Central Clearing and Systemic Liquidity Risk

By stepping between bilateral counterparties, central counterparties (CCPs) transform credit exposure, thereby improving financial stability. But, large CCPs are concentrated and interconnected with major global banks. Moreover, although they mitigate credit risk, CCPs create liquidity risks, becaus...

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Bibliographic Details
Published in:Finance and economics discussion series 2022-05, Vol.2020 (9r1), p.1-46
Main Authors: King, Thomas B., Nesmith, Travis D., Paulson, Anna, Prono, Todd
Format: Article
Language:English
Online Access:Get full text
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Summary:By stepping between bilateral counterparties, central counterparties (CCPs) transform credit exposure, thereby improving financial stability. But, large CCPs are concentrated and interconnected with major global banks. Moreover, although they mitigate credit risk, CCPs create liquidity risks, because they require participants to provide cash. Such requirements increase with market volatility; consequently, CCP liquidity needs are inherently procyclical. This procyclicality makes it more challenging to assess CCPs’ 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.
ISSN:1936-2854
2767-3898
DOI:10.17016/FEDS.2020.009r1