Deutsche Bank announced they plan to cut their US balance sheet by 25% to comply with capital rules levied on foreign banks operations in the US (see our write up on those rules here). There were a couple interesting repo-related comments that came out in the wash.
As part of the $100 billion reduction in balance sheet, DB will move their Frankfurt and Tokyo-based repo businesses, presumably to a capital friendlier jurisdiction. One questions why those operations would be part of their NY-based balance sheet anyway? Could it be driven by more favorable repo netting under US regs? What will happen to those businesses in their new “Plan B” home?
The other repo-related issue that came up in various articles had to do with reducing repo business with clients who don’t do other business with the bank. From a Reuters article dated February 23, 2014 “Deutsche Bank to slash U.S.-based assets by $100 billion: FT”
“…The financial daily said that the bank will also reduce a sizeable chunk of its repo business in the U.S. after discovering that some of its clients were not making use of its other offerings…”
Repo on HQLA has been one of those businesses that when measured as a stand-alone enterprise never made tons of economic sense. Lots of balance sheet, low returns – although with low RWA and not much risk. The justification for the business was often that repo was a service to the cash desks and facilitated client flows. Salespeople often maintain that selling an asset that the bank couldn’t finance did not look good. But what if those clients aren’t actually doing much more than financing their assets? Banks that end up with the low value-add part of the stick eventually find themselves bloating their balance sheets with not much to show for it.
For some banks, the expertise in short rates that comes with trading repo meant that was where banks speculated on short term markets – and with it repo often became a serious profit center. But trading short rates has been challenging for a while now and prop trading is a dirty word.
So it seems like repo desks are losing the battle with management. We hear and read a lot about shrinking balance sheets in repo specifically and fixed income more broadly. The irony is that managing collateral has become so much more important – and repo desks are the collateral traffic cops essential to doing the job. But to do it correctly, there needs to be a critical mass of traders, market share, balance sheet resources, and knowledge. Too few people and resources will result in swapping market risk for operational risk.