What You Need To Know About The Repo Market 3

If you have heard the term “shadow banking system” being bandied about in the past few years, the repo market is a big part of it.
There are (and will be) those who conceive of the shadow banking system as hedge funds and/or private equity firms using their own balance sheets to extend loans.
While this kind of lending definitely counts as unregulated shadow banking activity, the amounts involved there are dwarfed by the amounts flowing through the repo market.
According to IMF research , at the end of 2017, the amount of collateral pledged was approximately $7.5 trillion. This was collateral that could be re-pledged.
In 2007, pre-Great Financial Crisis, this number was even higher, at $10 trillion. Post crisis, it dropped to $6 trillion, and stayed at this number for about a decade.
The “could be re-pledged” part is important, because this means collateral can, like money in the economy, have velocity. In 2007, this came in at approximately 3, dropping to about 2 at the end of 2017.
Unfortunately, we do not have more up-to-date figures, given that the repo market is extremely opaque, and comprehensive reviews or overviews of its data and activity are very difficult to compile (hence the moniker shadow banking).
While 2017 is a long time ago in financial terms, the data from this report is the best we have at this point in time.
But, even with 2017 figures, it is quite clear that the repo market is very, very big; $7.5 trillion with a velocity of 2 puts the size of the market at $15 trillion ($30 trillion in 2007).
That’s a $15 trillion market that the majority of people do not even know exists!
Why is it so large, and what are the implications of its size?
The important thing to remember about the repo market is that it is international.
Different types of collateral are pledged for cash loans, and vice versa, all over the globe. This is done for a wide variety of purposes, not least the examples given in Part 2.
Repo transactions are also not confined to a certain currency or type of collateral.
For instance, Indonesian sovereign bonds can be pledged as collateral to obtain a USD loan.
Obviously, the haircut on the transaction would be quite a bit higher than if USTs were used as collateral, but different repo desks have different risk tolerances, and in normal times, there will be traders willing to transact against riskier collateral.
To be concluded…
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