Industry groups are defending the repo market in the wake of a European Commission green paper that seeks to shed light on the so-called 'shadow banking' sector, which is said to be worth about €50 trillion.
The commission is worried that new banking rules will push activity out of the traditional banking sector and towards shadow banking. The commission is particularly concerned about the repo market, in which banks and other institutions extend short-term loans to one another, secured with collateral.
Repo transactions can be so large, worry the regulators, that they have the potential to destabilise traditional banking. The commission therefore wants to investigate and perhaps extend regulation into the shadow banking sector.
“What we do not want is for financial activities and entities to circumvent existing and foreseen rules, allowing new sources of risk to accumulate in the financial sector,” said Michel Barnier, the EU's internal market and services commissioner.
“That is why we need to better understand what shadow banking actually is and does, and what regulation and supervision may be appropriate, and at what level.”
However, the International Capital Market Association (ICMA) has responded with a paper that argues repo has helped traditional banks ride out the financial crisis by giving them access to funding when unsecured term markets have been closed to them.
The ICMA paper denies that repo encourages excessive use of leverage, stating markets do not allow banks to borrow recklessly, even if they post good collateral. The market does not tend to lend to risky counterparties, it said.
The ICMA admitted there is a case for increasing transparency of the repo market but claimed there is already a lot data that is underexploited. It also said suggestions of a repo trade depository need to be carefully assessed.
“We should not lose sight of the fact that repo is a legitimate funding tool used by regulated banks and financial institutions and an instrument of financial policy for central banks,” said Godfried De Vidts, chair of ICMA’s European repo council.
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