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FRM Exam Part II · Repurchase Agreements and Financing

Repo Regulation and Liquidity Management for FRM Part II

Updated 11 October 2026 · Fact-checked

Repo regulation shapes how much a bank can borrow against collateral and how much liquidity it must hold. LCR and NSFR assign outflow and funding factors by collateral quality and counterparty. Safe harbors let lenders keep and sell collateral on default. Central bank repo facilities backstop funding. Haircuts cut buffer value.

Understand Repo Regulation and Liquidity Management

A repo is a cash loan secured by securities. The cash borrower sells securities and agrees to buy them back later at a slightly higher price. Regulation matters because repo is short-term wholesale funding. It can disappear quickly in stress, as it did for dealer banks in 2007-2009.

The Liquidity Coverage Ratio (LCR) asks whether a bank has enough high-quality liquid assets (HQLA) to survive 30 days of stress. For secured funding, the run-off rate depends on the collateral the bank pledged. Under the Basel LCR, maturing secured funding backed by Level 1 assets has a 0% run-off rate, regardless of counterparty. Funding backed by Level 2A assets has 15%. Funding backed by Level 2B residential mortgage-backed securities (RMBS) has 25%. Funding backed by other Level 2B assets, such as corporate debt and equities, has 50%. Funding backed by non-HQLA collateral from most counterparties has 100%. Some non-HQLA-backed funding from domestic sovereigns, multilateral development banks and domestic public sector entities has 25%. The logic is simple: lenders will roll over funding backed by safe collateral even in stress, but not funding backed by weak collateral.

The Net Stable Funding Ratio (NSFR) looks at a one-year horizon. It compares available stable funding (ASF) with required stable funding (RSF). Short-term repo from financial institutions gets a low ASF factor, so it counts for little. Under the Basel NSFR, secured funding from financial institutions with residual maturity under six months gets 0% ASF. Funding from financial institutions with residual maturity of six months to under one year gets 50% ASF. On the asset side, reverse repo lending to financial institutions with residual maturity under six months, secured by Level 1 collateral, gets a low RSF factor of 10%. Loans to financial institutions with residual maturity under six months, secured by non-Level 1 assets, get a higher RSF factor of 15%. This pushes banks toward longer-term funding and discourages heavy reliance on overnight repo.

Bankruptcy safe harbors (for example, in the US Bankruptcy Code) exempt repos from the automatic stay. If the borrower defaults, the lender can terminate, net and liquidate the collateral immediately. This lowers credit risk and keeps repo cheap. The cost is that it can speed up fire sales: when everyone can sell collateral at once, prices fall and haircuts rise. Policymakers debate this trade-off.

Central bank repo facilities provide a backstop. A standing repo facility, such as the Fed's Standing Repo Facility (SRF), lends cash against Treasuries and agency securities at a set rate, which caps money market rates. The Fed's overnight reverse repo facility (ON RRP) works the other way. Eligible counterparties lend cash to the Fed overnight against Fed-held securities at a set rate, which puts a floor under short-term rates. Haircuts matter for buffers: a security's liquidity value is its market value minus the haircut, not the market price. Keep two sources of haircuts apart. In the LCR, Basel prescribes the haircuts for HQLA: 0% for Level 1, 15% for Level 2A, 25% for Level 2B RMBS and 50% for other Level 2B assets. Central bank facilities apply their own haircuts to pledged collateral, and those set how much cash the central bank lends.

Key formulas to remember

LCR
LCR = Stock of HQLA ÷ Total net cash outflows over 30 days ≥ 100%
Net outflows = outflows minus the lesser of inflows and 75% of outflows.
NSFR
NSFR = Available stable funding ÷ Required stable funding ≥ 100%
One-year horizon. Secured funding from financial institutions under six months gets 0% ASF; six months to under one year gets 50%.
Repo outflow
Outflow = Maturing repo cash × run-off rate
Basel LCR rates by collateral: Level 1 = 0%, Level 2A = 15%, Level 2B RMBS = 25%, other Level 2B = 50%, non-HQLA = 100% (most counterparties).
Haircut value
Collateral value after haircut = Market value × (1 − haircut)
Cash raised or HQLA credit is based on this value, not market value. LCR uses Basel-prescribed HQLA haircuts; central bank facilities set their own.
Repo cash from haircut
Cash lent = Collateral market value ÷ (1 + haircut), or Cash lent = Collateral market value × (1 − haircut)
These are two different conventions and they give different cash amounts. For $120 million of collateral and a 4% haircut: 120 ÷ 1.04 = $115.38 million, but 120 × 0.96 = $115.2 million. The question specifies which convention to use, so follow it.

How to solve Repo Regulation and Liquidity Management questions

Use this order for any repo regulation or liquidity question.

