FSB assesses vulnerabilities in government bond-backed repo markets
The Financial Stability Board (FSB) has published a report assessing structural vulnerabilities and contagion risks in government bond-backed repo markets. The analysis highlights leverage build-up, demand-supply imbalances, and market concentration as key concerns.
Leverage, imbalances, and concentration
Repo markets, with an estimated $16 trillion outstanding at end-2024 and 80 percent backed by government bonds, are crucial for financial system liquidity.
However, the FSB identifies three structural vulnerabilities: first, the facilitation of leverage, particularly through low haircuts and high collateral reuse, with hedge fund cash borrowing reaching almost $3 trillion.
Second, the rapid emergence of demand and supply imbalances during stress periods, as cash borrowers require liquidity while lenders become unwilling.
Third, high market concentration among central nodes like CCPs and custodians, as well as within cash borrowers, lenders, and intermediaries, increases disruption probability from operational failures or financial distress.
Contagion risks across the system
The report outlines three channels through which repo market vulnerabilities can spread.
Firstly, deleveraging by cash borrowers during stress can depress sovereign debt prices, leading to fire sale dynamics as leveraged asset managers liquidate holdings.
Secondly, leveraged institutions expose counterparties to credit risk, exacerbated by approximately 70 percent of non-centrally cleared repo transactions operating with zero haircuts.
Thirdly, significant cross-border activity, particularly involving dealer-bank intermediaries and hedge funds, means stress in one jurisdiction can quickly affect others.
The FSB encourages authorities to address data gaps, strengthen surveillance using identified metrics, and implement recommendations on nonbank financial intermediation leverage.
Surveillance hampered by blind spots
This report provides a critical mapping of repo market vulnerabilities, underscoring the urgent need for better data.
While the analysis is thorough, the identified data gaps present a significant hurdle for effective surveillance and policy responses.
Without comprehensive and granular data, authorities will struggle to proactively address these systemic risks.