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Collateral, Netting and Systemic Risk in the OTC Derivatives Market

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  • Manmohan Singh
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    Abstract

    To mitigate systemic risk, some regulators have advocated the greater use of centralized counterparties (CCPs) to clear Over-The-Counter (OTC) derivatives trades. Regulators should be cognizant that large banks active in the OTC derivatives market do not hold collateral against all the positions in their trading book and the paper proves an estimate of this under-collateralization. Whatever collateral is held by banks is allowed to be rehypothecated (or re-used) to others. Since CCPs would require all positions to have collateral against them, off-loading a significant portion of OTC derivatives transactions to central counterparties (CCPs) would require large increases in posted collateral, possibly requiring large banks to raise more capital. These costs suggest that most large banks will be reluctant to offload their positions to CCPs, and the paper proposes an appropriate capital levy on remaining positions to encourage the transition.

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    Bibliographic Info

    Paper provided by International Monetary Fund in its series IMF Working Papers with number 10/99.

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    Length: 15
    Date of creation: 01 Apr 2010
    Date of revision:
    Handle: RePEc:imf:imfwpa:10/99

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    Related research

    Keywords: Asset management; Banks; Capital; Credit risk; Financial institutions; Financial instruments; Financial risk; Securities regulations; derivative; derivatives market; derivative contracts; financial system; margin requirements; derivative market; hedge; credit derivatives; hedge fund; financial markets; international financial markets; moral hazard; credit risks; financial services; financial statements; credit markets; hedge funds; derivative products; tax rate; derivatives market activity; derivative contract; financial regulation; guarantee funds;

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    Cited by:
    1. Xiao, Tim, 2012. "An Economic Examination of Collateralization in Different Financial Markets," MPRA Paper 47105, University Library of Munich, Germany.
    2. Darrell Duffie & Martin Scheicher & Guillaume Vuillemey, 2014. "Central Clearing and Collateral Demand," NBER Working Papers 19890, National Bureau of Economic Research, Inc.
    3. Rama Cont & Thomas Kokholm, 2013. "Central Clearing of OTC Derivatives: bilateral vs multilateral netting," Papers 1304.5065, arXiv.org.
    4. Joshua Slive & Jonathan Witmer & Elizabeth Woodman, 2012. "Liquidity and Central Clearing: Evidence from the CDS Market," Working Papers 12-38, Bank of Canada.
    5. Xiao, Tim, 2012. "An Economic Examination of Collateralization in Different Financial Markets," MPRA Paper 47371, University Library of Munich, Germany.

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