European banks have found a new way to bring in cash. They borrow it–but instead of turning to each other to bring in funds, they are borrowing it from companies that were once happy to deposit their excess cash in exchange for interest. Worries over the eurozone crisis have hit both the banks and their former depositors, and now both have worked out a new arrangement that seems to satisfy them both–at least for now.
Reuters reported Monday that banks, wary of borrowing from one another or a central bank over debt fears, have begun negotiating secured lending arrangements with companies flush with extra cash–which, instead of receiving a regular unsecured interest payment in exchange for their money, now insist on collateral and other measures in so-called repo deals or short-term secured lending.
While companies themselves are reluctant to talk about such measures, one source said that in one specific category of lending, companies account for 25% of these deals. Very large companies with an abundance of cash are typically the ones that will execute such arrangements. Johnson & Johnson, Pfizer and Peugeot are reported to be among them, as some of the most recent entrants into the repo field.
Frank Reiss, who oversees some of the repo business at Euroclear, the Brussels, Belgium-based settlement house owned by a group of banks and the largest administrator of repo trades in Europe, was quoted saying, "Companies in the past were ... happy to deposit cash on an unsecured basis to a bank for an interest payment."
He added, "Now following the crisis, we have seen that companies are engaging in repos secured with collateral against the cash they are lending."
Repos work by one participant purchasing collateral from the other; it is obliged to sell it back later at a predefined date and for a slightly lower price, or so-called haircut. In that manner the seller has provided cash to the buyer.
European companies held $872 billion cash in total at the middle of 2011, according to numbers from Moody's. Companies other than banks engaging in repos generally use a third-party firm to administer collateral; these are known as triparty repos, and the triparty market has grown 22.3% in the first half of 2011, according to figures from the International Capital Market Association. That compares to a lesser growth rate overall in repos.
Reiss estimated, based on what he sees daily, that as much as 25% of the triparty market is on behalf of companies. Traditionally such transactions made up only 2% to 5% of the overall repo market.
Regulators have expressed concern over the transparency of repo transactions, and have been critical of closed-door deals known as shadow banking. The U.S. Federal Reserve has set up a working group to suggest reforms for the repo market.