A Repo Resolution Authority to Help Regulate Financial Systems
— October 2, 2012
By Viral Acharya, C.V. Starr Professor of Economics and Director, NSE-NYU Stern Initiative on the Study of Indian Capital Markets and T. Sabri Öncü, Stern Visiting Professor and Head of Research, Centre for Advanced Financial Research and Learning
In “A Proposal for the Resolution of Systemically Important Assets and Liabilities: The Case of the Repo Market,” Acharya and Öncü postulate that when confronting failing SIFIs, regulators should deal first with their systemically important assets and liabilities (SIALs) and worry about the institutions later – what they call a bottom-up versus top-down approach.
To remedy this, the authors propose the creation of a Repo Resolution Authority – in essence, a clearinghouse for the repo market to prevent the kind of runs that characterized the 2008 crisis.
Acharya and Öncü point out that a key failure behind the crisis was the regulatory focus on the individual risk of financial institutions, rather than on the systemic risk of their assets and liabilities. That top-down focus, they write, informed the Dodd-Frank Act (DFA)’s Orderly Liquidation Authority (OLA).
But the authors question not only whether the OLA suffices to induce market discipline and mitigate moral hazard – two main DFA goals – but also if it can address the systemic risk associated with the repo market or money market mutual funds, both systemically important sectors.
The authors’ call for a Repo Resolution Authority is an element in their hybrid approach. Says Acharya: “What we propose is that top-down (or institution‐level) approaches such as contingent capital, bail‐in, or living wills, be built on top of a bottom-up approach – one that works at the level of the SIALs rather than at the level of the SIFI that owns them.”