Repo Chains and Financial Instability

Repo Chains and Financial Instability

There are three issues with Repos.

  • Repo chains as source of instability
  • Impact of Repo on Money Supply
  • Re-hypothecation: Reuse of Repo and Leverage

 

From Collateral Shortages and Intermediation Networks

 

In the pre-crisis period, financial markets witnessed a growing reliance on short-term funds raised in wholesale markets. In particular, there was a dramatic rise in the use of sales and repurchase (repo) agreements to fund longer-term investment opportunities or to finance inventories of securities held for market-making purposes. Given that such funding opportunities were secured by collateral, they were mostly considered to be safe. Since the crisis of 2007–8, however, the repo and the asset-backed commercial paper (ABCP) markets have been viewed as one of the potential sources of fragility in the financial system, with conventional wisdom (partially) attributing the collapse of Bear Stearns, Lehman Brothers, and Northern Rock to their reliance on wholesale funding.

 

From The Economics of Collateral Chains

 

The ‘supply’ of pledged collateral is typically received by the central collateral desk of banks that re-use the collateral to meet the ‘demand’ from the financial system. The key providers of primary (or source) collateral to the ‘street’ (or large banks) are: hedge funds; securities lending (via custodians) on behalf of pension funds, insurers, official sector accounts, etc. and commercial banks that liaise with large banks. The securities they hold are continuously re-invested to maximize returns over their maturity tenor. Source collateral is collateral that can be re-pledged, creating dynamic collateral chains. The term re-pledged is a legal term and means that the dealer receiving the collateral has the right to reuse in its own name.  Since a single piece of source collateral can be re-used several times by several different intermediaries, the aggregate volume of repledged collateral reflects both the availability of collateral (that is collateral from the source) as well as the velocity (or reuse rate) of source collateral.

 

From The Economics of Collateral Chains

 

The ratio of the total collateral received by the large banks divided by the ‘source’ collateral is the velo- city of collateral due to the intermediation by the street. For end-2007, the numerator of $10 trillion is what the large banks received in pledged collateral. We then compare it to the denominator or the primary sources of collateral via the hedge funds and security lenders acting on behalf of pension, insurers, official accounts, etc. − this was about $3.4 trillion. Empirical evidence suggests that the chains were longer pre-Lehman and around 3 as of end-2007; they have decreased to about 2.4 as of end-2010. Intuitively, this means that collateral from a primary source now takes ‘fewer steps’ to reach the ultimate client. This is due to the concern of source collateral providers about counterparty risk of the large banks, and also from the demand for higher quality collateral by the ultimate clients. Lower quality collateral is difficult to move in the present time.

 

From The Economics of Collateral Chains

 

This decline in the re-use of collateral may be viewed positively from a financial stability perspective. However, from a monetary policy perspective, the lubrication in the global financial markets is now lower as the velocity of money type instruments has declined. The shorter “chains” − from constraining the collateral moves lowers global financial lubrication will increase overall cost of capital to the real economy.

Overall, global liquidity remains below pre-Lehman levels. When we consider collateral use/re-use in addition to M2 or the monetary base in U.S., U.K. and Eurozone, financial lubrication was over $30 trillion before Lehman (and one-third came via pledged collateral); now it is lower by about $4-5 trillion. Since cross-border funding is important for large banks, allowing for the efficient arbitrage of their funding operations, (e.g., consider the recent surge in the demand for U.S. dollar funding by European banks), the state of the pledged collateral market needs to be considered when setting monetary policy.

 

Key Sources of Research:

 

Velocity of Pledged Collateral: Analysis and Implications

Manmohan Singh

November 2011

http://papers.ssrn.com/sol3/papers.cfm?abstract_id=1961904

 

Sizing Up Repo 

Arvind Krishnamurthy   Stefan Nagel

Dmitry Orlov

June 2011

 

http://www.banqueducanada.ca/wp-content/uploads/2011/11/Sizing-up-repo_June29.pdf

 

RESALEABLE DEBT AND SYSTEMIC RISK

Jason Roderick Donaldson Eva Micheler

January 2, 2016

 

http://eprints.lse.ac.uk/66042/1/__lse.ac.uk_storage_LIBRARY_Secondary_libfile_shared_repository_Content_LSE%20SRC%20Discussions%20papers_2016_dp-53.pdf

 

Infante, S. (2015).

