Skipping a beat: FSB points to hidden fragilities in repo market
Prasad Gollakota
The repo market is the heartbeat of bond markets. Like a real heartbeat, when all is well, there is nothing more boring. But when things go wrong … watch out.
So it is worth paying attention to a new report from the Financial Stability Board with the snappy title “Vulnerabilities in Government Bond-backed Repo Markets”.
To many, repo is the market’s dullest transaction: a collateralised loan that clears in the background and barely gets a mention. But it matters. The government bond-backed repo market at the end of 2024 came to roughly US$16trn, according to the report, about 80% of the global repo market.
And while repo is not usually the underlying cause of financial crises, it is often where deeper pressures surface and then transmit quickly.
So when repo terms shift abruptly, through higher haircuts, faster margin calls, collateral that becomes harder to mobilise, and overnight funding that no longer rolls, the funding that quietly holds the ecosystem together can disappear.
The effects show up fast – in forced selling, wider spreads and reduced intermediation – spilling from funding markets into government bonds and then into broader credit conditions.
Bear Stearns and Lehman Brothers did not fail because a quarterly capital ratio flickered red. In March 2008, Bear told the New York Fed it expected many of its repo counterparties would not renew funding the next day, leaving it unable to meet obligations without emergency liquidity. Six months later, Lehman’s last days were defined by a simple squeeze: repo stopped rolling on normal terms, collateral demands rose, and day-to-day liquidity evaporated.
Four key inputs
The FSB’s warning is straightforward: vulnerabilities are visible, and have already surfaced, in precisely the part of the market most people assume is safest.
Stability in the repo market relies on a small set of key assumptions, and the market depends on all of them holding at the same time, continuously.
First is rollability: this is the assumption that short-term funding, typically overnight, can be renewed day after day on predictable terms, without sudden jumps in price.
Second is haircut stability: the haircut is the initial margin in the trade, meaning how much less cash the borrower receives than the market value of the collateral. The system assumes haircuts are low and stable for good collateral, so borrowing capacity is predictable. Haircuts also reflect bargaining power and collateral preferences, making them an imperfect proxy for managing leverage as it builds.
Third is margining cadence: this refers to how the repo is marked to market, when margin calls are made, and how quickly they must be met. The system assumes counterparty liquidity buffers can absorb calls without forcing asset sales.
Fourth is collateral usability: the assumption that collateral remains deliverable, financeable and easy to mobilise across counterparties and venues.
Dislocation tends to begin when any one of these inputs shifts abruptly. The FSB tracks this through a five-day moving average of the absolute gap between overnight repo rates and policy rates. In calm periods it sits close to zero. In stress, it can jump sharply.
Four recent dislocations
The FSB reviews several recent examples. In September 2019, the FSB observed the five-day moving average jumped to almost 80bp in the US repo market before the US Federal Reserve injected liquidity. This was not a credit event, but an acute mismatch between supply and demand for repo funding. Cash lenders stepped back and borrowers were caught short.
Then came the “dash for cash” in March 2020 at the start of the pandemic, when haircuts widened and margin calls surged. Leveraged positions were forced to deleverage and the pressure ultimately spilled into forced government bond selling.
Next was the UK’s September 2022 liability-driven investments episode, where Gilt volatility rose, haircuts and margin calls increased, and some LDI funds could only meet them by selling Gilts. That pushed yields higher and triggered further calls, amplifying the stress. The five-day moving average in the Gilt market jumped to 30bp–40bp.
The final dislocation the FSB examines is the euro area’s repo volatility in September 2022. It showed a different trigger but the same fragility. Here, the input that moved first was collateral usability. Rising margin needs drove demand for high-quality collateral that was already scarce, pushing repo spreads further negative, particularly at the shortest tenors.
The FSB identifies three interlinked structural vulnerabilities. The first is leverage. It notes that hedge fund repo borrowing now amounts to about US$3trn, roughly 25% of hedge fund assets. That matters because if leverage is concentrated in similar trades, stress can force a crowded unwind. The second is imbalance. When volatility spikes, cash borrowers may need liquidity to meet margin calls at the same time as cash lenders step back, turning a mismatch into a sharp repricing. The third is concentration. The FSB flags concentration among borrowers, lenders and intermediaries, raising the risk that a capacity constraint, or an operational failure at a key node, disrupts market functioning.
What lurks beneath
When confidence turns, the repo market can falter because it reprices continuously through haircuts, margins and access. The key is ensuring funding remains available at scale and at speed, through the pipes that settle the market.
The policy challenge, then, is to manage the cliff effects that can turn ordinary volatility into forced deleveraging and system-wide liquidity stress. The FSB’s argument is that we should stop treating the repo market as neutral plumbing and recognise it as a leverage and liquidity transformation machine whose failure modes repeat.
Any fix aimed purely at the repo market risks treating the symptom rather than the cause. To change the analogy, the aim is to manage wildfire risk before a spark lands. The deeper challenge is to tackle the underlying imbalance beneath the surface.
Prasad Gollakota is a former FIG banker and co-head of the global capital solutions group at UBS. He was later chief content and operating officer at edtech company xUnlocked and specialises in financial institutions, banking regulation, capital markets and complex capital and funding solutions.