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Banks may be disguising their borrowings in a way similar to that used by Lehman Brothers Holdings Inc., with debt ratios falling within limits imposed by regulators just four times a year.
Lenders use repurchase agreements — known as repos — to massage down their assets as reporting dates approach, typically as quarters end, the Bank for International Settlements said in its Annual Economic Report. The practice boosts leverage ratios — the ratio between capital and so-called leverage exposures — allowing banks to report them as being in line with regulatory requirements, it said.
“The data indicate that window-dressing in repo markets is material,” BIS analysts said in the report. “Data from U.S. money market mutual funds point to pronounced cyclical patterns in banks’ U.S. dollar repo borrowing, especially for jurisdictions with leverage ratio reporting based on quarter-end figures.”
The practice “reduces the prudential usefulness of the leverage ratio, which may end up being met only four times a year,” said the Basel, Switzerland-based BIS, which is known as the central bank for central banks.
Lehman used repos to disguise its borrowings before it imploded in 2008 in the biggest-ever U.S. bankruptcy. The collapse prompted regulators to close an accounting loophole the firm had wriggled through to mask its debts and to introduce a leverage ratio globally. The Basel Committee on Banking Supervision recommends a minimum 3 percent ratio is used.
As well as negative effects on financial stability, using repos to game the requirement hinders access to the market for those who need it and obstructs monetary policy implementation, the BIS said.
In a repo, banks borrow short term against some of their assets with a promise to repurchase the collateral. The cash raised can then be lent out in a reverse repo and the collateral obtained used to back further borrowing. Closing the reverse repo at quarter-end raises cash that can be used to unwind the repo, shrinking the balance sheet and reducing leverage.
Banks’ ability to engage in this kind of window-dressing depends on the jurisdiction they are in, the BIS said. That’s because while countries including the U.S. and U.K. require lenders to report their leverage ratios based on daily averages over the period, others including France, Germany and Switzerland use end-period reporting.
Since early 2015, when banks began reporting leverage ratios, the size of the swings in the volume of repo transactions carried out by euro-area banks has been rising, according to the BIS. Contractions in the repo market have soared to more than $145 billion at the end of last year from about $35 billion over the period, the BIS said.