Liquidity windfalls: The consequences of repo rehypothecation.

Technical report, Federal Reserve Board of Governors Finance and Economics Dis- cussion Series 2015-22.

http://papers.ssrn.com/sol3/papers.cfm?abstract_id=2460979

 

Kahn, C. M. and H. J. Park

(2015).

Collateral, rehypothecation, and efficiency.

UIUC Working paper.

 

Lee, J. (2015).

Collateral circulation and repo spreads.

Technical report

http://papers.ssrn.com/sol3/papers.cfm?abstract_id=2548209

 

Singh, M. (2010).

The velocity of pledged collateral.

Technical report, IMF.

 

Singh, M. and J. Aitken (2010).

The (sizable) role of rehypothecation in the shadow banking system.

Technical report, IMF.

 

Gorton, G. and A. Metrick (2010).

Haircuts.

Review (Nov), 507–520.

 

Gorton, G. and A. Metrick (2012).

Securitized banking and the run on repo.

Journal of Financial Economics 104(3), 425–451.

 

Copeland, A., A. Martin, and M. Walker (2014).

Repo runs: Evidence from the tri- party repo market.

The Journal of Finance 69(6), 2343–2380.

 

Antinolfi, G., F. Carapella, C. Kahn, A. Martin, D. Mills, and E. Nosal (2014).

Repos, Fire Sales, and Bankruptcy Policy.

Review of Economic Dynamics, (forthcoming).

 

Financial Intermediation Networks

Marco Di Maggio† Alireza Tahbaz-Salehi

March 2015

http://www.lse.ac.uk/fmg/events/Intermeidation-March2015.pdf

 

Collateral Shortages and Intermediation Networks

Marco Di Maggio  Alireza Tahbaz-Salehi

October 1, 2015

http://papers.ssrn.com/sol3/papers.cfm?abstract_id=2492007

 

The political economy of repo markets

Daniela Gabor

https://info.brot-fuer-die-welt.de/sites/default/files/blog-downloads/gabor_political_economy_of_repo_markets.pdf

 

Collateral Risk, Repo Rollover and Shadow Banking

Shengxing Zhangú

August 28, 2014

 

http://www.econ.queensu.ca/files/other/Zhang%20paper.pdf

 

Shadow Interconnectedness: The Political Economy of (European) Shadow Banking

Daniela Gabor

September 16, 2013

http://papers.ssrn.com/sol3/papers.cfm?abstract_id=2326645

 

Systemic Risk, Contagion, and Financial Networks: A Survey

Matteo Chinazzi Giorgio Fagiolo

June 3, 2015

http://papers.ssrn.com/sol3/papers.cfm?abstract_id=2243504

 

A Map of Collateral Uses and Flows

 

Andrea Aguiar Richard Bookstaber Dror Y. Kenett Thomas Wipf

https://financialresearch.gov/working-papers/files/OFRwp-2016-06_Map-of-Collateral-Uses.pdf

 

Aguiar, A., R. Bookstaber, and T. Wipf.

“A Map of Funding Durability and Risk.”

Office of Financial Research Working Paper no. 14-03, 2014.

 

Baklanova, V.,

“Repo and Securities Lending: Improving Transparency with Better Data.”

Office of Financial Research Brief no. 15-03, 2015.

 

Baklanova, V., A. Copeland, and R. McCaughrin.

“Reference Guide to U.S. Repo and Securities Lending Markets.”

Office of Financial Research Working Paper no. 15-17, 2015.

 

Shadow Banks and Systemic Risks

Rui Gong Frank H. Page Jr.

