Reciprocal Lending Relationships Between Financial Conglomerates: Evidence from the Mexican Repo Market

Abstract

This paper examines the reciprocal lending between Financial Conglomerates in the repo market to better understand both what motivates powerful firms to engage in this type of contemporaneous crossfunding relationships, and, on the other hand, some of the implications that such reciprocal transactions may entail for the agents involved and for the market as a whole. In particular, in terms of the implications we focus on two dimensions: first, the potential effects that reciprocal lending has on the market power of FCs and the competitiveness of the repo market for mutual funds and second, the potential implications that frequent and stable reciprocal lending can have in terms of the industry’s systemic risk. Using transaction-level data from the Mexican repo market, we show that reciprocal lending between financial conglomerates is mutually beneficial as it reduces search costs for borrowers and mitigates credit risk concerns for lenders. Further, we find that reciprocal lending favors market concentration of the repo lending in a few powerful funds and increases fund market power. Finally, we find that reciprocal lending also leads to centrality within the financial network and increases the dependence between the parties involved. Interestingly, a higher intensity of reciprocal lending can harmful, but this does not necessarily deteriorates financial stability.