OFR on Seasonality in Repo Markets
The US Treasury's Office of Financial Research released a new white paper called, "Regulatory Arbitrage in Repo Markets" by Benjamin Munyan. The abstract says, "Non-U.S. banks with relatively low capital ratios appear to temporarily remove an average of $170 billion from the U.S. market for tri-party repurchase agreements (repo) before each quarter-end in order to appear safer and less levered. This amount is more than double the $76 billion market-wide drop in tri-party repo during the turmoil of the 2008 financial crisis and represents about 10% of the entire tri-party repo market. Such window dressing-induced deleveraging spills over into agency bond markets and money market funds and affects market liquidity each quarter." A blog post, "Seasonality in Repo Markets Described in Latest Working Paper" by OFR's Acting Deputy Director of Research and Analysis Greg Feldberg provides an overview. He writes, "An OFR working paper published today documents that the amount of a key type of short-term borrowing by foreign-owned broker-dealers has declined by about 10 percent at the end of each quarter since July 2008 and rebounded at the beginning of each following quarter. The paper illustrates that this abrupt, seasonal rhythm in triparty repo borrowing is consistent with a pattern of "window-dressing" by the U.S. broker-dealer affiliates of foreign banks. They seek to reduce the size of their balance sheets at quarter end to reduce their capital requirements in particular, to comply with the leverage ratio. Window-dressing is a term commonly used to describe period-ending transactions that are reflected on a statement or report. The triparty repo market provides critical overnight funding to banks, broker-dealers, and other companies Since the financial crisis of 2007-09, regulators have sought a better understanding of risk taking in this market and worked to develop policies to mitigate vulnerabilities in it.... The author of today's paper used confidential regulatory data from the OFR and Federal Reserve. The paper concludes that dealers with foreign parent companies that borrow cash in the U.S. triparty repo market collectively reduce their borrowing by an average of $170 billion at each quarter end. In contrast, U.S. banks' broker-dealer affiliates do not make such reductions. These differences partly reflect different regulatory practices. Foreign regulators use a quarter-end measure of total exposures in calculating a bank's leverage ratio, which includes the activities of its U.S. broker-dealer affiliate. U.S. regulators use a quarter-average measure.... The paper finds that the decline in triparty repo borrowing by foreign-owned broker-dealers at quarter end is largely in transactions backed by government securities, leaving the remaining repo backed by more risky collateral. The findings of the paper suggest that the leverage ratio may have some unintended consequences on the repo market by encouraging firms to reduce their activity in repo backed by lower-risk collateral, such as government securities."
