Credit mitigation techniques such as netting and collateralisation are significantly reducing the exposure of US banks, according to a new report from the International Swaps and Derivatives Association (ISDA).
"The Office of the Comptroller of the Currency (OCC) reports and ISDA's analysis demonstrate that the credit risk losses and exposure of US banks related to derivatives are quite manageable," said Conrad Voldstad, ISDA chief executive officer. "It's also clear that a renewed focus on robust risk management practices - including netting, collateralisation, clearing and portfolio compression - is helping to increase the safety and efficiency of OTC derivatives markets."
After netting, exposure of the US banking system is 14 basis points of the $244 trillion of notionals outstanding. Collateralisation further reduces this to $107 billion, or four basis points, but only considered liquid collateral, mostly cash and securities.
Of this, $79 billion is exposure to corporations and another $10 billion is exposure to sovereigns. In all, the $107 billion of uncollateralised exposure represents less than one per cent of the US banking industry's assets.
Less than one-third of this amount - or approximately $30 billion - is with entities covered by Dodd-Frank requirements on margining and clearing. Among other rules, The Dodd-Frank Act imposes clearing and trade execution requirements for standardised OTC derivative products. Supporters say the Act will increase transparency and reduce systemic risk as a result of counterparty defaults.
In terms of losses to US banks on OTC derivatives products due to counterparty defaults, OCC figures show a total of less than $2.7 billion since 2007.
During this time, over 350 banks with assets of more than $600 billion failed, Fannie Mae and Freddie Mac failed and Lehman Brothers collapsed.
