Europe banks exploit loophole in key rule to cut $145bn in trades

Bloomberg

Some of Europe’s biggest banks may have found a perfectly legal way to exploit a weakness in one of the finance industry’s most loathed rules.
Euro-area and Swiss lenders cut their short-term borrowings by tens of billions of dollars just before the end of each quarter, improving their reported financial health, only to build them up again in the following weeks, according to the Bank for International Settlements (BIS). BNP Paribas SA, Credit Agricole SA and Societe Generale SA regularly shrink such trades, US statistics show.
Almost a decade after the global financial crisis, lenders in Europe may be taking advantage of a loophole in the implementation of a key reporting requirement that aims to curb the amount of debt banks take on. While US and UK banks must use an average figure over the quarter when reporting the measure, known as the leverage ratio, the Europeans only have to report numbers for the end of a quarter, enabling them to apply “window dressing,” according to a BIS report last month.
“It allows banks to provide a picture of their own state to the market that is distorted,” said Francesc Rodriguez-Tous, a finance professor at City University in London. “The leverage ratio is precisely there to ensure that banks don’t game the system.”
The BIS report points to the $1 trillion US market for short-term collateralised loans known as repurchase agreements, or repos, a segment that provides a glimpse into how banks fund themselves. In a typical deal, a bank borrows cash by selling US Treasuries to a money-market fund and agreeing to buy back the securities the following day. Banks can also use the borrowed cash to make loans through trades known as reverse repos.
If the repo market sounds complex, the “window dressing” is relatively simple, according to the BIS. As the end of a quarter approaches, euro-area and Swiss banks just pull back from the market for a few weeks, unwind much of their existing repo trades and turn down new ones.
Since European banks started disclosing their leverage ratio in early 2015, the “amplitude of swings” in euro-area banks’ repo trades has been rising, with major banks showing a contraction in borrowing from US money market funds of $145 billion at the end of 2017. That compared with $35 billion two years earlier, according to the report. “Similar patterns are apparent” for Swiss lenders, the BIS said.
“Window dressing in repo markets is material,” wrote the BIS, which acts as a central bank for the world’s central banks. “Data from US money market mutual funds point to pronounced cyclical patterns in banks’ US dollar repo borrowing, especially for jurisdictions with leverage ratio reporting based on quarter-end figures.”
BNP Paribas, based in Paris, was a counterparty to $99 billion of repo trades with US money-market funds backed by Treasuries at the end of May, 16 percent of the total and more than any other lender, data from the Office for Financial Research show. The next four biggest — Barclays Plc, Credit Agricole, HSBC Holdings Plc and Societe Generale — account for about 23 percent of the market.
Many of them show big swings between the middle and the end of a quarter that have been increasing in size. Since the start of 2015, Credit Agricole and Societe Generale cut their Treasury repo exposures during the final month of every quarter, with declines averaging more than 50 percent, according to Bloomberg calculations. BNP Paribas reduced its dealings in the vast majority of periods, by an average of 34 percent.