DP13090 Repo market functioning: The role of capital regulation

Author(s): Antonis Kotidis, Neeltje Van Horen
Publication Date: July 2018
Keyword(s): Capital regulation, leverage ratio, non-bank financial institutions, repo market
JEL(s): G10, G21, G23
Programme Areas: Financial Economics
Link to this Page: cepr.org/active/publications/discussion_papers/dp.php?dpno=13090

This paper shows that the leverage ratio affects repo intermediation for banks and non-bank financial institutions. We exploit a novel regulatory change in the UK to identify an exogenous intensification of the leverage ratio and combine this with supervisory transaction-level data capturing the near-universe of gilt repo trading. Studying adjustments at the dealer-client level and controlling for demand and confounding factors, we find that dealers subject to a more binding leverage ratio reduced liquidity in the repo market. This affected their small but not their large clients. We further document a reduction in frequency of transactions and a worsening of repo pricing, but no adjustment in haircuts or maturities. Finally, we find evidence of market resilience, based on existing, rather than new repo relationships, with foreign, non-constrained dealers stepping in. Overall, our findings help shed light on the impact of Basel III capital regulation on repo markets.