The Impact of Margin on Regulatory Capital

Michael Pykhtin

6.1 INTRODUCTION

The Basel Committee on Banking Supervision and International Organization of Securities Commissions (BCBS–IOSCO) uncleared margin requirements (UMR; often referred to in the industry as the “uncleared margin rules”), discussed in Chapter 3 of this volume, have dramatically changed the landscape of bilateral over-the-counter (OTC) derivatives trading. Banks now have to post significant amounts of initial margin (IM) when trading bilaterally with large financial institutions. The IM that a bank’s trading desks have to post results in substantial funding costs for the trading desks, known as a margin valuation adjustment (MVA). On the other hand, as discussed in great detail in Chapter 11, margin posting dramatically reduces a bank’s potential claim amount in the event of a counterparty default, known as credit exposure, leading to a reduction in the price of the counterparty risk, known as credit value adjustment (CVA). MVA, CVA and the trade-off between these two costs are discussed in Chapter 7.

The quantification of exposures and the risks associated with them can take many forms. In a capital context, one of the most widespread quantitative measures of risk

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