Bankruptcy Exemption of Repo Markets: Too Much Now for Too Little Tomorrow?

Viral Acharya, V. Ravi Anshuman and S Viswanathan

No 18499, CEPR Discussion Papers from Centre for Economic Policy Research

Abstract: We examine the desirability of granting "safe harbor" provisions to creditors of financial intermediaries in sale-and-repurchase (repo) contracts. Exemption from an automatic stay in bankruptcy can enable financial intermediaries to raise greater liquidity and operate at a higher leverage during normal times. This liquidity creation occurs, however, at the cost of ex-post inefficiency when there are adverse aggregate shocks to the fundamental quality of collateral underlying the contracts. When exempt from bankruptcy, creditors of highly leveraged financial intermediaries respond to such shocks by engaging in collateral liquidations. Financial arbitrage by less leveraged financial intermediaries equilibrates returns from acquiring collateral at fire-sale prices and returns from real-sector lending, inducing a rise in lending rates, a deterioration in endogenous asset quality, and in the extremis, a credit crunch for the real sector. Given this inefficiency, not granting safe harbors, i.e., requiring an automatic stay on repo contracts in bankruptcy, can be not only ex-post optimal, but also ex-ante optimal, especially for illiquid collateral with high exposure to aggregate risk.

JEL-codes: D62 G01 G21 G28 G33 K11 K12 (search for similar items in EconPapers)
Date: 2023-10
References: Add references at CitEc
Citations:

Downloads: (external link)
https://cepr.org/publications/DP18499 (application/pdf)

Related works:
This item may be available elsewhere in EconPapers: Search for items with the same title.

Export reference: BibTeX RIS (EndNote, ProCite, RefMan) HTML/Text

Persistent link: https://EconPapers.repec.org/RePEc:cpr:ceprdp:18499

Ordering information: This working paper can be ordered from
https://cepr.org/publications/DP18499

Access Statistics for this paper

More papers in CEPR Discussion Papers from Centre for Economic Policy Research 33 Great Sutton Street, London EC1V 0DX, UK.
Bibliographic data for series maintained by CEPR ().