July 23, 2015

 

Financial Contagion with Collateralized Transactions: A Multiplex Network Approach

Gustavo Peralta  Ricardo Crisóstomo

July 2016

http://papers.ssrn.com/sol3/papers.cfm?abstract_id=2717411

 

Non-bank financial institutions: Assessment of their impact
on the stability of the financial system

 

http://ec.europa.eu/economy_finance/publications/economic_paper/2012/pdf/ecp472_en.pdf

 

Taxonomy of Studies on Interconnectedness

Gazi Kara  Mary H. Tian Margaret Yellen

December 15, 2015

http://papers.ssrn.com/sol3/papers.cfm?abstract_id=2704072

 

 

Financial Plumbing and Monetary Policy

Manmohan Singh

June 2014

 

http://www.reflektion.org/wp-content/uploads/2014/07/wp14111.pdf

 

Haircuts and Repo Chains

Tri Vi Dang

Gary Gorton

Bengt Holmström

http://www.columbia.edu/~td2332/Paper_Repo.pdf

 

Nonbank Financial Intermediation, Financial Stability, and the Road Forward

Stanley Fischer

 

https://www.federalreserve.gov/newsevents/speech/fischer20150330a.pdf

 

Financial Intermediation Chains in an OTC Market

Ji Shen  Bin Wei  Hongjun Yan

December 15, 2015

http://papers.ssrn.com/sol3/papers.cfm?abstract_id=2577497

 

Dealer Networks

Dan Li Norman Schürhoff

October 22, 2014

http://papers.ssrn.com/sol3/papers.cfm?abstract_id=2023201

 

Systemic Risks in Repo Markets

 

Somnath Chatterjee

Repo Runs

Antoine Martin David Skeie Ernst-Ludwig von Thadden

https://www.newyorkfed.org/medialibrary/media/research/staff_reports/sr444.pdf

 

Securitized Banking and the Run on Repo

Gary Gorton

Andrew Metrick

First version: January 22, 2009 This version: November 13, 2009

https://www.moodys.com/microsites/crc2010/papers/gorton_run_on_repo_nov.pdf

 

Who Ran on Repo?

Gary Gorton, Andrew Metrick

October 4, 2012

http://faculty.som.yale.edu/garygorton/documents/whorancompleteoctober4.pdf

 

Repo Runs: Evidence from the Tri-Party Repo Market

Adam Copeland Antoine Martin Michael Walker

https://www.newyorkfed.org/medialibrary/media/research/staff_reports/sr506.pdf

 

Matching Collateral Supply and Financing Demands in Dealer Banks

 

Adam Kirk, James McAndrews, Parinitha Sastry, and Phillip Weed

DECEMBER 2014

https://www.newyorkfed.org/medialibrary/media/research/epr/2014/1412kirk.pdf

 

Collateral Reuse in Shadow Banking and Monetary Policy

Ameya Muley∗

7th January 2016

http://economics.mit.edu/files/10999

 

Money for Nothing: The Consequences of Repo Rehypothecation

Sebastian Infante

Federal Reserve Board September 19th, 2014 Abstract

 

Intermediary Funding Liquidity and Rehypothecation as Determinants of Repo Haircuts and Interest Rates

Egemen Eren

Stanford University July 23, 2014

http://web.stanford.edu/~eren/eren2014.pdf

 

Re-use of collateral in the repo market

Lucas Marc Fuhrer, Basil Guggenheim and Silvio Schumacher

2015

http://www.snb.ch/n/mmr/reference/working_paper_2015_02/source/working_paper_2015_02.n.pdf

 

Collateral Reuse as a Direct Funding Mechanism in Repo Markets

George Issa Elvis Jarnecic

 

http://www.efmaefm.org/0EFMAMEETINGS/EFMA%20ANNUAL%20MEETINGS/2016-Switzerland/papers/EFMA2016_0566_fullpaper.pdf

 

