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Rehypothecation is when a custodian, such as a bank or brokerage, loans out more assets or cash deposits than they actually own in the pursuit of financial gain or to cover their own obligations. For example, a prime brokerage will rehypothecate securities posted with them as collateral by a hedge fund for the brokerages transactions and trades.

Typically, a bank or broker has access to a variety of collateral assets, including tangible assets and securities. Banks or brokers may incentivize clients to permit rehypothecation of their collateral by offering a lower cost of borrowing, decreased fees, or lower interest payments. Rehypothecation happens most often when a client leaves securities with a broker as a deposit in a margin account, and the broker uses the securities as collateral for the margin in the broker’s margin account or as backing for a loan.