What Drives Repo Haircuts? Evidence from the UK Market

Abstract

Using a unique transaction-level data, we document that only 61% 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 and exploit netting benefits. Furthermore, maturity, collateral rating and asset liquidity have important effects on repo liquidity via haircuts. Counterparty types also matter: non-hedge funds, large borrowers, and borrowers with repeated bilateral relationships receive lower (or zero) haircuts. Furthermore, we observe a pecking order in the posting of collateral, with higher quality one more likely to be used first. Overall, the evidence supports a first order role of information frictions in driving haircuts. In contrast, we do not find significant roles in the data for lenders’ liquidity position or default probabilities.

Keywords: Repurchase agreement, systemic risk, repo market, margin; haircut

JEL Classification: E44, G14, G23