When it comes to short-term trading, some of the biggest institutions in the world also need access to cheap financing to make the whole thing worthwhile. At the end of the day, if the rate of interest on short-term borrowing for trading purposes goes up even by a small percentage, it can eat into the profits and make the whole structure vulnerable. Regarding Wall Street, the stakes are much higher, and hence, the rise in the cost of short-term borrowing on Monday led to widespread turmoil. Some of the biggest banks on Wall Street and hedge funds depend on the short-term money lending market to finance their trades, and on Monday, the cost of such borrowing rose by an incredible $2 trillion.
Over the course of the past weeks, borrowers had paid an annualized interest rate of 2% for such short-term borrowing but on Monday that rate rose to 4% and caused immense turmoil in the world’s biggest capital market. However, the most important thing to keep in mind in this regard is that traders, as well as experts, are still trying to figure out how the rate surged in such a fashion on Monday. The interest rate in question is known as the Repo rate, and an expert has stated that the Repo rates are not supposed to fluctuate in such a fashion on a single day.
That being said, it is also necessary to point out that such movements in the Repo rate have served as an indication for the state of the financial markets. For instance, in the days leading up to the financial meltdown back in 2008, there were a lot of unforeseen fluctuations in the costs for borrowing short-term financing for trading purposes. Some experts have expressed their surprise at the events of Monday and stated that Repo rates are supposed to be stable, which is why the rise yesterday has proven to be a huge wake-up call for many banks. That being said, it should be noted that the events of Monday may have been an isolated event and might not actually even be an indicator of long-term well-being of the financial system. However, the borrowing rate needs to be watched closely over the next days.