Notes on BIS Working Paper No 708, March 2018
Abstract from BIS:
Since the eurozone crisis, there has been a stark divergence between European banks and Japanese banks in their dollar uses and sources. We show that these shifts have implications for the price of dollar funding. We document a “Japan Repo Premium.” Japanese banks pay a premium for repos with US money market funds (MMFs), despite identical contract and risk characteristics. Using the US MMF reform as a natural experiment, we establish that Japanese banks’ long maturity dollar assets generate a relatively inelastic demand for long maturity dollar borrowing. Differences in the demand for dollar funding combined with market and supply side frictions can explain these pricing differences. MMFs mainly provide short term repos and favor longer term clients for long maturity repos. Japanese banks concentrate their repo borrowing, reducing their bargaining power in order to extend their funding maturity. Our results have implications for the formation of global dollar funding networks. We provide evidence for European banks intermediating repos to Japanese banks, with economically significant estimated spreads from maturity transformation.
Non-US banks collectively hold $12.6 trillion of dollar-denominated assets – almost as much as US banks. Since the Great Financial Crisis (GFC) and the eurozone crisis, however, there has been a stark divergence between European and Japanese banks’ business models. We study the impact of this divergence on pricing of dollar funding and dollar funding networks. We use transaction-level data from the regulatory filings of US money market funds (MMFs) as well as quarterly regulatory filings of US branches and agencies of foreign banks, and BIS international banking statistics to develop a rich picture of the dollar funding landscape.
Dollar funding stress of non-US banks was at the center of the GFC. The dollar funding landscape has changed dramatically since then, owing to the shifts in demand and differential implementation of Basel III regulations across jurisdictions. Our research shows how the demand for dollar funding has changed, how global banks obtain dollar funding and differential funding cost across banks for different funding instruments. This information is crucial in case of a new surge in dollar funding stress.
We find that Japanese banks pay a premium in their repurchase agreements (“repos”) with US MMFs. We show that the bargaining power of MMFs fund families, together with the particular demand for long term funding of Japanese banks, help explain this premium. Our findings point to the existence of dollar funding networks. We derive implications from the existence of these networks and provide supporting evidence for them. Finally, we also show that disruptions in dollar repo markets spill over to other important dollar funding markets, such as that of foreign exchange swaps.
The repatriation of offshore funds, encouraged by recent changes to US regulations, held by US companies like Apple, and Microsoft, which currently totals about $2.5 trillion (£1.8 trillion) will reduce the availability of dollars available for global lending. Evans-Pritchard also quotes Matt King, credit strategist at Citigroup, who said the Libor-OIS spike has so far been benign but it threatens to become more painful over coming months. The latest moves have “awakened unwelcome memories of 2007-2008”. In other words the reduction in availability of offshore dollars could tighten dollar lending and at worse could result in growing pressures in the financial markets. The BIS Paper therefore comes at an important time.
Download: BIS Working Paper No 708