Programa de Reeducación Muscular

In the run up to the financial crisis of 2008 and 2009, an increase in the level of repo transactions was noted (see Gorton & Metrick, 2010b). The demand for repo grew with the rapid growth of institutional investors, such as mutual funds, pension funds, hedge funds, and other managed funds. These institutions do not come under deposit insurance. Therefore, institutional investors do not have access to a safe, short-term, demand deposit-like product that earns interest while retaining flexibility. Furthermore, repurchase agreement transactions represent an important source of funding for loan originators (Gorton & Metrick, 2010a, see also King, 2008, for institutional features of the repo market, e.g., Duffie, 1996; Garbade, 2006 and Federal Reserve Bank of New York, 2010).

Chapter 2. Definition and Development of the Shadow Banking System 49 Broker-Dealer Shadow Bank Institutional Investor Fund Collateral worth $ 100 $ 95 Haircut 5%

Figure 2.18: Structure of a repurchase agreement transaction. Author’s drawing on

basis of Krishnamurthyet al., 2011, p. 11

Sale and repurchase agreements (i.e., repos) present a type of short-term funding used by a variety of market participants, such as institutional investors and non-financial firms with large holdings, to store cash safely, earn some interest, and have ready access. The market of sales and repurchase agreements can be divided um into repo transactions and securities lending. Whereas the term securities lending describes the lending of actual securities by investors against the collateral cash. The repo transaction describes the lending of cash by capital seeking parties against a collateral in the narrow sense, a security. The securities lending activity can also be named a reverse repo. For the following analysis and further descriptions both activities will be summarized by the term repo transaction. These activities by counterparties seeking to invest money or to borrow securities are called security driven repo transactions (i.e., securities lending). Depository institutions and broker–dealers use repo transactions to finance inventories, create leverage, cover short positions, or hedge and speculate in interest rate movements. Activities of counterparties that seek to borrow cash are cash driven repo transactions (i.e., the pure repo transaction). A repo transaction involves the simultaneous sale of a security (i.e., collateral) and the agreement to repurchase the security at a later date at an agreed-upon higher price. Furthermore, institutional investors, such as di↵erent mutual funds, insurance companies, or corporate treasures use these transactions either to invest surplus cash and earn returns, or to raise cash for investments (H¨ordahl & King, 2008, p. 38, see Figure 2.18 for a model of the repurchase agreement structure). Non-bank financial intermediaries largely use repurchase agreements for funding (e.g., broker–dealers) or investment purposes (e.g., MMF). The di↵erence between the pur- chase price or value of the collateral (Yt) and sale price of the collateral at a later date

(Y_(t+n)) is the interest rate, also known as the repo rate (Y(t+n) Yt

Yt ). A repo transaction

can also be viewed as a short-term collateralized loan, where the lender of the security posts an asset as collateral with a cash provider (Gorton & Metrick, 2010a, p. 508 and H¨ordahl & King, 2008, p. 37).

Collateral can be divided into traditional forms of collateral, such as treasuries and agency securities, and non-traditional forms of collateral, such as ABSs, MBSs, corpo- rate debt, and equity. Depending on the type of collateral, the depositor may demand

a margin or haircut. Typically, the borrower has to post collateral in excess of the notational amount of the loan (i.e., overcollateralization). This haircut is defined as a risk control measure applied to the underlying asset. The value of the collateral is calculated as marketable value reduced by a certain percentage. Haircuts are defined as di↵erence between the value of the cash and the value of the collateral and reflect the expectations of the future development of the underlying collateral and are used to protect the depositor from potential losses due to declines in the market value (Adrian et al. , 2013 and European Central Bank, 2011b, p. 143). Repo haircuts vary with the risk of the underlying collateral. The haircut is defined as (1 V_F), with value of the collateral V and notational amount of the loan F. Prior to the 2008–2009 crisis, haircuts on non-traditional collaterals, especially ABSs, were extremely low (2%). Over the course of the crisis, haircuts rose to more than 50% (see also; Gorton & Metrick, 2009; Stein, 2010, p. 46 and Krishnamurthy et al. , 2011, p. 8 f.).

Data available on repurchase agreement transactions is limited due to their complexity and a lack of transparency. Also, the majority of repo agreements are over-the-counter transactions (OTCs), and are therefore not recorded. Proposed regulation of repo agree- ments addresses the problems associated with this complexity and proposes standard- ization and documentation to avoid raising haircuts and instability. For the purpose of the analysis in the present paper, it is important to highlight major lenders in repo transactions. Figure 2.19 confirms the assumption that MMFs and other funds are ma- jor providers of repo agreements (Board of Governors of the Federal Reserve System, 2011, Table L.207).

Figure 2.19: Lenders in Repo Transactions (U.S.) (Flow of Funds – Board of

Governors of the Federal Reserve System Data Download Program; http://www.

federalreserve.gov/datadownload/Choose.aspx?rel=Z.1; Table L.207, Date of Download: 06. June 2014).

Chapter 2. Definition and Development of the Shadow Banking System 51