BIS: the role of margin requirements and haircuts in procyclicality
25 March 2010
The report recommends several enhancements to haircut-setting and margining practices in order to slow the build-up of leverage in good times and soften the system-wide effects during a market downturn.
During the recent crisis a number of procyclical behaviours in markets amplified financial system stress. The 2009 Committee on the Global Financial System (CGFS) report on The role of valuation and leverage in procyclicality identified haircut-setting in securities financing transactions and margining practices in over-the-counter (OTC) derivatives as one source of procyclicality. The report recommended exploring whether minimum haircuts or minimum initial margins help to reduce procyclicality.
In view of this recommendation, the CGFS asked a study group, chaired by David Longworth (Bank of Canada), to review haircut-setting and margining practices in securities financing transactions and OTC derivatives markets, and to explore various options for reducing their procyclical effects on financial markets. The report recommends several enhancements to haircut-setting and margining practices to dampen the build-up of leverage in good times and soften the system-wide effects during a market downturn. It also recommends that macro-prudential authorities consider measures that involve countercyclical variations in margins and haircuts.
The report takes a system-wide perspective, which complements other initiatives on margining practices directed at strengthening the resilience of individual institutions. I hope that this report will inform policy deliberations on how to reduce financial system procyclicality.
© BIS - Bank for International Settlements
