The repo market could become increasingly important in the medium term as a result of the financial crisis, the European Central Bank (ECB) has suggested in its monthly bulletin.

In a feature on the repo market’s performance in the eurozone over the last two years, the ECB discussed how the industry has changed, highlighting a flight to government bonds as collateral as well as an increased reliance on central counterparties.

The report questioned whether these trends would hold as the European economy moved back to stability, questioning whether non-government bonds would come back into vogue as a form of collateral as they regain liquidity. However, this could be impacted by more stringent requirements on collateral liquidity in interbank repos in future, the ECB suggested.

Another aspect of the crisis touched on by the report was the increased market share of general collateral repos over special repo markets, which are generally seen as used for enabling short selling strategies. While the report hinted that special repo could return, it added: “Given their advantages as regards banks’ credit and liquidity risk management, it may be that repos are used more for funding purposes than was the case prior to August 2007.”

It was this increased focus on risk management among financial institutions that could signal a bright future for the repo market, the ECB concluded. “The repo market may be one of those markets that gain in importance in the medium term as a result of the turmoil,” it said.