Eurozone repo markets are slowing policy transmission, ECB paper says

The structure of eurozone repo markets is hampering the transmission of the European Central Bank’s monetary policy, a working paper published by the ECB argues.

In Monetary policy transmission in segmented markets, Jens Eisenschmidt, Yiming Ma and Anthony Lee Zhang examine the eurozone repo market. They use transaction data on the repo market from the ECB’s Money Market Statistical Reporting dataset.

The eurozone repo market has two “fundamentally distinct segments,” the authors say. “The first segment, the inter-dealer market, is a very efficient market between large repo dealer banks, which all have access to electronic repo trading platforms.”

But “the vast majority of market participants”, including banks without the designated dealer status, and non-bank financial institutions, cannot access these electronic trading platforms. Instead, they have to trade repos with dealer banks in the over-the-counter segment of the market.

This means dealer banks can obtain better prices in repo markets against those excluded from the platforms, the authors say. This, they find, “hinders the efficient transmission of the ECB’s monetary policy to the majority of repo market participants”.

To improve policy transmission, the European Union should allow non-bank financial institutions access to the ECB’s deposit facility, the authors argue. Such a move, they say, “may improve monetary transmission efficiency by 26% to 39% in different OTC repo markets”.

The ECB should also introduce a secured funding facility for non-banks, giving them access to the liability side of the Eurosystem balance sheet, they say. This facility would be similar to the Federal Reserve’s Reverse Repurchase Facility, the authors say.