Tracy Alloway of the Financial Times looks at how collateral is starting to drain away from the financial system.
While many of the commentators point out that collateral is the ‘grease’ of the lending system, the reality is that the reuse of collateral is dying out. According to the article, the number of times a security used for collateral is passed around the financial system has fallen from an average of three times leading up to 2008, to under two times at the end of 2010.
GreySpark maintains that this fall in the use of collateral is down to market participants becoming more scathing about the creditworthiness of counterparties they deal with. The firm is of the opinion that people are less trusting about the use of collateral, and that many financial institutions are taking “haircuts” to manage their risk, involving clipping some of the value on assets being traded, to add a bigger safety cushion should a default occur.
The article goes on to discuss the boom in specialist collateral management services – “collateral transformation” – which is being marketed to derivatives users as a way to obtain the correct collateral for clearing.