Behind an Estimated $30 Trillion Drain on Banks, a Lot of Hypotheticals

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The New York Times
Tuesday, October 30, 2012

Behind an Estimated $30 Trillion Drain on Banks, a Lot of Hypotheticals

By PETER EAVIS

Imagine a situation in which the world's banks have to find as much as $30 trillion to comply with just one new regulation. That might be something of a stretch, given that the gross domestic product of the United States is only $15.8 trillion, and the world's 10 largest banks hold only $25 trillion of assets.

Yet a banking industry group recently looked into a new rule and sketched out a possibility in which banks were forced to come up with as much as $30 trillion in cash.

The potential cash call is outlined in a letter the International Swaps and Derivatives Association sent in September to regulators. It is the latest eye-popping number that lobbying firms and banks have produced to support their view that many new regulations will be enormously expensive - and the big, scary numbers seem to be gaining traction.

Some of the concern may be warranted, especially in Europe, where certain stressed banks have had trouble borrowing regular amounts in the markets. But a deeper look at the industry association's $30 trillion figure suggests that many of the worries might be overdone.

The gargantuan sum relates to the market for derivatives, which are financial contracts that banks and investors use to bet on interest rates, stock prices, creditworthiness of corporations and the like.

Derivatives played a central role in the 2008 financial crisis. The market for many contracts was opaque, which stoked panic when certain players started to falter.

Before the financial crisis, big participants like large Wall Street banks were often able to avoid following certain rules intended to make the market safer. One of those practices involves something called initial margin. This is the cash or easy-to-sell assets that parties have to set aside at the outset of a derivatives trade. If one side can't pay up, the other side can make a claim on the initial margin.

Now, regulators want to tighten up the margin rules. To do so, they are introducing regulations aimed at pushing derivatives trades through entities called central clearinghouses. These organizations effectively agree to pay out if one side of the original trade cannot pay.

Because of that pledge, clearinghouses have to make sure they can pay out if one party defaults. One way they do this is to demand margin from the parties that trade through them.

But a large number of derivatives trades won't necessarily go through clearinghouses, even after the overhaul is in place. Such trades will still be done directly between two financial firms.

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