Can the Financial Markets Privately Regulate Risk?: The Development of Derivatives Clearinghouses and Recent over-the-Counter Innovations

This paper explores how organization and contract design has evolved to address regulatory challenges in risk management. In the early part of the century, futures exchanges responded to credit risks by developing clearinghouses that act as guarantors. The liability structure of the clearinghouse in...

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Bibliographic Details
Published in:Journal of money, credit and banking credit and banking, 1999-08, Vol.31 (3), p.596-618
Main Author: Kroszner, Randall S.
Format: Article
Language:English
Subjects:
Bank clearings
Bank credit
Banking
Banking regulation
Capital market
Clearinghouses
Contracts
Credit ratings
Credit risk
Decentralization
Federal Reserve Bank
Financial risks
Futures contracts
Futures markets
Regulation
Risk
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Summary:This paper explores how organization and contract design has evolved to address regulatory challenges in risk management. In the early part of the century, futures exchanges responded to credit risks by developing clearinghouses that act as guarantors. The liability structure of the clearinghouse involves mutualization of risks through "partial permanent" integration of the exchange members. Bank clearinghouses historically involved "contingent" integration and risk mutualization during panics. Recent organizational innovations have allowed the risk-control benefits of the clearinghouse to be replicated in the decentralized over-the-counter derivatives markets. Credit rating agencies and advances in risk modeling are key to permitting the recent "disintegration," which has implications for the scope of public versus private regulation in banking and financial markets.
ISSN:0022-2879
1538-4616
DOI:10.2307/2601077