Softer NSFR may not save repo, banks warn

Final rule slashes funding requirement for reverse repo, but applies it more widely

Dealers are warning repo businesses will struggle to comply with new international rules on bank funding, even after regulators softened their stance.

“We’re still running our internal numbers and back-testing individual businesses, but it’s still not clear to us how economical those businesses will be, even with the new, lower funding requirements,” says a regulatory specialist at one European bank.

The net stable funding ratio (NSFR) – the second of Basel III’s two new liquidity ratios – tries to make banks more resistant to liquidity risk by pushing them away from short-term wholesale funding. The ratio is calculated by dividing a bank’s available stable funding (ASF) by its required stable funding (RSF), with a minimum compliance level of 100%. The ASF and RSF totals are determined by applying a regulator-set multiplier to bank assets and liabilities.

The problem for repos was that a draft version of the NSFR, published in January, applied an asymmetrical treatment to “non-bank financial institutions” such as money market funds, hedge funds and asset managers, which are big users of the market. According to an International Capital Market Association survey last December, around 37% of reverse repos are transacted with these entities.

The draft rules said unencumbered loans – including reverse repos – with non-bank financial institutions would receive a 50% RSF. However, the opposite repo trade with a non-bank financial institution receives a 0% ASF. This meant that for every $100 lent to these counterparties via a reverse repo, $50 of term funding would be required. Fierce protests followed, with banksestimating the cost of some reverse repos would rise by more than 850%.

Speaking at a Risk conference in Stockholm in May, one bank executive claimed the issue had caused a rift within the Basel Committee on Banking Supervision: “When we have talked to regulators at the Basel Committee about this, it’s quite clear there is a US camp and a European camp, and there are some negotiations going on there,” said Jonas Svärling, head of risk and capital management at SEB.

The final rule, published on October 31, retains the asymmetrical treatment, but slashes the funding requirement from 50% to 10% as long as the assets backing a reverse repo can be rehypothecated and are also defined as highly liquid in the NSFR’s companion regime. If those boxes are not ticked, the RSF would be 15%. The total reduction in RSF can be substantial, say dealers.

On the other hand, this treatment has now been expanded to a wider range of counterparties – the old category of non-bank financial institutions has been eliminated, meaning the 10% RSF will apply to trades with all financial institutions. The 10% RSF appears to also apply to cleared reverse repos – a situation one regulatory expert at another European bank describes as “counterintuitive”.

While banks are still analysing the impact, one European and one UK bank say the final NSFR is likely to be a net positive from a firm-wide perspective. But while it’s a positive generally, bank regulatory sources say the fact they will be required to find long-term financing for 10% of their reverse repos with all financial counterparties means the business may struggle to hit profit targets.

“If you look at the bank-wide NSFR, it clearly is very beneficial. Whether that is actually beneficial for individual businesses or not is what we’re still trying to figure out. Some people have said ‘No, this is still going to kill the repo business’; others are saying ‘Maybe not’. We’re still trying to nail it down. For now, the headline is that the final rule overall is great, but for actual repo desks it’s not clear it’s enough,” says the first European bank’s regulatory expert.

The NSFR is not the only pressure on banks’ repo businesses – in March, foreign banks with a US presence said they would retreat from the repo markets as a result of rules requiring them to hold capital and liquidity locally. The leverage ratio also delivers a hit to the market. As a result, pension funds have questioned whether they will be able to rely on repo as a means of raising enough eligible collateral to meet incoming clearing and bilateral margining rules.

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