Ripple Effects of Repo Pullback
On Wall Street wrote Tuesday, "Repo Pullback Impacts Money Market Funds." The article says, "New capital and liquidity rules are forcing banks to pull back from a vibrant market that has allowed them access to inexpensive overnight funding. With the decline in funding volumes come potential outcomes that impact the $2.591 trillion market for money market mutual funds. "There are ripple effects," says Joseph Abate, a money market strategist at Barclays PLC in New York. "The first ripple effect is there is a significant shortage of safe assets for cash-long investors to buy." During the past two years, banks have been steadily reducing the volume of repurchase agreements, known as repos, that have served as a significant source of liquidity but which regulators see as an unreliable funding source for banks during crisis periods. In this situation, money market funds may find themselves scrambling to find enough repo, which forces the funds to use an overnight reverse repo facility run by the Fed. This also keeps interest rates down on bills and other short-duration instruments as well. "That may or may not be a bad thing. However, it does create a disconnect in the market," says Abate." The piece continues, "It's been a long, steady and substantial 20% slide in repo activity from the recent peak of $2.18 trillion in the collateral value of repos in November 2012 to $1.74 trillion in July 2014, according to the Federal Reserve Bank of New York -- with more likely to come. The implementation of new Basel III regulations is expected to put further downward pressure on the repo market. Since the regulators first proposed a supplemental leverage ratio for the largest banks last summer, the repo market has declined by $750 billion as of July 2014, according to estimates from Goldman Sachs. Though the new leverage ratio will not go into effect until January 2018, Tier 1 leverage capital becomes a binding constraint under the Fed's annual stress tests of major banks beginning next year. As a result, the drawback from the repo market by banks is likely to be permanent, according to a research note published in April by Goldman Sachs."
