The use of repurchase agreements by the Maltese banking sector

Abstract

The local banking sector adopts a traditional model for funding its operations. Use of innovative financial instruments is minimal or nonexistent in funding their operations. Repurchase agreements are a useful tool in raising liquidity where securities are exchanged for cash for a specified period of time by converting illiquid assets into liquid ones. Following the financial crisis, repurchase agreements were classified under the shadow banking umbrella and immediately a call on regulators to control this phenomenon kicked off. However during the consultation stage market players revealed the economic importance such instrument provides. Repurchase agreement acts as an alternative source of finance and is a cheaper tool to raise liquidity by participating in the capital market. The purpose of this study is to see if financial instruments identified under the shadow banking umbrella can act as an alternative source of finance domestically with special emphasis on repurchase agreements. The study focuses on the use of repurchase agreements, which is discreetly used by core domestic banks while on the other hand regularly used by the Central bank. The thesis shows through case study that repos (Lehman Brothers & repo 105), and also structured vehicles (Malita Investment plc) together with securitisation are not opaque type of instruments. A proper corporate governance structure together with the adoption of accounting standards and regulations, one can setup an efficient and cost effective model of finance. The domestic intermediation system is well funded by customer deposits and is quite stable leaving less room for innovation. The study shows that domestically the two largest banks can tap this market through securitisation and benefit in transferring credit risk or participate in the repo market for funding. However domestic banks are reluctant to venture in introducing innovative instruments to fund their balance sheet for the time being even if the traditional model for funding is less cost effective.