Leverage Ratio Regulation Will Hurt Liquidity, Introduce Risks
Sober Look | Jul 22, 2013 02:36AM ET
New bank regulation focused on the so-called Leverage Ratio is expected to do major damage to the US repo market. The measure is a blunt tool that does not permit any netting. That means if a client has a repo trade with a bank and an offsetting (reverse repo) transaction, the two can not be offset. Furthermore, the Leverage Ratio will show double the exposure by grossing up the transactions.
According to JPMorgan, this inability to offset positions will result in some $180bn of new capital requirements for major banks.
JPMorgan: The inability of banks to offset repos against reverse repos could increase the denominator of the Leverage Ratio by up to $6tr. Applying the 3% minimum capital requirement to this $6tr potentially results in additional capital of $180bn across G4 banks.
That is expected to shrink the market considerably. And lower repo balances will reduce trading and liquidity in the underlying securities the two markets are closely tied.
Some 80-90% of repo trades are collateralized with government securities, which will see declines in liquidity as the new rule goes into effect.
In 2008 financial institutions faced a major liquidity crisis that was in large part the result of short-term financing of highly illiquid securities. In order to address these problems, the regulators are now attacking the most liquid part of the market the exact opposite of where they should be focusing. Ironically these new rules may actually introduce additional risks into the financial system by cutting trading volumes and reducing secured lending against government bonds, both of which are essential in a liquidity crisis.
Get The News You Want
Trading in financial instruments and/or cryptocurrencies involves high risks including the risk of losing some, or all, of your investment amount, and may not be suitable for all investors. Prices of cryptocurrencies are extremely volatile and may be affected by external factors such as financial, regulatory or political events. Trading on margin increases the financial risks.
Before deciding to trade in financial instrument or cryptocurrencies you should be fully informed of the risks and costs associated with trading the financial markets, carefully consider your investment objectives, level of experience, and risk appetite, and seek professional advice where needed.
Fusion Media would like to remind you that the data contained in this website is not necessarily real-time nor accurate. The data and prices on the website are not necessarily provided by any market or exchange, but may be provided by market makers, and so prices may not be accurate and may differ from the actual price at any given market, meaning prices are indicative and not appropriate for trading purposes. Fusion Media and any provider of the data contained in this website will not accept liability for any loss or damage as a result of your trading, or your reliance on the information contained within this website.
It is prohibited to use, store, reproduce, display, modify, transmit or distribute the data contained in this website without the explicit prior written permission of Fusion Media and/or the data provider. All intellectual property rights are reserved by the providers and/or the exchange providing the data contained in this website.
Fusion Media may be compensated by the advertisers that appear on the website, based on your interaction with the advertisements or advertisers.