Securing liquidity with repo transactions

November 17, 2005
Money Market Event, Geneva

Summary

A bank’s primary objective is to generate as high a return as possible with the equity capital invested and to sustain it in the long term. By taking greater risks, the bank can boost its average rate of return. This notwithstanding, it should only take risks that do not put its survival on the line. The solvency of a bank is not the only survival factor, however; liquidity also plays a vital role. It is essential that a bank always be able to meet its liabilities on time.

Under normal circumstances, a solvent bank should have no real difficulty in securing the required liquidity. The bank can draw on credit lines with other institutions or use its own liquid assets to cover its liquidity needs. In exceptional cases, however, procuring liquidity may prove far more problematic. The liquidity requirement could increase sharply at the same time as previous sources of liquidity suddenly become unavailable. It is therefore important that provisions be made in advance so that banks also have reliable liquidity sources in such situations. Even in difficult times, every bank is responsible for its own liquidity. With a view to being prepared for such eventualities, therefore, banks should hold sufficient assets that are eligible at the central bank as collateral and which can be mobilised via the repo market or the central bank. Liquidity management is one of the core tasks of a bank and, given its importance in times of crisis, one for which the bank's management should be directly responsible.

With regard to security, repo transactions have many advantages over traditional money market instruments. The credit risks are minimised because the financial claim is always fully covered by securities. Where securing liquidity is concerned, the repo business also has clear advantages over traditional money market transactions. A functioning repo market makes a significant contribution to securing liquidity in the banking sector. Collateral eligible for SNB repos can be exchanged for cash in the interbank market at any time. Reliance on credit lines, by contrast, is rather risky, as it is a source of liquidity that can dry up very quickly. In addition, as of 2006, access to all the National Bank’s facilities will only be possible via repo transactions. In order to ensure a modern liquidity management, every autonomous domestic bank ought to affiliate itself with the Swiss franc repo system.

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Author(s)

  • Thomas Jordan
    Alternate Member of the Governing Board

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