  1. 1Identify the regulatory lens: LCR (30 days), NSFR (one year), safe harbor (legal), or central bank facility (backstop).
  2. 2Identify the repo direction: is the bank borrowing cash (repo) or lending cash (reverse repo)?
  3. 3Classify the collateral: Level 1, Level 2A, Level 2B (RMBS or other) or non-HQLA. This sets the run-off or RSF factor.
  4. 4Classify the counterparty and maturity: financial institution or not, and under or over six months or one year.
  5. 5Apply the factor to the amount and compute outflow, ASF or RSF. Apply any haircut to collateral first.
  6. 6Compute the ratio or net the effect, then compare with 100%.
  7. 7Interpret: say whether the bank is compliant, and what the result shows about run risk or reliance on short-term funding.
  8. 8Check the answer against the logic: safer collateral should give lower outflow.

Quickest way: Collateral first, then factor

When to use it: Use when a question asks which option raises or lowers LCR or NSFR, or asks for a quick outflow.

  1. Find the collateral level. Level 1 = 0% outflow, Level 2A = 15%, Level 2B RMBS = 25%, other Level 2B = 50%, non-HQLA = 100%.
  2. Multiply by the maturing repo amount to get outflow.
  3. For direction questions, remember: better collateral means less outflow. For NSFR, secured funding from financial institutions under six months gets 0% ASF, and six to twelve months gets 50%, so shorter maturity means less ASF.
  4. Eliminate options that confuse LCR (30 days) with NSFR (one year).

Common mistakes in Repo Regulation and Liquidity Management

  • Applying the same run-off rate to all repo funding.

    Students remember repo as short-term and assume full outflow.

    Fix: Rate depends on collateral. Level 1 collateral gives 0%. Only non-HQLA collateral from most counterparties gives 100%.

  • Mixing up the 30-day LCR horizon and one-year NSFR horizon.

    Both are Basel III liquidity ratios with a 100% minimum.

    Fix: LCR is short-term stress survival. NSFR is structural, one-year funding stability.

  • Confusing repo with reverse repo at the central bank.

    The names sound alike and the direction flips with the viewpoint.

    Fix: In the Fed's reverse repo facility, the Fed borrows cash. In the standing repo facility, the Fed lends cash.

  • Saying safe harbors remove all repo risk.

    Students focus on the legal exemption from the automatic stay.

    Fix: Safe harbors reduce credit risk to the lender. Market risk, haircut risk and fire-sale risk remain.

  • Counting collateral at full market value in the buffer.

    Students forget haircuts.

    Fix: Apply the haircut first. HQLA credit and borrowing capacity use value after the haircut.

Worked examples

Example 1

A bank has $800 million of repo funding maturing within 30 days. $500 million is backed by Level 1 securities, $200 million by Level 2A and $100 million by non-HQLA securities from a corporate counterparty. Using Basel LCR run-off rates, what is the total outflow from this repo funding?

Show the solution
  1. Level 1: $500 million × 0% = $0.
  2. Level 2A: $200 million × 15% = $30 million.
  3. Non-HQLA: $100 million × 100% = $100 million.
  4. Total = 0 + 30 + 100 = $130 million.

Answer: $130 million

Example 2

A bank pledges $120 million (market value) of Treasuries to a central bank facility that applies a 4% haircut. How much cash can it raise, and what is the liquidity value of the collateral?

Show the solution
  1. Value after haircut = 120 × (1 − 0.04).
  2. = 120 × 0.96 = $115.2 million.
  3. The facility lends up to this value, so cash raised is $115.2 million.
  4. The $4.8 million difference is the buffer the central bank keeps against price falls.

Answer: $115.2 million

Exam tips

  • Memorize the LCR repo run-off rates by collateral: 0% (Level 1), 15% (Level 2A), 25% (Level 2B RMBS), 50% (other Level 2B), 100% (non-HQLA).
  • Read the direction carefully: repo is borrowing cash, reverse repo is lending cash.
  • Expect conceptual MCQs on the trade-off of safe harbors: lower lender credit risk versus fire-sale amplification.
  • For central bank facilities, ask who lends and who borrows, and whether it sets a ceiling or a floor on rates.
  • Always apply haircuts before computing buffer value or cash raised.

Practice questions from Repurchase Agreements and Financing

Repo Regulation and Liquidity Management: frequently asked questions

How is repo treated in LCR and NSFR?

In the LCR, maturing secured funding gets run-off rates by collateral: 0% for Level 1, 15% for Level 2A, 25% for Level 2B RMBS, 50% for other Level 2B and 100% for most non-HQLA. In the NSFR, secured funding from financial institutions with residual maturity under six months gets 0% available stable funding, and six to twelve months gets 50%.

What is a central bank standing repo facility?

It is a permanent facility where the central bank lends cash against eligible securities, such as Treasuries, at a set rate. It acts as a backstop and helps cap short-term funding rates.

How does the Fed reverse repo facility work?

Eligible counterparties lend cash to the Fed overnight and receive securities as collateral at an announced rate. This sets a floor under short-term money market rates.

What is the bankruptcy safe harbor for repo?

It exempts repo from the automatic stay in bankruptcy. The lender can terminate the contract and sell the collateral at once. This lowers credit risk but can speed up fire sales.