Foreign banks operating in the US short-term debt markets are “window-dressing” their accounts, routinely cutting about $170bn of balances at the end of each quarter to appear safer and more profitable, says a new study.
The study from the Washington, DC-based Office of Financial Research describes a pattern of behaviour that has prevailed since July 2008, and suggests that the banks are carrying more risk than their investors or customers can easily see.
The study examines the vast market for repurchase agreements, or “repos,” where banks lend out assets in return for short-term financing. It finds that dealers sell heavily to customers in the last days of the quarter, and immediately buy assets back once the new quarter starts. By trimming their balance-sheets over that brief period, the foreign banks can report better quarter-end ratios of capital to total assets.
US banks, which have to report average daily balances over the quarter, do not make similar adjustments, the study found.
“This abrupt, seasonal rhythm . . . is consistent with a pattern of ‘window-dressing,’” wrote Greg Feldberg, acting deputy director for research and analysis at the OFR, in a blog post.
Analysts said the behaviour outlined in the study has shades of the notorious “Repo 105” trades that Lehman Brothers used to bring down its reported leverage in the quarters leading up to its collapse. In that programme, the broker accepted a relatively high 5 per cent fee in order to count its repo transactions as true sales, even though it remained under a contractual obligation to buy the assets back.
Joshua Ronen, a professor of accounting at New York University’s Stern School of Business said the OFR’s study — which did not cite individual banks by name — showed that lenders with the lowest capital ratios were making the biggest quarter-end reductions.
Deutsche Bank, Credit Suisse and Barclays — three of the biggest foreign players in the US repo markets — declined to comment on the study.
One bank pointed out that foreign banks will have to adopt US-style daily leverage reporting requirements by January 2018, and that many had already begun to adjust their repo activities to comply with daily averaging — including reducing the absolute amounts and quarter-end adjustments.
For now, though, outsiders should take the banks’ reported ratios with a pinch of salt, said Mayra Rodriguez Valladares of MRV Associates, a former official at the Federal Reserve Bank of New York.
“If they’re moving assets around to look better it is a big problem for us, as we don’t get to see the day-to-day information,” she said.
“If something adverse happens, we could have been lulled into a false sense of security that [the banks] are sufficiently capitalised.”
- Ben McLannahan in New York
- (This story is on Page 16 of the 11/2/15 Financial Times paper edition, however the headline is different: “Foreign groups accused over repo deals”)
NEW YORK — A government research paper says foreign-owned broker-dealers are dumping an average of $170 billion in certain U.S. assets before the end of each quarter in order to appear safer and less levered.
The practice, driven by an effort to comply with overseas regulatory requirements, could hurt U.S. money market funds, as well as bond investors, according to the report by the Office of Financial Research (OFR), a unit of the Treasury Department.
The report, written for OFR by Benjamin Munyan of Vanderbilt University, is based on confidential regulatory data from the OFR and the Federal Reserve.
The paper concludes that broker-dealers with foreign parent companies are collectively dumping certain short-term borrowings by an average of $170 billion at the end of each quarter to better meet capital requirements, which are measured at the end of each quarter.
The report calls this practice “window-dressing,” and says no such practice was found by U.S. banks because U.S. banking regulators use a quarter-average measure of leverage ratios.
But the dumping — of an asset known as re purchase agreements, or repos — could affect U.S. money market funds and Treasury investors, the paper warned.
Repo agreements are a form of borrowing — usually overnight — that are a major source of liquidity for money-markets funds and institutional investors.
JPMorgan CEO Jamie Dimon and former Treasury Secretary Larry Summers have both warned of a liquidity problem that some experts have said could be linked to declines in repo funding.
The OFR paper said the selling by foreign banks could affect prices for U.S. Treasuries and other government bonds, which are a major form of collateral in the repo market.
The quarterly selling may also leave money market mutual funds with excess cash they cannot invest.
Despite being able to anticipate quarterly window dressing, money market fund manager were unable to find any investment for about $20 billion of cash each quarter-end before September 2013, the paper said.
The Federal Reserve’s reverse repurchase agreement program began at that time as a substitute investment for repo lenders during times of window dressing.