Repo Turmoil Prompts U.S. Regulators to Scrutinize Market Dangers

(Bloomberg) -- The repo turmoil that put traders on edge in September has prompted a full scale review by regulators, who identified disruptions to short-term funding markets as a potential risk to the U.S. financial system.

The Financial Stability Oversight Council is calling for federal agencies to collect data and scrutinize cleared repurchase transactions to determine what prompted rates to spike three months ago, according to Treasury Department officials. The group, led by Treasury Secretary Steven Mnuchin, highlighted the examination in its annual report released Wednesday.

Read More: Why the Fed's Pumping Big Money Into the Repo Market

The repo market is essential to the plumbing of the financial system, with trillions of dollars in cash and collateral swapped daily to meet the funding requirements of U.S. corporations. Borrowing rates soared in September, prompting the Federal Reserve to inject cash into the market to stave off a liquidity crisis.

Since the disruption, bankers have complained that excessive regulation might be a factor. JPMorgan Chase & Co. Chief Executive Officer Jamie Dimon said Oct. 15 that his bank had the money and inclination to step in, but was prevented from doing so by liquidity rules.

After the 2008 financial crisis, regulators required banks to hold a stockpile of safe assets that could be easily converted into cash in the event of a meltdown. The rules are meant to prevent banks from facing a funding squeeze.

Randal Quarles, the Fed's vice chairman of supervision, granted Wednesday that Wall Street may have been right in arguing that the central bank shares blame for what happened to money markets in September. The Fed's bank supervisors may have created an impression that lenders should prize cash reserves over Treasuries when the firms try to keep their liquidity levels about regulatory minimums, Quarles said in testimony before the House Financial Services Committee.

Read More: Quarles Concedes Fed Might Be Part of the Problem in Repo Crunch

The Fed, Securities and Exchange Commission, Office of the Comptroller of the Currency and Commodity Futures Trading Commission are among FSOC's members. The council was set up after the crisis to monitor risks that could threaten financial stability.

Other topics flagged in FSOC's annual report include:

• The council's member agencies are taking a closer look at leveraged lending. Regulators are concerned that if credit markets continue to deteriorate, collateralized loan obligations and big investors in the loans could face liquidity shortfalls
• Regulators are examining the rapid growth of non-banks in the origination and servicing of home loans. The concern is that non-banks are more prone to financial stress because they are more reliant on short-term funding than banks

To contact the reporter on this story: Jesse Hamilton in Washington at jhamilton33@bloomberg.net

To contact the editors responsible for this story: Jesse Westbrook at jwestbrook1@bloomberg.net, Gregory Mott

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