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Macroprudential Regulation under Repo Funding

Author/Editor: Valderrama, Laura
Authorized for Distribution: September 1, 2010
Electronic Access: Free Full Text (PDF file size is 823KB)
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Disclaimer: This Working Paper should not be reported as representing the views of the IMF. The views expressed in this Working Paper are those of the author(s) and do not necessarily represent those of the IMF or IMF policy. Working Papers describe research in progress by the author(s) and are published to elicit comments and to further debate.

Summary: The use of collateral has become one of the most widespread risk mitigation techniques. While it brings stabilizing effects to the individual lender we argue that it may exacerbate systemic risk through margin call activation. We show how a liquidity shock to the cash lender may propagate as a solvency shock via liquidity hoarding even if the cash lender remains solvent in all states of nature. Albeit a cost-effective response of the cash lender to a liquidity shock, liquidity hoarding may lead to the bankruptcy of its repo counterparties triggering contagion across asset classes. To buttress the resilience of the financial system, we lay out a menu of macroprudential policies that deactivate this channel of financial contagion.
 
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Series: Working Paper No. 10/220
Subject(s): Bank regulations | Bankruptcy | Capital | Economic models | Financial institutions | Financial risk | International financial system | Liquidity
Author's keyword(s): Repurchase Agreement; Haircut; Margin Call; Liquidity Hoarding; Systemic Risk; Financial Contagion; Macroprudential Regulation.
 
English  
    Published:   September 1, 2010        
            Format:   Paper
    Stock No:   WPIEA2010220   Pages:   37
    Price:   US$18.00 (Academic Rate: US$18.00 )
       
     
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