The Five Largest Banks Hold More Than 90% of the Supply of Total Repos.
Activity in the repos (repurchase agreements) market, where banks and investors seek more than a trillion dollars in cash loans daily, is being dominated by 5 of the biggest banks. According to a study by the Fed published a year ago, when those banks hoard reserves it drives borrowing costs higher for smaller firms. Currently, the five largest banks hold more than 90% of the supply of total reserves and a more even distribution would help cushion against such shocks to the supply, the study found.
Under the current market structure, “concentration levels among the biggest banks are only going to get more concentrated,” said James Tabacchi, president of South Street Securities, a brokerage specializing in repos.
When the Fed lends money through the repo market, officials are acting in the expectation that what they lend will be recirculated by the primary dealers (i.e. Chase, Bank of America, Citibank). However, the Fed faces the risk that those dealers may hold on to funds to meet their own needs, analysts said.
One risk is that the larger banks could opt to lend less cash than usual at the end of the quarter to smaller dealers. At the end of last year, those larger banks cut back on lending, sending repo rates soaring above 6%. The large banks may have held on to cash then because regulators typically examine their balance sheets at the ends of fiscal quarters to ensure they are following rules that safeguard the banking system.
When the big banks make these decisions it can make borrowing in the repo market difficult for smaller dealers, said Seth Carpenter, chief U.S. economist at UBS Group AG and a former official at the Fed and the Treasury Department.
“This question about segmentation in the market and what happens at quarter-end is important,” Mr. Carpenter said.
The Fed has stepped up making two separate announcements of increases to its cash loans in the repo market after demand from banks repeatedly exceeded the funds made available. Demand was strongest for a recent offering of two-week loans that were intended to ensure that banks have cash available heading into the end of the quarter, which is a time when they frequently try to hold on to reserves.
“There’s still a very big demand for cash that may not be satisfied by the current operations,” said Gennadiy Goldberg, a fixed-income strategist at TD Securities.
Matters are made worse as the number of smaller firms that borrow from the larger dealers through the repo market continues to shrink. These firms include CRT Group LLC, which closed in 2017; KGS-Alpha Capital Markets L.P., which was acquired last year by BMO Capital Markets; and the repo operations of Rosenthal Collins Group LLC, which were shuttered in February after the company was bought by Marex Spectron, a commodities brokerage.
Smaller firms also tend to have less cash on hand and fewer ways to quickly raise it than their bigger peers. Primary dealers have structural advantages, including more lines of credit connecting them with large regional banks, and trading relationships with Vanguard Group and T. Rowe Price which roll billions of dollars each day into the repo market.
Bigger banks just have more sources to tap when they seek funding. They are first to see the infusions from the Fed and they decide at what pace it will be released.