Question

How is the financing strategy of repurchase agreement profitable for dealer banks? And how would an increase in repo haircut have impacts on the dealer banks? What actions would dealer banks take dealing with an increase in repo haircut?

Answer 1

Repurchase agreements or also knows as repos,they are one of the tools which help investors to get the access of cash without being on que for the longer period of time.They are the type of contracts which can last for months or even end at a overnight.
They are popular tools in the market and frequently used by the central banks.Because of their financial strategies ,they are profitable for the dealer banks .For example ,one of the strategies of repurchase agreement is that FED bank can buy bonds to temporarily to increase their reserves or selling government securities to reduce the money circulation in the market.Repurchase agreements give short term funding and thats why they are very famous among investors as they provide them quick access to high liquidity or high quality securities.

Increased or decreased haircut is dependent on the liquidity of the collateral.A high liquid collateral is easily sold out without having any loss of value.An asset which is difficult to sold out has a larger amount of haircut .Also when haircut is lower it involves less amount of risk.for example bank dealers use t-bills as a collateral while doing repurchase agreements so to avoid any risk the amount of haircut will be negligible.
Actions taken by dealer banks would be they will withdraw their hands from the deal to avoid any future risks.Also having high haircut will make the asset difficult to be sold out in the market.To avoid such problems they will wait for the time until the rate of repo haircut gets decreased.