August 03, 2018

BoE published a staff working paper that examines the role of capital regulation in the functioning of the repurchase agreement (repo) market. The paper shows that the leverage ratio affects repo intermediation for banks and non-bank financial institutions.

The paper reviews the related literature that studies the repo market. Next, the paper describes the gilt repo market and how the leverage ratio affects repo market intermediation. It then outlines the empirical methodology and describes the Sterling Money Market database that is being used. The study exploits a novel regulatory change in the UK to identify an exogenous intensification of the leverage ratio and combine this with supervisory transaction-level data capturing the near-universe of gilt repo trading. The paper moves on to present and discuss the empirical findings and analyzes the aggregate effect and market adjustment. Finally, it concludes and discusses the policy implications of the findings of this study.

Studying adjustments at the dealer-client level and controlling for demand and confounding factors, it was found that dealers subject to a more binding leverage ratio reduced liquidity in the repo market; this affected their small, but not the large, clients. The study documents a reduction in frequency of transactions and a worsening of repo pricing, but no adjustment in haircuts or maturities. Finally, evidence of market resilience is found, based on existing, rather than new repo relationships, with foreign, non-constrained dealers stepping in. Overall, the findings help shed light on the impact of Basel III capital regulation on repo markets.

 

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Keywords: Europe, UK, Banking, Securities, Capital Regulation, Basel III, Leverage Ratio, Repo Market, BoE

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