What Is Rehypothecation?

Rehypothecation is the practice where banks, and even the brokers themselves, use assets that have been posted as collateral by their clients for their own purposes. Clients that permit rehypothecation of their collateral can be compensated through a lower cost of borrowing or a rebate on fees.

Rehypothecation occurs when the lender ends up using its rights to the collateral in order to participate in their own transactions, with the hopes of eventual financial benefits.

Rehypothecation occurs when a borrower promises the right to an asset, as a form of collateral, in exchange for funds. Rehypothecation was a common practice all the way until the year 2007, where hedge funds became warier about it.

Rehypothecation takes place if a customer leaves a number of securities with a broker as a deposit, in a margin account, where the broker can then use the securities as a pledge for the margin on his own margin account or as backing for a loan.

In this instance, you have hypothecation, which occurs when a borrower promises the right to an asset as a form of collateral in exchange for funds.

A common example of this occurs in the primary housing market, where a borrower can use the home he or she is purchasing as collateral for a mortgage loan.

Now, even though the borrower asserts a level of ownership over the property, the lender has the ability to actually seize the asset if payments are not made as required.