Breaking News
0
Ad-Free Version. Upgrade your Investing.com experience. Save up to 40% More details

U.S. banks' reluctance to lend cash may have caused repo shock: BIS

Stock MarketsDec 08, 2019 12:11PM ET
Saved. See Saved Items.
This article has already been saved in your Saved Items
 

By Olga Cotaga

LONDON (Reuters) - The unwillingness of the top four U.S. banks to lend cash combined with a burst of demand from hedge funds for secured funding could explain a recent spike in U.S. money market rates, the Bank for International Settlements said.

Cash available to banks for short-term funding all but dried up in late September, and interest rates deep in the plumbing of U.S. financial markets climbed into double digits.

That forced the Fed to make an emergency injection of billions of dollars for the first time since the global financial crisis more than a decade ago.

While the exact cause of the squeeze is unclear - with explanations ranging from large withdrawals for quarterly tax payments to a big settlement of a trade in U.S. Treasuries - BIS analysts said the growing reliance on the biggest U.S. banks to keep the repo market functioning may have been a big factor.

The big four banks, which BIS did not name in its report, have become net providers of funds to repo markets as they account for more than half of all Treasuries held by banks in the United States at the Federal Reserve.

The repo market underpins much of the U.S. financial system, helping ensure banks have liquidity to meet their daily operational needs.

In a repo trade, Wall Street firms and banks offer U.S. Treasuries and other high-quality securities as collateral to raise cash, often just overnight, to finance their trading and lending. The next day, borrowers repay the loans plus what is typically a nominal rate of interest and get their bonds back. In other words they repurchase, or repo, the bonds.

The system typically hums along with the interest rate charged on repo deals hovering close to the Fed's benchmark overnight rate, which it cut on Wednesday to 1.75%-2.00% from 2.00%-2.25%.

But in late September, interest rates shot up to as high as 10% for some overnight loans, more than four times the Fed's policy rate, raising concerns about the fragility of U.S. dollar funding markets.

(Graphic: U.S. banks - https://fingfx.thomsonreuters.com/gfx/mkt/12/9650/9562/US%20BANKS.png)

ATROPHY

After the U.S. Federal Reserve began to run down its $4 trillion plus balance sheet from October 2017, banks' cash reserves at the Fed also contracted, while their holdings of U.S. Treasuries grew rapidly, the BIS said.

That reduction in cash holdings at the Fed sped up after the U.S. debt ceiling was suspended in early August.

The Treasury drained more than $120 billion of reserves from Aug. 14 to Sept. 17, reducing the cash buffers of the big four banks and hence their willingness to lend in the repo market, the BIS found.

The repo rate rose to an intraday high of about 700 basis points, with some trades reportedly occurring at up to 10%.

"The dislocations suggest that central banks’ post-crisis unconventional operations have left a profound imprint on market functioning," said Claudio Borio, head of the monetary and economic department at BIS.

"Banks get used to a protracted period of abundant excess reserves, withdrawing them may result in unpredictable and sudden market adjustments. It is as if a muscle had atrophied," he said.

That rush for short-dated secured funding was exacerbated by hedge funds who had ramped up their Treasury repos to fund arbitrage trades between cash bonds and derivatives.

The BIS also noted that the spike in the repo rate spilled over into the currency derivatives market, on which banks rely increasingly for short-term funding.

In the past three years, FX swap volumes have grown to make up as much as 49% of the overall foreign exchange market due to the growing participation of lower-tier banks which depend on swaps for funding as they lack direct access to U.S. dollar markets.

"Repo markets, alongside the.. .FX swap market for U.S. dollar funding, may again find themselves in the eye of the storm should financial stress arise at some point," Borio said.

"The surge in FX short-dated swap trading. ..underlines this risk."

U.S. banks' reluctance to lend cash may have caused repo shock: BIS
 

Related Articles

Add a Comment

Comment Guidelines

We encourage you to use comments to engage with other users, share your perspective and ask questions of authors and each other. However, in order to maintain the high level of discourse we’ve all come to value and expect, please keep the following criteria in mind:  

  •            Enrich the conversation, don’t trash it.

  •           Stay focused and on track. Only post material that’s relevant to the topic being discussed. 

  •           Be respectful. Even negative opinions can be framed positively and diplomatically. Avoid profanity, slander or personal attacks directed at an author or another user. Racism, sexism and other forms of discrimination will not be tolerated.

