The wholesale financial system relies heavily on the Repurchase Agreement (Repo) market to secure short-term funding, using financial assets as collateral for overnight loans.

A primary driver of leverage in the shadow banking sector is Collateral Rehypothecation—the practice where a lender uses the collateral pledged by a borrower to secure their own funding from another counterparty:

Bank Alpha pledges bond to Bank Beta for cash -> Bank Beta re-pledges same bond to Fund Gamma -> Builds a chain of leveraged claims

This reuse increases Collateral Velocity and expands credit capacity across the financial system. However, it builds a complex web of interdependent claims. If a default occurs or a major asset class experiences a sudden downgrade, the collateral chain can break rapidly, triggering margin calls and liquidity squeezes across the network.