemic risk, repo market, margin, haircut.

JEL Classification: G12, G21, G23, E43, E58