10:29 pm - Monday December 18, 2017

Collateral management – Latest Developments

Collateral management is no more a back office function.

Thanks to the recent crises in financial markets, it has graduated itself to a core function status driving the very front office function.

Gone are the days of cost centre approach to collateral business. This function is now looked upon more as a profit centre. The focus of collateral business has therefore become more effective and profitable.

The new age has its own demands – greater accountability, transparency and automation, more diversification, risk reduction and finally cross product exposure management.

Yes. Your assumptions are right. Regulatory changes, ever expanding collateralized markets and products, ever changing counterparty profile and settlement scenario / environment / landscape fragmentation have contributed to these demands.

In addition, traditional mindsets, inadequacies in infrastructure support, differing regulatory prescriptions across borders and wild fluctuations in the underlying asset prices drive and disturb the financial institutions from their comfort zones.

What is the way forward then to overcome these challenges and make this business more effective and profitable?

  •  Top priority to collateral data quality
  •  Enhanced capability to capital adequacy calculations
  •  Efficient collateral registration process
  •  Real time collateral information update
  •  Statistical analysis and study of collateral data
  •  Flexible and efficient IT infrastructure support
  •  Total compliance with regulatory prescriptions
  •  Streamlined systems, processes and controls
  •  Appropriate and new credit risk and valuation models
  •  Improvements in operational efficiency
  •  Reconciliation and audit at periodical intervals
  •  Harmonization of procedures for domestic and cross border collaterals
  •  Pooling of collateral provided by entities in a group
  •  Straight Through Processing
  •  Dedicated Collateral clearing house
  •  Golden copy?

What are the various risks that may strike collateral business in any type of financial institution and at any time?

  •  Concentration risk
  •  Market risk
  •  Settlement risk
  •  Legal risk
  •  Correlation risk
  •  Procedural risk
  •  Perfection risk
  •  Local risks
  •  Agreement enforcement risk
  •  Third party risk

May be a structured approach to collateral business – transaction management, collateral management and customer management – will alone save the financial institutions from any of these risks and resultant bad publicity and business losses.

The following responses to certain important requirements to facilitate collateral management in the new era reveal our present levels of preparedness.

  •  Do we have proactive exposure modeling techniques in place? – No
  •  Are we enabled with advanced reconciliation support? – No
  •  Do we have in place perfect disputes resolution mechanisms? – No. Not fully.
  •  Have we arrived at a satisfactory operational risk management framework? –No
  •  Have we perfected real time straight through processing of margin calls? – No
  •  Have we perfected the art of asset optimization in available collateral pool? – No
  •  Do we practice periodic stress testing to arrive at maximum possible exposures? – No
  •  Where are we now with respect to spreading and diversifying collateral risks? – Not satisfactory and not fully protected
  • Have we perfected acceptance of cross border collaterals and agreements? – We still prefer and practice a localized approach
  • Have we graduated to a level of competency and mastery in merging and managing banking books and trading books together to optimize operations? – No industry wide approach and competency

Therefore the new age of collateral management will need a complete revamp of the extant functional model (architecture) to start with.

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