Gerardo Ferrara


October 21st 2019

Time: 1.00 - 2.00pm Venue: Room 3.21, Old Building, LSE (map)
Speaker: Gerardo Ferrara (Bank of England)
Seminar Title: Stimulating liquidity stress in the derivatives market

Abstract: We investigate whether margin calls between derivative counterparties could strain their ability to pay and thereby spread liquidity stress through the market. Using trade repository data on derivative portfolios, we simulate variation margin calls in a stress scenario and compare these with the liquid-asset buffers of the institutions facing the calls. Where buffers are insufficient to meet margin calls we assume institutions borrow additional liquidity to cover the shortfalls, but only at the last moment when payment is due. Such delays can force recipients to borrow more than otherwise. Thus, liquidity strains can grow in aggregate as they spread through the network. Nevertheless, we find an aggregate liquidity shortfall equivalent to only a modest proportion of average daily cash borrowing in international repo markets. We also find that only a small part of this aggregate shortfall could be avoided if payments were coordinated centrally. These results are scenario specific, but our methodology could be applied to various scenarios on a regular basis to investigate whether margin calls could generate systemic liquidity strains. If that were the case, additional liquidity requirements targeted at institutions that would spread most liquidity stress could reduce potential liquidity shortfalls efficiently. Changes to the infrastructure of margin payments could also reduce potential liquidity shortfalls. We show how our toolkit can quantify the effects of such policies.