Risks related to central counterparties in derivatives markets

January 11, 2013

The large volumes of notionals and market values in OTC (rates and credit) derivatives markets have spurred a regulatory enhancement of risk buffers at banks. However, an IMF working paper by Li Lin and Jay Surti points out that no commensurate prescriptions apply to the two monopolistic central counter parties (CCPs) that clear a large share of the OTC derivatives market. This bears the risks that CCPs could become a medium of regulatory arbitrage of even systemic pressure.

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BIS on safe asset shortage and need for low real interest rates

January 6, 2013

A recent BIS working paper reminds us that the securitized credit and euro area sovereign credit crises have structurally diminished the world’s reserves of perceived safe assets. As safe assets are essential for institutional finance (pensions, insurances) and transactions (collateralization) their continued shrinkage would propagate a financial sector meltdown. This is why persistent negative real interest rates on sovereign and central bank liabilities are a critical stabilizer: they increase safe asset supply, reduce demand, and stabilize the finances of sovereign borrowers. Central banks play the lead role in sustaining this real rate compression, as they have often done in history.

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Solvency issues of European insurances

December 18, 2012

The latest ECB’s financial stability report has a short but insightful section on the position of the EU insurance sector. While financial positions according to current (Solvency I) standards seem satisfactory, the ECB fears that “a persistent low-yield environment could become a major solvency risk in the medium term”. The planned introduction of the EU’s Solvency II directive in 2014 and the related prospective marking to market of liabilities in a majority of countries could make this issue more obvious.

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On collateral chains

December 8, 2012

A new IMF paper investigates the role of shadow banks in securitization and collateral intermediation. One important forward-looking concern is the potential vulnerability of collateral chains, i.e. the use of a single security for multiple secured loan transactions.

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Functions and risks of shadow banking

December 1, 2012

Shadow banking encompasses credit intermediation outside the regulated banking system, mostly through investment funds, money market funds, structured finance vehicles, broker-dealers, and finance companies. In parallel to the classical deposit-based funding of bank intermediation, the shadow banking system establishes secured transactions-based wholesale funding of non-bank intermediation. Thereby, the role of asset managers and off-balance vehicles of banks in intermediation has greatly increased, as has the importance of asset managers as source for “collateral mining. Regulators fear that shadow banking has been conducive to excessive leverage in the economy and contributed to systemic pressure through sudden stops and asset fire sales.

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A review of euro area bank deleveraging

October 27, 2012

Since 2008, Bank delevering has been on of the key drivers of the euro areas poor economic performance and its vulnerability to recurrent financial crises. Barclays Cross Asset Research nicely summarized and discussed its main drivers, whose impact is widely seen as most intense in 2012 and maybe 2013. ECB and IMF research suggests that the deleveraging is ongoing and could eventually reach an equivalent of 10-30% of euro area GDP.

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Consequences of euro area break-up fears

September 29, 2012

A very interesting Banca d’Italia study shows how euro area break-up expectations are becoming self-reinforcing, i.e. precipitating a divergence of sovereign yields and financial conditions beyond what is consistent with sovereign credit fundamentals.

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A review of euro area rescue funds

May 1, 2012

The European Financial Stability Facility (EFSF) and its permanent replacement, the European Stabilization Mechanism (ESM) haven proved less effective than the ECB in quelling crisis dynamics. However, the funds are large in size and will play major role in the euro area’s institutional response to crisis pressue.

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