Rehypothecation and Liquidity

David Andolfatto Fernando M. Martin  Shengxing Zhang

2015-02-02

 

http://papers.ssrn.com/sol3/papers.cfm?abstract_id=2646142

 

Matching Prime Brokers and Hedge Funds∗

Egemen Eren†

JOB MARKET PAPER

December 23, 2015

http://web.stanford.edu/~eren/eren_jmp.pdf

 

Collateral, Rehypothecation, and Efficiency

Charles M. Kahn† Hye Jin Park‡

Last updated: April 15, 2015

https://research.stlouisfed.org/conferences/summer_workshop/docs/Collateral_Rehypothecation_and_Efficiency.pdf

 

The market for Collateral: the Potential impact of Financial Regulation

Jorge Cruz Lopez, Royce Mendes and Harri Vikstedt

http://www.bankofcanada.ca/wp-content/uploads/2013/06/fsr-0613-lopez.pdf

 

Rehypothecation

David Andolfatto Fernando Martin Shengxing Zhang

February 26, 2014

http://tippie.uiowa.edu/economics/tow/papers/andolfatto_spring2014.pdf

 

Collateralized Security Markets

John Geanakoplos William R. Zame

http://levine.sscnet.ucla.edu/archive/refs4661465000000000040.pdf

 

Rehypothecation

CRL MONNeT

https://www.phil.frb.org/research-and-data/publications/business-review/2011/q4/brq411_Rehypothecation.pdf

 

Collateral and Monetary Policy

Manmohan Singh

2013

https://www.imf.org/external/pubs/ft/wp/2013/wp13186.pdf

 

Financial Plumbing and Monetary Policy

Prepared by Manmohan Singh

June 2014

https://www.imf.org/external/pubs/ft/wp/2014/wp14111.pdf

 

Understanding the role of collateral in financial markets

M Singh

 

http://www.brookings.edu/~/media/events/2015/02/23-collateral-financial-markets/20150223-singh-slides.pdf

 

Systemic Risk and Stability in Financial Networks

Daron Acemoglu Asuman Ozdaglar Alireza Tahbaz-Salehi
This version: January 15, 2013

http://dspace.mit.edu/bitstream/handle/1721.1/77606/Acemoglu13-03.pdf?sequence=1

 

 

Systemic Risk in Endogenous Financial Networks

Daron Acemoglu Asuman E. Ozdaglar Alireza Tahbaz-Salehi

January 22, 2015

http://papers.ssrn.com/sol3/papers.cfm?abstract_id=2553900

 

Towards a theory of shadow money

Daniela Gabor and Jakob Vestergaard

https://ineteconomics.org/uploads/papers/Towards_Theory_Shadow_Money_GV_INET.pdf

 

Do Shadow Banks Create Money?

Jo Michell

http://eprints.uwe.ac.uk/28552/1/1602.pdf

 

How Does Monetary Policy A􏰝ffect Shadow Bank Money Creation? 

Kairong Xiao†

June 17, 2016

http://www.cicfconf.org/sites/default/files/paper_296.pdf

 

The Economic Consequences of ‘Market-Based’ Lending

Carolyn Sissoko

May 24, 2016

http://papers.ssrn.com/sol3/papers.cfm?abstract_id=2766693

 

Key Mechanics of the U.S. Tri-Party Repo Market

Adam Copeland, Darrell Duffie, Antoine Martin, and Susan McLaughlin

2012

https://www.newyorkfed.org/medialibrary/media/research/epr/12v18n3/1210cope.pdf

 

The Failure Mechanics of Dealer Banks

Darrell Duffie

2010

http://www.darrellduffie.com/uploads/pubs/DuffieFailureMechanicsDealerBanks2010.pdf

 

The Euro Interbank Repo Market

Loriano Mancini Angelo Ranaldo Jan Wrampelmeyer

March 26, 2014

http://www.cbs.dk/files/cbs.dk/angeloranaldopaper_4.pdf

 

 

 

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Author: Mayank Chaturvedi

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