Central Counterparty Capitalization and Misaligned Incentives

61 Pages Posted: 13 Feb 2019

See all articles by Wenqian Huang

Wenqian Huang

Bank for International Settlements

Multiple version iconThere are 2 versions of this paper

Date Written: February 7, 2019

Abstract

Financial stability depends on the effective regulation of central counterparties (CCPs), which must take account of the incentives that drive CCP behavior. This paper studies the incentives of a for-profit CCP with limited liability. It faces a trade-off between fee income and counterparty credit risk. A better-capitalized CCP sets a higher collateral requirement to reduce potential default losses, even though it forgoes fee income by deterring potential traders. I show empirically that a 1% increase in CCP capital is associated with a 0.6% increase in required collateral. Limited liability, however, creates a wedge between its capital and collateral policy and the socially optimal solution to this trade-off. The optimal capital requirements should account for clearing fees.

Keywords: Central counterparties (CCPs), capital requirement, financial stability

JEL Classification: G01, G12, G21, G22

Suggested Citation

Huang, Wenqian, Central Counterparty Capitalization and Misaligned Incentives (February 7, 2019). BIS Working Paper No. 767, Available at SSRN: https://ssrn.com/abstract=3332852

Wenqian Huang (Contact Author)

Bank for International Settlements ( email )

Centralbahnplatz 2
Basel, Basel-Stadt 4002
Switzerland

HOME PAGE: http://wenqianhuang.org

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