Central Clearing and Systemic Liquidity Risk

39 Pages Posted: 15 May 2020

See all articles by Thomas B. King

Thomas B. King

Federal Reserve Bank of Chicago

Travis D. Nesmith

Federal Reserve Board

Anna L. Paulson

Federal Reserve Bank of Chicago

Todd Prono

Federal Reserve Board

Date Written: January 31, 2020

Abstract

By stepping between bilateral counterparties, a central counterparty (CCP) transforms credit exposure. CCPs generally improve financial stability. Nevertheless, large CCPs are by nature concentrated and interconnected with major global banks. Moreover, although they mitigate credit risk, CCPs create liquidity risks, because they rely on participants to provide cash. Such requirements increase with both market volatility and default; consequently, CCP liquidity needs are inherently procyclical. This procyclicality makes it more challenging to assess CCP resilience in the rare event that one or more large financial institutions default. Liquidity-focused macroprudential stress tests could help to assess and manage this systemic liquidity risk.

Keywords: Financial systems; Central counterparties; CCPs; Margin; Liquidity risk; Systemic risk; Financial stability; Procyclicality

JEL Classification: E58; G21; G23; G28; N22

Suggested Citation

King, Thomas B. and Nesmith, Travis D. and Paulson, Anna L. and Prono, Todd, Central Clearing and Systemic Liquidity Risk (January 31, 2020). FEDS Working Paper No. 2020-009 https://doi.org/10.17016/FEDS.2020.009 , Available at SSRN: https://ssrn.com/abstract=3600407

Thomas B. King (Contact Author)

Federal Reserve Bank of Chicago ( email )

230 South LaSalle Street
Chicago, IL 60604
United States

Travis D. Nesmith

Federal Reserve Board ( email )

20th & C St. NW
Mail Stop 188
Washington, DC 20551
United States
(202) 452-2907 (Phone)
(202) 872 7533 (Fax)

HOME PAGE: http://www.federalreserve.gov/research/staff/nesmithtravisd.htm

Anna L. Paulson

Federal Reserve Bank of Chicago ( email )

230 South LaSalle Street
Chicago, IL 60604
United States
312 322 2169 (Phone)

Todd Prono

Federal Reserve Board ( email )

20th and Constitution Ave NW
Washington, DC 20551
United States

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