Understanding Rehypothecation

Rehypothecation refers to the practice of banks and brokers using assets posted as collateral by their clients for their own purposes. When clients allow rehypothecation of their collateral, they may receive benefits such as lower borrowing costs or fee rebates.

In rehypothecation, the lender or broker utilizes the rights to the collateral to engage in their own transactions, aiming to generate financial gains.

The process of rehypothecation typically involves a borrower pledging an asset as collateral in exchange for funds. This practice was widespread until around 2007 when hedge funds became more cautious about rehypothecation.

Rehypothecation occurs 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 backing for a loan.

This practice is related to hypothecation, where a borrower pledges an asset as collateral in exchange for funds. An example of hypothecation is when a borrower uses the home they are purchasing as collateral for a mortgage loan.

Although the borrower asserts ownership over the property, the lender retains the ability to seize the asset if the borrower fails to make the required payments.