Researchers outline risk of collateral collapse
- Thread starter seidu
- Start date
Thanks @seidu but this is paywall protected-yes? I tried to find at http://www.bankofengland.co.uk but the research does not appear to be published yet ...
seidu
Member
@David Harper CFA FRM I don't know why this stuff works for me without any demand for payments and otherwise for people.
See below the article:
BoE researchers outline risk of collateral collapse
In stress periods, collateral chains could break, paper warns
BoE: high-quality collateral could become stretched during times of stress
Future bouts of market stress will cause demand for high-quality collateral to spike while simultaneously limiting its supply, pushing financial markets deeper into crisis, according to research by three Bank of England economists.
The research – to be published in the Journal of Financial Market Infrastructure in September – ties this pro-cyclical risk in part to incoming rules requiring collateralisation of non-cleared derivatives trades. The authors call for regulators to be careful when issuing rules that affect collateral demand.
Yuliya Baranova, Zijun Liu and Joseph Noss predict that in a future period of stress – like that seen in late 2008 – the supply of collateral could be suddenly interrupted. This short-term imbalance between supply and demand would eventually resolve itself as the returns available to collateral lenders climb, but could be accompanied by a more damaging breakdown in the network of intermediaries on which collateral posting relies.
In total, the financial system contains around $42 trillion in high-quality collateral, the research estimates – primarily in the form of high-rated mortgage-backed securities, government debt and supranational bonds – but only $9.5 trillion is available to satisfy a jump in demand. The rest is already tied up by liquid asset buffers, initial margin, and default fund contributions among other needs.
The incoming non-cleared margining framework is set to reduce this further, the researchers estimate, to $8.5 trillion. Of this total, far less is available for loan – just $2.2 trillion from owners and $0.8 trillion from dealers.
Collateral demand – and the danger of collateral shortages – has been a key focus for lobbyists, regulators and researchers since 2009, when the G20 nations mandated the use of central clearing for standardised over-the-counter derivatives, and Basel III introduced liquidity buffer requirements internationally for the first time.
Motives, and conclusions, have been mixed. In 2012, the International Swaps and Derivatives Association estimated that bilateral margin requirements alone would consume up to $29.9 trillion of initial margin. Later that year, the BoE's head of payments and infrastructure conceded regulation would create increased demand for collateral, but argued increased supply would mitigate the risk of a shortage.
In 2015, regulatory standard-setters for securities markets joined forces with banks and insurers to carry out a survey of market participants. They warned of growing collateral demands and called on officials to take "appropriate steps to promote the monitoring and evaluation of the availability of such collateral".
Baranova, Liu and Ross attempt to move the debate on by looking at the impact of market stress on collateral demand and supply. At present, the $1.6 trillion demand for collateral is still less than the supply. But historical experience suggests an increase in counterparty risk – measured in the research by the price of credit default swaps on dealers – leads asset owners to reduce their supply of available-for-loan securities. Market stress also simultaneously increases demand for collateral in initial margin payments and liquidity buffers as market volatility increases, reflected by the Vix index in the research.
The authors predict the supply of collateral will run out, assuming central banks do not intervene by issuing more debt, when the Vix rises above 44 for sustained periods of around three months; it did so in late 2008, but at no other time since records began in the 1980s. On August 10, the Vix opened at 11.55. Its highest level in the past year was just above 28 points in August 2015.
An added danger is that dealers will become less willing to act as intermediaries: falling and volatile asset prices will lead them to reduce their leverage, and thus their ability to pass collateral from suppliers to users, in chains that typically have an average of 3.9 intermediate members. (Future work will address whether these chains tend to shorten or lengthen in times of stress, changing the demand for intermediation capacity, Liu says.)
At Vix levels of around 46, the authors forecast there will no longer be enough intermediation capacity to meet collateral demand – with serious knock-on effects including interruptions in the derivatives markets, a drought of funding for leveraged investment activity, and damage to the secondary markets in other securities.
The researchers warn these estimates are highly uncertain, especially in light of recent regulatory changes – in particular, higher collateral requirements would push the Vix threshold at which the effects begin considerably lower than 44 and 46 – and they call on regulators to use similar analysis before introducing more reforms that could push the trigger threshold lower still.
See below the article:
BoE researchers outline risk of collateral collapse
In stress periods, collateral chains could break, paper warns
BoE: high-quality collateral could become stretched during times of stress
Future bouts of market stress will cause demand for high-quality collateral to spike while simultaneously limiting its supply, pushing financial markets deeper into crisis, according to research by three Bank of England economists.
The research – to be published in the Journal of Financial Market Infrastructure in September – ties this pro-cyclical risk in part to incoming rules requiring collateralisation of non-cleared derivatives trades. The authors call for regulators to be careful when issuing rules that affect collateral demand.
Yuliya Baranova, Zijun Liu and Joseph Noss predict that in a future period of stress – like that seen in late 2008 – the supply of collateral could be suddenly interrupted. This short-term imbalance between supply and demand would eventually resolve itself as the returns available to collateral lenders climb, but could be accompanied by a more damaging breakdown in the network of intermediaries on which collateral posting relies.
