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1 1 (December 9, 2019)

handle is hein.crs/govbgvu0001 and id is 1 raw text is: 01;0i E~$~ & December 9, 2019 Repurchase Agreements (Repos): A Primer Repurchase agreements (repos) are a major source of short- term funding for financial institutions. Repos are a policy concern because they have long been identified as a potential source of systemic risk, meaning that problems in that market could lead to broader financial instability. 0kwactelrism ,lc' Repos are legally arranged as a contract between two parties to sell a security, such as a Treasury bond, and then repurchase it at a later date at a higher prearranged price (Figure 1). Economically, a repo is equivalent to a short- term collateralized loan, with the security serving as collateral and the percentage change in price between sale and repurchase acting as the interest rate on the loan (called the repo rate). From the borrower's perspective, the transaction is called a repo (or an RP); from the lender's perspective, it is called a reverse repo (or an RRP). Figure I. Bilateral Repurchase Agreement Rep urw D, S;, erx C ash Source: CRS. Repos' characteristics vary widely, including the length to maturity, whether they last for a specified term or are open- ended, types of collateral accepted, and the size of the haircut (i.e., the difference in value between the securities sold and cash delivered). As a result, repo rates vary based on these varying characteristics. Generally, repos are short- term and repo rates are relatively low. Repos can be bilateral or triparty. In bilateral repos, cash and securities are exchanged directly between the two parties. In triparty repos, the cash and securities are exchanged through a third-party clearing bank. In the United States, the Bank of New York Mellon (BoNYM) is currently the only clearing bank for triparty repos. Triparty repos eliminate the risk that the counterparty to the repo will not fulfill its terms at the unwind date. Instead, counterparty risk is borne by the clearing bank if it provides credit. Bilateral repos can also eliminate counterparty risk if they are cleared. The primary U.S. clearinghouse for repos is the Fixed Income Clearing Corporation (FICC). FICC's counterparty exposure is mitigated through margin requirements, which require cash to be posted upfront. Ra, - t iip a ts Repos are large-scale transactions that do not directly involve retail investors. Financial institutions enter into repos either because (1) one institution has short-term borrowing needs and another institution has unused cash that it would like to earn interest on (as shown in Figure 1); or (2) one institution needs to borrow a certain security (e.g., to complete a short sale) and another institution is willing to lend it for cash. Many types of financial institutions participate in repo markets, including hedge funds, money market funds, pension funds, insurance companies, government-sponsored enterprises, and banks. Typically, repos involve securities dealers on at least one side of the transaction. Securities dealers are market makers in securities markets, requiring them to borrow and lend securities and cash to execute client orders. Many of the largest securities dealers are owned by large bank holding companies or foreign bank organizations. Market i'.N According to the Federal Reserve (Fed), there were $3.9 trillion of repos outstanding in the second quarter of 2019, up 21.6% from the previous year. However, outstanding repos are probably lower now than they were before the financial crisis. Due to data gaps, the current relative size of bilateral versus triparty repos and different institutions' shares of the repo market are uncertain. In the 2007-2009 financial crisis, problems in the repo market contributed to the widespread liquidity problems faced by financial firms, including Bear Stearns and Lehman Brothers. Many types of financial firms face a liquidity mismatch, meaning that their assets are less liquid (i.e., easily convertible into cash) than their liabilities. To meet ongoing cash-flow needs, some of these firms convert securities into cash by borrowing short term in the repo market. But the amount of borrowing available on the repo market depends on the willingness of other firms with surplus cash to lend it. In normal conditions, firms are relatively indifferent about whom they lend to in repo markets because they are protected by collateral. During the financial crisis, some argue that firms became less willing to lend and required higher-quality collateral or a larger haircut (particularly for non-Treasury collateral), thereby reducing the amount of liquidity available to firms including solvent firms. Although all short-term credit markets can be subject to this sort of run in a panic, the repo market is a particular concern because of its size and use by a broad range of financial firms. The plethora of different types of firms using repos also meant there was inconsistent K~:> - , gnom ggmm , q a 'S

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