Shadow banking and repo explored by ERC
23 March 2012 Zurich
Image: Shutterstock
ICMA’s European Repo Council (ERC) has published the white paper: ‘Shadow banking and repo’, which explores concerns raised by regulators about shadow banking and its relation to the European repo market.
Written by Richard Comotto of the ICMA Centre, the paper makes four key points:
Point One: repo is not inherently a shadow banking tool, having been widely used by traditional banks in Europe for many years and has helped many of these to ride out the crisis by giving them continued access to a source of term funding when unsecured term markets have been closed to them.
Point Two: Regulators are concerned that collateralised instruments like repo facilitate or even encourage excessive leverage, which was a major factor in the recent crisis. In practice however, markets will not allow banks to keep borrowing, even against good collateral.
Point Three: Use of collateral does not make borrowing risk‐free but its prudent use is a source of stability for individual institutions and markets. There is a danger that the current discussion about collateralised lending paints collateral in a negative light. But collateralised lending is always preferable to unsecured funding. Regulators should therefore avoid action on repo that distorts the relative pricing advantage of secured over unsecured funding.
Point Four: There is a case for improving the transparency of the repo market, although a lot of data already exists and much is underexploited. Suggestions of a repo trade repository need to be carefully assessed. Trade repositories in instruments like derivatives have been proposed in order to address operational complexity, not just to collect market data.
Written by Richard Comotto of the ICMA Centre, the paper makes four key points:
Point One: repo is not inherently a shadow banking tool, having been widely used by traditional banks in Europe for many years and has helped many of these to ride out the crisis by giving them continued access to a source of term funding when unsecured term markets have been closed to them.
Point Two: Regulators are concerned that collateralised instruments like repo facilitate or even encourage excessive leverage, which was a major factor in the recent crisis. In practice however, markets will not allow banks to keep borrowing, even against good collateral.
Point Three: Use of collateral does not make borrowing risk‐free but its prudent use is a source of stability for individual institutions and markets. There is a danger that the current discussion about collateralised lending paints collateral in a negative light. But collateralised lending is always preferable to unsecured funding. Regulators should therefore avoid action on repo that distorts the relative pricing advantage of secured over unsecured funding.
Point Four: There is a case for improving the transparency of the repo market, although a lot of data already exists and much is underexploited. Suggestions of a repo trade repository need to be carefully assessed. Trade repositories in instruments like derivatives have been proposed in order to address operational complexity, not just to collect market data.
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