The Financial Times highlighted an analysis box in the latest ECB Financial Stability Review, describing it as “a decent candidate for the Regulatory Arbitrage Hall of Fame”.
In the related footnote, the ECB writes: “In US dollar repo markets, euro area banks benefit from different leverage ratio reporting requirements. While US banks report daily averages on a quarterly basis, euro area banks report quarter-end figures. This creates an incentive to indulge in “window dressing” by reducing volumes at reporting dates.”
As long as European banks sort themselves out to look better at the quarter end, they can, structurally, do repo business with less capital than their US competitors. When they do that repo business, the addition to their balance sheet doesn’t affect their deposit insurance premiums in the same way, either, giving them another structural advantage.
The reason that the ECB is putting a research box in its Financial Stability Review is that “[a]fter a decade in which their presence in the United States declined, euro area banks have recently expanded the balance sheets of their branches and broker-dealer subsidiaries”. Things are still a long way below the peak associated with the arbitrage trade, but they’re on the way up.
Furthermore, the borrowing is apparently taking place disproportionately through the broker-dealer operations of a small number of banks (particularly French ones), and its counterpart is lending to non-bank financial institutions outside the Euro area.
In other words, a few systemically important EU institutions are getting bigger and bigger in the business of intermediating dollar liquidity and carrying out maturity transformation, with shadow banks as counterparties, and they’re mainly gaining market share in this business because of a long-standing and remarkably silly regulatory arbitrage.