The ‘‘21st Century Glass-Steagall Act of 2013’’: how will it impact broker/dealer funding?

What happens to broker/dealer funding if Glass-Steagall is brought back? Or for that matter, if the retail/investment bank ring-fencing proposals in the UK’s Independent Commission on Banking (a/k/a Vickers Report) separate out depositor liquidity from broker/dealer financing? It could get very messy quickly.

The ‘‘21st Century Glass-Steagall Act of 2013’’ appears to include repurchase agreements as a prohibited activity for banks. From the bill:

Glass Steagall

If repo desks end up in the investment banking business side, then there are rafts of questions that will need to be answered on how those i-banks will fund themselves. The new investment banks will probably need to be rated for many of their funding clients to continue to do business with them. Will rating agencies take a dim view toward the riskier businesses that the new Glass-Steagall bill was meant to hive off? What happens if the ratings are lower (or non-existent)?

We wonder if anyone will lend cash unsecured to the investment banks? Probably not in any serious way. The focus will shift to collateral and repo (or related products) that will be used to source funding. Most analysis of repo starts with the counterparty credit and then goes to the collateral. If credit is happy with the counterparty, they tend not to get into the weeds on the collateral. But if flags are raised about the counterparty – after all, the purpose of the legislation is really to prevent taxpayer funded bailouts again and without a LOLR backstop the investment banks may not look so good – then increased scrutiny on the collateral may be inevitable. US Treasuries and agencies may be fine. Exotic structured paper, corporates, or even equities from all but the best investment banks may struggle to find takers. This will, in turn, impact business models, restrict client offerings, and constrain market liquidity. Be careful what you wish for.

There was a particularly good article in Time magazine by Christopher Matthews on July 16th “Regulatory Rumpus: The Battle Over Reinstating Glass-Steagall” looking at the debate over the issue. It is worth a read.

A link to the text of the ‘‘21st Century Glass-Steagall Act of 2013’’ is here.

A link to the Time article is here.

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