Dealers run large securities financing “matched books” in which they borrow cash against securities, lend cash against securities, borrow securities against cash, lend securities against cash and borrow securities against other securities. At first hearing, that sounds like a rather pointless daisy chain. But securities financing markets are important (Chart 4). First, reverse repo transactions (short-term cash loans against high-quality bonds) provide moneylike assets for risk-averse wholesale investors, like money funds and sovereign reserves managers. As Zoltan Poszar has shown, their demand for money, particularly in US dollars, far outstrips traditional supply in the form of insured bank deposits or Treasury bills (Poszar 2014). Securities financing markets fill the gap. Second, acting as prime brokers, dealers finance the long and short positions of leveraged investors such as hedge funds. Third, securities financing markets facilitate the flow of high-quality securities from their underlying beneficial owners, such as pension funds and insurance companies, to banks and dealers which increasingly need to use and reuse them in order to meet regulatory requirements to collateralise their obligations: for example, to other banks and dealers and to central counterparty clearing houses. Securities financing markets may be important but the financial crisis demonstrated that they can also be fragile. Securities thought to be “safe” collateral, such as AAA-rated mortgagebacked securities and peripheral European sovereign bonds, became “risky” collateral. Haircuts on lending against those securities increased (Chart 5).

The flipsides of more resilient dealers and markets in periods of stress may well be less leverage, less maturity transformation and lower dealer inventories in more normal periods. The balance is not easy to strike; we may need to readjust our approach as we learn. But the goal of these reforms is clear: to make securities financing markets resilient. Robust securities financing markets should help to stabilise rather than destabilise the financial system in the face of shocks. The reduction in dealer inventories has attracted a lot of comment, with questions about whether they will be willing and able to provide liquidity as market makers in falling markets on the same scale as in the past. But the role of dealers in providing stable financing to leveraged investors may be equally important. Those investors may be the most likely to see a market crash as a buying opportunity – but only if they are not over-leveraged and have access to borrowing from financially-sound dealers. Put another  4  http://www.bis.org/publ/bcbs270.pdf. 5  http://www.bis.org/bcbs/publ/d295.pdf. 6  http://www.bis.org/publ/bcbs238.pdf. 7  In October 2014, the FSB published Strengthening Oversight and Regulation of Shadow Banking: Regulatory framework for haircuts on non-centrally cleared securities financing transactions (http://www.financialstability board.org/publications/r_141013a.pdf). 4  BIS central bankers’ speeches  way, we want dealers and leveraged investors to be providers not demanders of liquidity in a crisis. References Gorton, G B, Metrick, A, & Xie, L (2014), The flight from maturity. No. w20027. National Bureau of Economic Research, 2014.