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FRM Part II · FRM Exam Part II · Repurchase Agreements and Financing

A regulator proposes requiring minimum haircuts on all securities financing transactions that are not centrally cleared, with numerical floors increasing with collateral risk. What is the main systemic risk this is designed to limit?

Minimum haircut floors are meant to limit procyclical leverage. When haircuts are low in good times, borrowers build up leverage, and when haircuts jump in stress they must deleverage through fire sales. Floors keep haircuts from falling too low, which dampens this amplification.

  1. AProcyclical build-up of leverage, as haircuts fall in good times and jump in stress, forcing fire salesCorrect
  2. BThe risk that central banks cannot set the policy rate accurately
  3. CCredit risk in unsecured interbank deposits
  4. DSettlement failures arising from differing time zones

Explanation

Haircuts tend to be low during booms, allowing high leverage, and rise sharply in crises, forcing deleveraging and asset sales. Minimum haircut floors dampen this procyclicality. The other options are not what numerical haircut floors target.

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