BIS Releases Central Counterparty Risk Weighting Consultation

The Banking Subcommittee of the Bank for International Settlements has released a consultation paper titled Capitalisation of bank exposures to central counterparties:

Generally speaking, the Committee proposes that trade exposures to a qualifying CCP will receive a 2% risk weight. In addition, default fund exposures to a CCP will, in accordance with a risk sensitive waterfall approach (based on a CCP’s actual financial resources and hypothetical capital requirements), be capitalised according to a method that consistently and simply estimates risk arising from such default fund.

As has been discussed on PrefBlog, the purpose of Central Counterparties is to increase the vulnerability of the global financial system to single-point failure, and to provide additional extra-judicial power to bureaucrats who will be empowered to decide who gets to be a member of the Clearing Corporation.

This is considered to be far superior to a system in which the bank at risk makes a credit assessment and, when a trade is going their way, either gets collateral for the exposure or accepts an increment to Risk-Weighted Assets. Such a system would require banks such as CIBC to be as thoughtful about their counterparty exposure as Goldman Sachs; decent risk-management procedures in the industry would leave regulators with less to do.

With the new system, CIBC will be able to load up the Central Counterparty with billions in exposure to the Bank of Downtown Medicine Hat, without having to worry overmuch about its credit quality – the exposure will be covered by the other clearinghouse members.

One of the great problems with the Panic of 2007, we are told, was moral hazard. What I initially misunderstood was the regulators’ attitude: it’s not that they feel there was too much of it; they feel that there wasn’t enough, so they have designed a system to create more.

Sic transit gloria mundi.

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