In total, the financial system contains around $42 trillion in high-quality collateral, the research estimates – primarily in the form of high-rated mortgage-backed securities, government debt and supranational bonds – but only $9.5 trillion is available to satisfy a jump in demand. The rest is already tied up by liquid asset buffers, initial margin, and default fund contributions among other needs.
The incoming non-cleared margining framework is set to reduce this further, the researchers estimate, to $8.5 trillion. Of this total, far less is available for loan – just $2.2 trillion from owners and $0.8 trillion from dealers.
Collateral demand – and the danger of collateral shortages – has been a key focus for lobbyists, regulators and researchers since 2009, when the G20 nations mandated the use of central clearing for standardised over-the-counter derivatives, and Basel III introduced liquidity buffer requirements internationally for the first time.
Motives, and conclusions, have been mixed. In 2012, the International Swaps and Derivatives Association estimated that bilateral margin requirements alone would consume up to $29.9 trillion of initial margin. Later that year, the BoE's head of payments and infrastructure conceded regulation would create increased demand for collateral, but argued increased supply would mitigate the risk of a shortage.
In 2015, regulatory standard-setters for securities markets joined forces with banks and insurers to carry out a survey of market participants. They warned of growing collateral demands and called on officials to take "appropriate steps to promote the monitoring and evaluation of the availability of such collateral".
Baranova, Liu and Ross attempt to move the debate on by looking at the impact of market stress on collateral demand and supply. At present, the $1.6 trillion demand for collateral is still less than the supply. But historical experience suggests an increase in counterparty risk – measured in the research by the price of credit default swaps on dealers – leads asset owners to reduce their supply of available-for-loan securities. Market stress also simultaneously increases demand for collateral in initial margin payments and liquidity buffers as market volatility increases, reflected by the Vix index in the research.
The authors predict the supply of collateral will run out, assuming central banks do not intervene by issuing more debt, when the Vix rises above 44 for sustained periods of around three months; it did so in late 2008, but at no other time since records began in the 1980s. On August 10, the Vix opened at 11.55. Its highest level in the past year was just above 28 points in August 2015.
An added danger is that dealers will become less willing to act as intermediaries: falling and volatile asset prices will lead them to reduce their leverage, and thus their ability to pass collateral from suppliers to users, in chains that typically have an average of 3.9 intermediate members. (Future work will address whether these chains tend to shorten or lengthen in times of stress, changing the demand for intermediation capacity, Liu says.)
At Vix levels of around 46, the authors forecast there will no longer be enough intermediation capacity to meet collateral demand – with serious knock-on effects including interruptions in the derivatives markets, a drought of funding for leveraged investment activity, and damage to the secondary markets in other securities.
The researchers warn these estimates are highly uncertain, especially in light of recent regulatory changes – in particular, higher collateral requirements would push the Vix threshold at which the effects begin considerably lower than 44 and 46 – and they call on regulators to use similar analysis before introducing more reforms that could push the trigger threshold lower still.
Dr. Jayanthi Sankaran
Well-Known Member
Hi @seidu,
Unfortunately, I am also unable to access the articles on Risk.net, without subscribing! Thanks a lot
Unfortunately, I am also unable to access the articles on Risk.net, without subscribing! Thanks a lot
Hi @seidu, I think you havr signed up for 7 day trial subscription so you can read it otherwise it is paid.
Thank you
Thank you
Hi @David Harper CFA FRM, I have question in mind regarding collateral. Bitcoin is becoming famous, as on 2015 100,000 stores are using bitcoin. But do you think it will be possible to use bitcoin as a collateral? I have seen way to much volatility in bitcoin price. How will bitcoin will impact on market as collateral? There will be many downside using a bitcoin as collateral but what are they? And importantly is bitcoin can become a financial threat to market? Please share your views.
Thank you!
Thank you
!
Dr. Jayanthi Sankaran
Well-Known Member
Hi Deepak,
Here is a link regarding the possible use of bitcoin as collateral:
http://articles.bplans.com/lenders-face-serious-issues-taking-bitcoins-collateral/
If you google, there are a lot of interesting debates about this - also, there are a lot of regulatory issues, under bankruptcy, since bitcoin is an intangible asset. Since it is not physical money, the lender has to have access to the bitcoin owner's wallet and password.
Hope that helps!
Here is a link regarding the possible use of bitcoin as collateral:
http://articles.bplans.com/lenders-face-serious-issues-taking-bitcoins-collateral/
If you google, there are a lot of interesting debates about this - also, there are a lot of regulatory issues, under bankruptcy, since bitcoin is an intangible asset. Since it is not physical money, the lender has to have access to the bitcoin owner's wallet and password.
Hope that helps!
Thank you so much @Dr. Jayanthi Sankaran that is a great article! Thank you for ssharing!
!Similar threads
