Central counterparty capitalization and misaligned incentives

Wenqian Huang

No 767, BIS Working Papers from Bank for International Settlements

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 (search for similar items in EconPapers)
JEL-codes: G01 G12 G21 G22 (search for similar items in EconPapers)
Pages: 61 pages
Date: 2019-02
New Economics Papers: this item is included in nep-ban and nep-cba
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (22)

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