Seasonality in Repo Markets Described in Latest Working Paper

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.

In September, the OFR published a working paper that served as a reference guide on U.S. markets for repo and securities lending.

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 leverage ratio requires banks to hold capital in proportion to their total exposures without regard to the riskiness of those exposures. When the leverage ratio is the binding capital ratio requirement for a bank, the bank has an incentive to reduce exposures to lower-risk, lower-return activities.

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.

The OFR is committed to understanding the dynamics and potential financial vulnerabilities of secured funding and market liquidity. This paper and other research improve that understanding and foster discussion among stakeholders about ways to promote a more resilient financial system.

Greg Feldberg is Acting Deputy Director for Research and Analysis at the Office of Financial Research