Structural issues may be more to blame than a temporary supply-and-demand imbalance for the turmoil that roiled the funding markets in September, according to the Bank for International Settlements.

In a report on the lack of liquidity that caused repo rates to spike as high as 10%, the Basel-based “bank for central banks” said “the distribution of liquid assets in the U.S. banking system” was an “underlying structural factor” that “could have amplified the repo rate reaction.”

In particular, the BIS said, the U.S. repo markets currently rely heavily on four large banks for funding and “as the composition of [those banks’] liquid assets became more skewed towards U.S. Treasuries, their ability to supply funding at short notice in repo markets was diminished.”

The U.S. Federal Reserve has pointed to stresses from a due date for U.S. corporate taxes coinciding with a large settlement of Treasury securities.

But the BIS differed with that explanation, saying that “none of these temporary factors can fully explain the exceptional jump in repo rates.”

As The Financial Times reports, “Investors, bankers and policymakers were left stunned in September when the cost of borrowing cash overnight in exchange for high-quality collateral such as U.S. government debt shot higher.” The “repo spike” caused the Fed to conduct repurchase operations, its first interventions in the funding markets since the Great Recession.

In singling out the structural role of the four large banks in the dislocation, the BIS noted that as of the second quarter of 2019, they accounted for more than 50% of total Treasury securities held by banks in the U.S., while holding only about 25% of reserves that they could use to supply funding at short notice in repo markets.

BIS analysts also suggested an increased demand for funding via Treasury repos from cash-hungry hedge funds contributed to the turmoil.

Repo markets “may again find themselves in the eye of the storm should financial stress arise at some point,” warned Claudio Borio, head of the monetary and economic department at the BIS.

Photo by Harold Cunningham/Getty Images

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