European repo activity recovers modestly as banks cut ECB reliance

LONDON, Sept 3 Wed Sep 3, 2014 5:00pm EDT

LONDON, Sept 3 (Reuters) - The European repo market grew modestly in the first half of this year after a sharp fall in the last six months of last year, as banks repaid cheap European Central Bank loans and relied more on wholesale funding markets.

Repos are short-term loans in return for collateral, such as government or corporate bonds, and are a key element of day-to-day financing in the economy.

A survey by the European Repo Council of the International Capital Market Association however showed that year-on-year, activity in the repurchase market, a major source of secured short-term funding for the region, shrank slightly.

The snapshot of the value of outstanding repo contracts showed the market grew to 5.782 trillion euros ($7.6 trillion) at close of business on June 11 compared with 5.499 trillion six months earlier.

The recovery contrasts with reports of cuts in repo activity by U.S. banks but reflected differences between U.S. and European markets, where the latter are not subject to quite the same degree of regulatory pressure to reduce reliance on short-term wholesale funding, the ICMA said.

"The growth in European repo may also be a sign of continuing normalisation of financial markets. Reduced reliance on the ECB, reflected in lower liquidity surpluses and repayments of the three-year LTROs (long term loans) is forcing banks back into market," it said in a statement.

A full recovery back to the pre-financial crisis peak of 6.775 trillion reached in the June 2007 survey remains some way off though. The survey's authors say current and prospective regulatory concerns are weighing on the market.

As part of attempts to curb excessive risk-taking and avert a repeat of the 2007/2008 financial crisis, regulators are pursuing plans to set minimum discounts, known as "haircuts", on the value of collateral to back repos to ensure a big enough cushion if market valuations plunge.

Market participants say this could disrupt markets at a time when funding is needed to spur economic growth.

The survey highlighted the continuing dominance in the share of Italian and Spanish collateral at the expense of top-rated German and French collateral, thanks to growing investor confidence on ebbing fears over the euro zone debt crisis. (1 US dollar = 0.7608 euro)

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