  • Use standard writing style. Include punctuation and upper and lower cases. Comments that are written in all caps and contain excessive use of symbols will be removed.
  • NOTE: Spam and/or promotional messages and comments containing links will be removed. Phone numbers, email addresses, links to personal or business websites, Skype/Telegram/WhatsApp etc. addresses (including links to groups) will also be removed; self-promotional material or business-related solicitations or PR (ie, contact me for signals/advice etc.), and/or any other comment that contains personal contact specifcs or advertising will be removed as well. In addition, any of the above-mentioned violations may result in suspension of your account.
  • Doxxing. We do not allow any sharing of private or personal contact or other information about any individual or organization. This will result in immediate suspension of the commentor and his or her account.
  • Don’t monopolize the conversation. We appreciate passion and conviction, but we also strongly believe in giving everyone a chance to air their point of view. Therefore, in addition to civil interaction, we expect commenters to offer their opinions succinctly and thoughtfully, but not so repeatedly that others are annoyed or offended. If we receive complaints about individuals who take over a thread or forum, we reserve the right to ban them from the site, without recourse.
  • Only English comments will be allowed.

Perpetrators of spam or abuse will be deleted from the site and prohibited from future registration at Investing.com’s discretion.

Write your thoughts here
 
Are you sure you want to delete this chart?
 
Post
Post also to:
 
Replace the attached chart with a new chart ?
1000
Your ability to comment is currently suspended due to negative user reports. Your status will be reviewed by our moderators.
Please wait a minute before you try to comment again.
Thanks for your comment. Please note that all comments are pending until approved by our moderators. It may therefore take some time before it appears on our website.
Comments (1)
Stefon Walters
AgapeGrace Dec 08, 2019 12:51PM ET
Saved. See Saved Items.
This comment has already been saved in your Saved Items
Complete US CREDIT quagmire that noone really understands, yet everyone realizes is a house of cards awaiting collapse.
Mo Ali
Av8er31 Dec 08, 2019 12:51PM ET
Saved. See Saved Items.
This comment has already been saved in your Saved Items
nothing to understand just that the banks are in big trouble. Enough said.
TA XVCI
TA XVCI Dec 08, 2019 12:51PM ET
Saved. See Saved Items.
This comment has already been saved in your Saved Items
Mo Ali  Big big big trouble. Banks in China are getting bankrupt, already happening.
Andrew Hook
Andrew Hook Dec 08, 2019 12:51PM ET
Saved. See Saved Items.
This comment has already been saved in your Saved Items
Big four: Deutsche Bank included ? ;)
Stefon Walters
AgapeGrace Dec 08, 2019 12:51PM ET
Saved. See Saved Items.
This comment has already been saved in your Saved Items
Mo Ali Glad Av8 understands all the interaction between Credit Swaps, Currency Swaps, Repos, T-bills, Hedge Fund borrowing, Fed borrowing and Treasury printing. Noone else does ... not even them. But makes us feel much better that a reader here gots it down pat. Congrats. Now please call the Fed and Banks to explain the repo crunch to them + how the derivatives / swap instruments exacerbated the problem. They are waiting to hear from you.
 
Are you sure you want to delete this chart?
 
Post
 
Replace the attached chart with a new chart ?
1000
Your ability to comment is currently suspended due to negative user reports. Your status will be reviewed by our moderators.
Please wait a minute before you try to comment again.
Add Chart to Comment
Confirm Block

Are you sure you want to block %USER_NAME%?

By doing so, you and %USER_NAME% will not be able to see any of each other's Investing.com's posts.

%USER_NAME% was successfully added to your Block List

Since you’ve just unblocked this person, you must wait 48 hours before renewing the block.

Report this comment

I feel that this comment is:

Comment flagged

Thank You!

Your report has been sent to our moderators for review
Disclaimer: Fusion Media would like to remind you that the data contained in this website is not necessarily real-time nor accurate. All CFDs (stocks, indexes, futures) and Forex prices are not provided by exchanges but rather by market makers, and so prices may not be accurate and may differ from the actual market price, meaning prices are indicative and not appropriate for trading purposes. Therefore Fusion Media doesn`t bear any responsibility for any trading losses you might incur as a result of using this data.

Fusion Media or anyone involved with Fusion Media will not accept any liability for loss or damage as a result of reliance on the information including data, quotes, charts and buy/sell signals contained within this website. Please be fully informed regarding the risks and costs associated with trading the financial markets, it is one of the riskiest investment forms possible.
Continue with Google
or
Sign up with Email