Central banks fear growing risk from increasing use of collateral

 
Tim Wallace
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THE INCREASED use of collateral in the interbank loan markets could build up risks as the practice encumbers loans and ties up assets away from senior creditors, the Bank of International Settlements (BIS) warned yesterday.

The practice has re-opened credit markets to banks which struggled to convince other lenders of their creditworthiness, by offering up packages of loans as collateral. But as a result more assets are tied up with specific loans and cannot be used to support either depositors or senior creditors if the bank fails.

Regulations alone have added $4 trillion to demand for collateral, but supply has risen by $10.8 trillion since 2007 meaning there is no imminent shortage.

However the report warned that sudden increases in demand or fall in asset quality could cause a crunch in markets as eligible assets run short for brief periods – for instance when markets fear a government is in financial trouble.

The central bank body believes more transparency on collateral postings and more consideration of the practice when designing deposit protection schemes will help mitigate these risks.