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Collateral, Netting and Systemic Risk in the OTC Derivatives Market

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  • Manmohan Singh

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.

Suggested Citation

  • Manmohan Singh, 2010. "Collateral, Netting and Systemic Risk in the OTC Derivatives Market," IMF Working Papers 10/99, International Monetary Fund.
  • Handle: RePEc:imf:imfwpa:10/99
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    Citations

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    Cited by:

    1. Yannick Armenti & Stéphane Crépey, 2017. "Central Clearing Valuation Adjustment," Working Papers hal-01169169, HAL.
    2. Xiao, Tim, 2012. "An Economic Examination of Collateralization in Different Financial Markets," MPRA Paper 47371, University Library of Munich, Germany.
    3. Duffie, Darrell & Scheicher, Martin & Vuillemey, Guillaume, 2015. "Central clearing and collateral demand," Journal of Financial Economics, Elsevier, vol. 116(2), pages 237-256.
    4. Malgorzata Olszak, 2012. "Macroprudential policy - aim, instruments and institutional architecture (Polityka ostroznosciowa w ujêciu makro - cel, instrumenty i architektura instytucjonalna)," Problemy Zarzadzania, University of Warsaw, Faculty of Management, vol. 10(39), pages 7-32.
    5. Rama Cont & Thomas Kokholm, 2013. "Central Clearing of OTC Derivatives: bilateral vs multilateral netting," Papers 1304.5065, arXiv.org.
    6. Vuillemey, G. & Breton, R., 2014. "Endogenous Derivative Networks," Working papers 483, Banque de France.
    7. Vahan Nanumyan & Antonios Garas & Frank Schweitzer, 2015. "The Network of Counterparty Risk: Analysing Correlations in OTC Derivatives," Papers 1506.04663, arXiv.org, revised Sep 2015.
    8. Xiao, Tim, 2012. "An Economic Examination of Collateralization in Different Financial Markets," MPRA Paper 47105, University Library of Munich, Germany.
    9. Cont Rama & Kokholm Thomas, 2014. "Central clearing of OTC derivatives: Bilateral vs multilateral netting," Statistics & Risk Modeling, De Gruyter, vol. 31(1), pages 1-20, March.
    10. Singh, M., 2013. "OTC derivatives market – regulatory developments and collateral dynamics," Financial Stability Review, Banque de France, issue 17, pages 207-213, April.
    11. repec:eee:jfinin:v:32:y:2017:i:c:p:76-87 is not listed on IDEAS
    12. Joshua Slive & Jonathan Witmer & Elizabeth Woodman, 2012. "Liquidity and Central Clearing: Evidence from the CDS Market," Staff Working Papers 12-38, Bank of Canada.
    13. Yannick Armenti & St'ephane Cr'epey, 2015. "Central Clearing Valuation Adjustment," Papers 1506.08595, arXiv.org, revised Feb 2017.

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