Here Comes The Repo Man

I was on a zoom call today with some colleagues, and we were discussing some financial terms, things that are going on in the markets, and the like. One of the questions that came up was the operations at the BOC over the last 10 days and the 5 Billion dollar repo facility activity. We actively discussed what it could be, and what it might be, but it left me with more questions than answers, and prompted me to do some digging. Now, I think it is a very important topic that needs to be widely made available to people, however, it is not exactly the easiest thing to describe. 

This is the part where I may lose a few of you, and that is okay. The topic here is not easily explained, and – full disclosure I am far from anything considered an expert on the topic of central bank repo facilities. I did have a little experience working the bond desk back in the day, but the topic here is something that even most seasoned veterans of the financial world can struggle with. You may want to grab a glass of Johnny or Jack to make the read a bit smoother.

By now everyone is, or should be aware of what quantitative easing is. It is basically when central banks inject liquidity into the marketplace. Quantitative tightening is when they take liquidity out of the financial system. Now, I have some real experts that follow my blog, and they are going to be emailing me with how over simplified I make all of this, but I am trying to make it understandable for the average mortgage agent – not writing a doctoral thesis on the modern central banking system.

Overnight, or repo facilities are the mechanism whereby central banks can either facilitate QE or QT. They use the repo facility to either inject, or remove liquidity from the financial system. The repo facility also serves other purposes, but I am not going to dive into that here. There are lots of reasons why a central bank uses an overnight repo facility – most commonly to fund asset/liability mismatches from the banks. A bank may loan out too much money in the course of a day ( on a mortgage for example ), and not have the cash on hand to settle its payments. So, they temporarily borrow funds in the overnight market, and post their assets as collateral ( the mortgage they funded is an asset to the bank ). It is kind of like you might use your credit card on a Thursday to buy groceries until you get paid on Friday. Banks typically borrow overnight from other banks, but sometimes other banks may not be flush with liquidity themselves, so they turn to the central bank – namely the BOC in Canada, the Fed in the US, and the ECB in Europe.

Central banks would also need to inject liquidity into the system in a 2008 type credit event whereby there was no other bank willing to loan. We saw this in 2008 when banks would not lend cash to other banks, as they would not accept the mortgage loans as collateral, as no one knew if they were any good. 

Okay, so we know what the repo facility is, and sort of what it does. The BOC has the authority to use the repo facility in 5 billion dollar chunks. They are allowed to add or remove up to 5 billion at a time in liquidity. They need no special permission, nor government approval, their mandate allows this. There is some debate as to how frequently they can do this. Some “experts” will tell you it is 5 billion a day, whereas other “experts” will tell you it is 5 billion per chunk, so in theory they could inject or remove 15 billion in a day, so long as they did it in 3 chunks of 5 billion dollars each. My personal opinion is that they will keep it to 5 billion a day, and if more is needed, it is probably because of a COVID style meltdown, so they would get authorization to do as much as needed – whenever needed, directly from the Finance Minister.

It has been reported over the last 10 days that the BOC has intervened overnight 6 times ( for 5 Billion a time ) for a total of 30 billion dollars. 30 billion in Canadian dollars is a lot of money, and it has raised a few eyebrows. I am super fortunate to know a lot of extremely smart people, and have been able to discern a little bit more from them on what it actually was. So, without further ado, here goes.

The BOC did inject 5 billion dollars on 6 separate occasions, in 2024, however, it was basically the same 5 billion – just recycled. The BOC was using the same 5 billion day after day, and not creating or injecting new money. Kinda like when you use your Visa to pay your Mastercard bill. No new funds were created or removed, you just cycled the funds over. So, if you hear a tinfoil hat person claiming the banks are collapsing, and the end is near – don’t worry, it is far from the truth. Had the BOC injected 30 billion in 10 days in new liquidity of QE, yes, you could think something was wrong. So, we are not nearing the end of the world, at least not yet. Banks are fine, balance sheets are strong, and 30 billion is actually 5 billion.

Ok, so now that we know the world isn’t ending, what did they do with the 5 billion? This is where it gets tricky. Canada is transferring / transitioning to a new system of overnight trading/lending/pricing. Canada used to use the CDOR system, and now it is switching over to the CORRA system. I am not getting into the finer points of these systems, but here is what you need to know:

Under the CDOR system, rates could trade within a range or a band. Unless overnight or intra day rates went outside of the band, the BOC did not need to use the repo facility. Under the CORRA system, it sets a floor for rates.  Under CORRA standards, if the overnight rate dips below a pre set floor, the BOC will inject liquidity to bring rates back above the floor level. Once rates rise back to an acceptable level, the BOC would then remove that 5 billion of liquidity they injected earlier. The next day it is rinse, lather, repeat if required. I have just given you the most oversimplified explanation of one of the most complex financial items of our time. I know the pros will eat me for lunch and point out 1689 things that are wrong about my explanation, but it is simplified to make it make sense to people.

You will probably hear more about the BOC injecting overnight funds via the repo facility this year. As we move off of the CDOR system completely by end of June 2024, it is going to take the markets some time to adjust to the new pricing, the new models, and get everyone in line to trade / borrow / time the overnight window. Once everyone is fully on the new CORRA system, I imagine the BOC overnight repo news will become a distant memory. Of course there still may be some injection required around quarter end, year end etc to balance things out, and window dress balance sheets here and there, but I imagine that once we get over the full moving of platforms all will be smooth sailing.

There are a lot of media outlets running with questions and stories, and as we all know – the media can word articles in a way that can make people fear the worst. Sometimes they don’t say it is bad, but they give one hell of an inference.

A lot of clients are scared, and seeing something that could lead them to believe banks are in trouble is not going to give them comfort. Show them how much you know, add some value, and put their mind at ease. Tiff Macklem may be the repo man, but that ain’t as bad as it seems!!!