The impact of minimum haircuts on non-bank leverage in the euro area

by Michael Grill, Felix Hermes and Michael Wedow

Published as part of the Macroprudential Bulletin 15, January 2025.

Repo haircuts – the differential between the market value of the collateral and the loan amount – are an important determinant of the amount of leverage that can be obtained via a repo. If market participants set haircuts too low, the leverage generated in repos may reach levels that are undesirable from a financial stability perspective. Regulators have long contemplated using requirements for haircuts as a mechanism to curb leverage in repos. In 2014, the Financial Stability Board (FSB) recommended introducing a framework for establishing numerical haircut floors, aimed at the non-bank financial sector. This framework targets non-centrally cleared securities financing transactions involving collateral other than government securities, where cash is provided to non-bank financial intermediation (NBFI) entities. The framework mandates minimum haircut levels, which are determined by the type and maturity of the underlying collateral.

In this focus piece, we explore whether the FSB minimum haircut framework would effectively contribute to curtailing leverage within the NBFI sector. In our analysis, we follow the approach taken by Banegas and Monin (2023). We use repo haircuts to estimate the collateralisation of a repo, which must be supported by capital. For example, if a fund wants to buy a security for 102 but can only borrow 100 by posting the security as collateral in the repo market, it must provide 2 of capital on its own. The ratio of repo borrowing to the supporting capital is referred to as “leverage on repo”.

We analyse the impact of minimum haircuts on non-bank borrowing using two different scenarios. In the first scenario, entities aim to maintain their cash borrowing levels, necessitating an increase in pledged capital due to higher haircuts under the framework. In the second, entities keep their capital constant, leading to a reduction in cash borrowing when the framework is applied. We then evaluate how each scenario affects leverage on repo.

Implementing minimum haircuts would likely lead to a sizeable reduction in non-bank leverage on repo. Table 1 shows the main findings from the two scenarios, displaying total repo borrowing, the capital supporting this borrowing and leverage on repo. It illustrates the impact of the minimum haircut framework across the entire non-bank subsample, encompassing all collateral types included in our sample. It reveals that applying the minimum haircut framework leads to an approximate 13% reduction in leverage on repo, as indicated by leverage being reduced from 73.03 to 63.36 in the last row of Table 1.

Minimum haircuts should target larger and more leveraged market participants that represent a risk to financial stability. This is because larger entities are more likely to amplify systemic risk through high leverage. An effective minimum haircut regime should therefore reduce leverage among these entities in particular, in line with the core objective of mitigating financial stability risks.

The minimum haircut framework reduces the leverage of the largest entities the most. Table 2 extends the analysis presented in Table 1, segmenting the data so that the influence of the largest entities can be studied. Here, we define large entities as those with the largest borrowing volumes. We consider entities in the top 50th, 75th and 90th percentiles of borrowing. The findings indicate that the minimum haircut framework significantly reduces leverage, particularly for the largest entities. Specifically, entities representing 50% of all non-bank borrowing experience a leverage reduction of 42%. This reduction tapers off when we include smaller entities, dropping to 29% for the 75th percentile and 19% for the 90th percentile.

Larger entities tend to have higher initial leverage levels for in-scope transactions.^[1] Chart 1 depicts a scatterplot of inverse leverage levels and total borrowing for transactions within the scope of the framework.^[2] This means that these entities will be more affected by the framework, because if two entities must raise the same amount of extra capital, the one with the higher initial level of leverage will display the larger reduction in leverage.

Chart 1

Larger non-bank borrowers tend to have higher initial levels of leverage

(EUR billions)

The higher initial leverage in affected transactions among the largest entities stems from their typically lower average haircuts. This is illustrated in Chart 2. One reason could be that larger entities may have more bargaining power and hence receive lower haircuts (Julliard et al., 2022 and Grill et al., 2025). Thus, larger entities can maintain high initial leverage levels because of their lower haircuts in all types of transactions.

Chart 2

Larger non-bank borrowers tend to have lower haircuts

(EUR billions)

Overall, the results suggest that minimum haircuts can be an effective policy tool for mitigating risks from highly leveraged non-bank financial institutions. We show that introducing minimum haircut levels would have a tangible impact on leverage, particularly among entities with higher initial leverage levels. Minimum haircuts could thus help mitigate risks stemming from NBFI leverage as part of a broader policy response to an important financial stability risk.

References

Banegas, A. and Monin, P. (2023), “Hedge Fund Treasury Exposures, Repo, and Margining”, FEDS Notes, September.

Julliard, C., Pinter, G., Todorov, K. and Yuan, K. (2022), “What drives repo haircuts? Evidence from the UK market”, BIS Working Papers, No 1027.

Grill, M., Hermes, F. and Wedow, M. (2025), “Repo haircuts: Market practices and the impact of minimum requirements on leverage”, Finance Research Letters, January.