OFR – Issued paper on counterparty choice and systemic risk

July 13, 2021 -Uses capital assessments and stress testing reports over the period 2013-2020, to empirically investigate how banks choose (mostly) non-bank counterparties to link to. Informs channels through which counterparty leverage can accumulate in opaque= financial markets through derivative positions of non-bank counterparties.

Paper Overview
Paper uses regulatory data to provide evidence of systemic risk-shifting in banks via their choices of nonbank counterparties in the over-the-counter derivative markets. Showed that banks prefer to establish and maintain relationships with non-bank counterparties that have a larger set of connections with other banks and are already heavily exposed to those banks, leading to a more densely connected network. Banks in densely connected networks are more likely to connect with riskier counterparties for most material exposures and effects strongest in the case of non-bank counterparties. These findings suggest moral hazard behavior in counterparty choices. Exposures are strongly linked to systemic risk; results suggest a network formation process that amplifies risk propagation via non-bank linkages in opaque financial markets. A more densely connected network provides the benefit of co-insurance in the case of a shock but also the cost that banks will have the incentive to take on greater risk.

For more information, visit www.financialresearch.gov.

Discover More Regulatory Insights

Visit the AxiomSL resource center for recent Regulatory Changes for financial institutions, InsideView Blog, and Thought Leadership.



We use cookies in order to give you the best possible experience on our website. By continuing to use this site, you agree to our use of cookies.
Accept