Collateral Scarcity a growing concern!


With the new regulations, Basel 3, EMIR, Dodd-Frank, etc. all require more and more collateral of high-quality assets, higher haircut margins for some instruments. Increased collateral requirement in the market means greater safety against default to maintain stability. However,   the growing demand for high-quality collateral is creating a destabilizing factor as the intermediaries have limited supply of collateral like the T-bills and Treasury MMF’s creating “Collateral scarcity”, which gets worse in the stressed market conditions leading to margin calls, customer unwinding the positions and a large number of margin disputes.

Collateral scarcity for $700 trillion in OTC derivatives market – TABB Group report

Just like in the yellow monster in the Pac-Man game is how I look at the financial regulator, eating the high-quality collateral in the market, smaller banks, broker/dealers, buy-side firms, etc. are getting lesser in number day by day due to large collateral requirements in the global financial markets.

PACMAN

The regulators around the world have been working very hard to strengthen policies to stabilize the global financial system and prevent future crises like 2008. To do so, there’s an increasing pressure from the regulators to increase the liquidity ratios and the minimum capital requirement for the banks. All the banks have lobbied hard to keep that number down, Basel committee also trying to find the aftermath of increased capital requirement from Basel 2 to Basel 3. A large number of small banks, broker-dealers have either shut down their shops or have been acquired by larger banks making the financial ecosystem a lot more unstable as it gives rise to the concentration risk.

The question of how to exercise regulatory control over the banks and intermediaries which favors larger population.

The overall demand is going to grow faster than the supply of collateral is is expected by increase, few of the reasons are

  • As the number of securities that qualify for collateral is decreasing.
  • Some collateral holders will keep a collateral buffer to mitigate settlement delays, buffers more than specific requirements, reduce collateral supply.
  • With new OTC derivate regulations, higher margin requirement for Non-CCP cleared transactions.

For example, currently Eurozone is facing a stressed market condition, with Greece going down, Spain and Italy following the same lines, German banks beeing leveraged more than 28 times their net capital holdings. The reason is the demand & supply imbalance of Euro-bonds or similar securities, which is leading to increased funding cost, the rise in the price of the collaterals. At the same time, say larger German banks have greater access to these high-quality collaterals creating a zone of inequality in the financial marketplace.

The regulators should closely follow and respond to market developments and need to come up new financial innovations, and accept similar credit rating instruments to be used as collateral.

#Regulations, #BaselIII, #EMIR,#DoddFrank, #CollateralManagement

ECB on Collateral

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