Every cloud has a silver lining. In 2008, bank liquidity shortages that resulted from the oversubscribed Safaricom initial public offer (IPO) and to an extent the preceding IPOs, namely, Kenya Re and KenGen, inadvertently helped birth the horizontal repurchase agreement market - the market through which lenders borrow and lend from each other by offering government securities as collateral.
However, owing to a legal obstacle surrounding ownership of title, the market has remained more or less inactive. But thanks to recent reforms, data from the Central Bank daily interbank lending activity reports show a resurgence of the horizontal repo market.
But with rates still pricey compared to the average interbank rates, I agree with the suggestions that perhaps it's time we allowed other non-bank players (read: pension funds, money market funds (MMFs), insurance funds, big public corporations, etc) to participate in this market segment.
If we take MMFs for example, the US repo market provides a good study. Out of the Sh467 trillion estimated total repo assets (or investments in repos), the Federal Reserve (Fed) estimates that MMFs account for close to a quarter of the total repo assets.
And one reason given for this significant market share is the increase in the growth of assets under management (AUM) in MMFs, which are required to invest at least 90 percent of their assets in cash, government securities, or repos collateralised by cash and government securities.
Having experienced cumulative inflows over the years, MMFs are a particularly necessary addition. Why?
Interbank market
First, besides their break-neck growth - AUM now stands at Sh148 billion as of March 20224, up from Sh140 billion in December 2023 - tapping these pools of cash may help correct the skewness in the distribution of liquidity within the banking system, a scenario that has long plagued the interbank market.
Secondly, repos are relatively safe, a quality that aligns them with the usual MMF mandate. In a typical repo trade, the market value of the collateral exceeds the principal amount of the repo by a certain margin required by the investor.
The overcollateralisation is intended to protect the investor from the risk that the value of collateral may decline over the life of the transaction and become insufficient to recover the principal and interest should the counterparty default.
Thirdly, with repo maturities falling within the 18 months maturity set for local MMFs, it means they form part of the investable universe.
In the above US example, the Fed reports that around 70 percent of MMF repos by volume are either overnight or have open terms and can be terminated at any time. It further states that 24 percent of MMF repos have maturities longer than one day but less than seven days with the remaining six percent of MMF repos featuring various other maturity terms.
Altogether, adding MMFs (amongst others) as repo players offers those with undeployed cash balances an option to invest cash on a secured basis.
For banks (especially small banks), a broad and a deep horizontal repo market will provide an alternate route to source relatively “cheap” short- term funding.
