Journal of
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Archive » June 2021 » Repos, collateral and financial stability

Repos, collateral and financial stability

Danilo Drago
June 2021 - n. 6
Keywords: Pronti contro termine, mercato monetario, regolamentazione bancaria, crisi bancarie
Jel codes: M15, G32

Repurchase agreements became the most traded financial instrument in the wholesale money market, as a result of the growing use of collateral to support a wide range of credit operations. In the money market the explosion in trading volume observed in the secured segment went along with the tumble of trading in the unsecured segment. The reported trend in the money market was also favored by the rules that strengthen the legal protection granted to the repo lender in the event of the counterparty's default, known as safe harbor provisions. The aforementioned rules were introduced with the aim of reducing the systemic risk originating from credit relationships between banks and other financial institutions. We question the ability of the safe harbor provision to effectively counteract systemic risk, since, once a crisis hits, lenders may simultaneously sell the assets held as collateral, depressing their prices and spreading contagion within the financial system. Moreover, we claim that safe harbor provisions weaken the effectiveness of market discipline and may originate other undesirable effects, particularly in the case of the Eurozone.

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