A situation that arises when market news causes information-insensitive collateral assets, in a repo transaction, to become information sensitive. The arrival of such public news triggers an increase in the repo margin (haircut) which, in turn, increases the information sensitivity of the collateral asset (security). Haircuts are determined based on a lender’s liquidity needs, the counterparty default risk, and the information sensitivity of the collateral. If the information sensitivity of the collateral increases, an increase in the haircut will be prompted. Conceptually and practically, an increase in haircuts is similar to a withdrawal from a bank (since, in such a situation, the bank has to make up the decrease in the collateral value in the tune of the haircut).

The bank/ lender would request a higher haircut which is tantamount to not renewing repo (i.e., the securitized loans will not be rolled over) in the same proportion of financing. To obtain the same amount of financing, the borrower has to place additional collateral. That is, when a security (e.g., a bond) of a financial institution that was completely financed by a loan in the repo market has become only 85 percent financed (due to a drop in its value), then there is a 15% repo haircut. This is technically equivalent a withdrawal from the financial institution of 15%, the amount that the financial institution (borrower) now has to secure “new” financing for. Otherwise, the borrower will be forced to sell assets.