SAG_Twitter_MEME_Collateral_Managementt_Nov16.jpgDealers with a blurry vision of their risk exposure are slowly coming undone. 

Internal clients want to know why there is a need for outsized capital buffers to balance out inadequately granular analysis. External clients see costs rising as a consequence of inefficient capital and collateral management. Regulators are dissatisfied with stress tests that show a paucity of good data at major banks.

The reason for the uncertainty is clear; banks are built from lots of business lines and from parts of banks that have merged. Only recently has the single view of risk become an imperative, as the cost of carrying risk has gone up. The legacy, fragmented view of risk has been challenged by a top-down imposition of standardized models. If you are holding risk on the books, you need more capital or collateral to balance it. Several regulations overlap to impose this situation.

Let us take the example of derivatives trading. Most trades for over-the counter derivatives are mandated to be centrally cleared under Dodd-Frank in the US, the European Market Infrastructure Regulation, and Japan’s Financial Instruments and Exchange Act as of 2010. Any trades not cleared are subject to specific margin rules under the Basel Committee on Banking Supervision’s and higher capital charges for the banks involved under the Basel III capital adequacy rules.

The standard initial margin model (SIMM) developed to help counterparties reach an agreement on margin for uncleared trades has taken some of the pain out of the process. Nevertheless the costs associated with these parts of the trading lifecycle are higher than they need to be.

Lacking a single view of risk and collateral means that big events – such as Brexit, a flash crash, a credit event – leave the bank to take a worst-case scenario figure, add to it, then borrow collateral to cover that exaggerated risk position. The costs for borrowing overnight are high, the likelihood of good collateral going tight on repo is high during a market event and liquidity risk is heightened.

Knowing the firm’s overall risk position would considerably reduce the strain. Knowing what eligible collateral is available and how it was committed would also reduce costs substantially. These figures are known for individual desks and the asset classes they work; in some cases cross-asset desks have pulled some of that data together.

To get an enterprise-wide view, the data that sits at the desk level needs be put into a consumable data layer that can normalize it and work with it. The appetite to "rip and replace" huge legacy systems is long gone. Now the ability to transform in the minimum timeframe  is critical, this can now be achieved by utilising real-time, decisioning platforms with In-memory capability.

In the most severe situations, those banks that cannot meet their obligations under the Comprehensive Capital Analysis and Review in the US – or even the European Banking Authority’s stress tests, which have been criticized by academics for being less rigorous – will find their licences under threat. A more optimistic scenario sees firms without an enterprise-wide view facing higher costs and ultimately becoming uncompetitive.

Clearing your vision to avoid these scenarios will depend on banks making enterprise-level technology investments that support enterprise-level risk and collateral analysis. Given the threat that exists, those investments are increasing.


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