Regulators willing to risk repo damage
Aug 16 (IFR) - The first salvo in the US bank attack on proposed supplementary leverage ratios - that the increase imperils the repo market - is unlikely to elicit much sympathy from US regulators.
For years, the Federal Reserve has been expressing concern about the risk associated with the tri-party repo market and is thus expected to embrace changes that see it shrink. Banks have argued to regulators that the lost liquidity may cost the US Treasury.
Treasuries account for the lion's share of the collateral in the repo market. If liquidity shrinks by even 10% as some analysts predict, the Treasury may have to pay up.
The Fed, Federal Deposit Insurance Corporation and the Office of the Comptroller of the Currency unveiled proposed leverage ratios in July and are receiving comments on the proposal until the end of September. But just as the regulators approved Basel III rules without making many concessions, the supplementary leverage rules may be a fait accompli, even if it makes it more expensive for the Treasury to fund the government, one regulator told IFR.
Market participants will have to find ways to adapt if the repo market shrinks and that includes the US Treasury.
The working assumption of US regulators so far, however, is that higher supplementary ratios proposed by regulators in July will not be a major issue for the Treasury department. However, the situation will be monitored carefully.
"If it does turn out to be a much bigger issue than we are anticipating we would want to think about how to mitigate disruption," the regulator said.
That may come as a blow to those hoping to enlist the Treasury to help push back against proposed regulations.
JP Morgan analyst Nikolaos Panigirtzoglou said that the Treasury would likely back the Fed in whatever it decides to do.
"In general there is a strong drive to strengthen bank oversight and regulation and the Treasury supports this drive," he said.
Panigirtzoglou was among the first to raise alarm bells about the impact of new leverage ratios on the repo market and others - although not regulators as yet - agree.
"It will be pretty dire if it goes ahead in its current form," said Richard Comotto, fellow at the International Capital Markets Association. Once regulators impose higher ratios, the capital requirement jumps and banks will have to decide if they want to devote more equity to a business where margins are very low, Comotto said. "It's logical for them to think of ways to cut it back."
And that is already beginning as banks look to meet the proposed 2018 deadline in the next 16 months.
"If you suddenly turn off the repo spigot, the borrowers of cash suddenly find that they can't finance big levered positions and have to shrink assets and that's the delevering we are likely to see," said a chief market strategist at a global bank.
That may be an unintended consequence, but one regulators are also willing to face.
"If the supplementary ratio has the effect of reducing the amount of leverage broker dealers take in the repo market, it will likely shrink the market. It makes sense. It's not an unintended consequence," the regulator said.
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