Rehypothecation

Understanding Rehypothecation

Rehypothecation is the practice of banks and brokers using assets provided by their clients as collateral for their own purposes. Clients who agree to rehypothecation may enjoy lower borrowing costs or fee rebates.

Rehypothecation occurs when lenders exercise their rights to the collateral to engage in their own transactions, expecting future financial gains.

When a borrower pledges an asset as collateral in exchange for funds, rehypothecation occurs. This practice was commonly used until 2007, when hedge funds became more cautious about it.

Rehypothecation can happen when a customer deposits securities with a broker in a margin account. The broker can then use these securities as collateral for their own margin account or as security for a loan.

In this scenario, we have hypothecation, which occurs when a borrower pledges an asset as collateral in exchange for funds.

A typical example of this can be seen in the primary housing market, where a borrower can use the property they are purchasing as collateral for a mortgage loan.

Although the borrower may claim ownership of the property, the lender retains the right to seize the asset if the required payments are not made.