Thursday, August 22, 2013
. . . perhaps most problematically, there is strong evidence questioning the role of changing haircuts in feeding pro-cyclicality and a serious likelihood that mandatory minimum haircuts would be circumvented by the tightening or relaxation of other credit conditions in response to increasing counterparty credit risk and vice versa.
. . . there is not sufficient data to calibrate mandatory minimum haircuts at a level which strikes an optimal balance between dampening pro-cyclicality and the build-up of excessive leverage on the one hand and maintaining the efficiency and liquidity of the market on the other.
. . . if minimum mandatory haircuts were to be adopted, it would be important to have an objective criterion for defining risky assets. Classification of securities by type and term to maturity is crude and inexact. A better measure would be the long-term volatility of price against a low-risk benchmark. Such an empirical risk-based metric would also avoid
the need to try to carve out non-procyclical, non-leveraging securities lending transactions, given that securities lending typically relies on low-risk collateral and would automatically qualify.
At least with regard to mandatory minimum haircuts, on the whole, the European Parliament appears unconvinced that the FSB proposals would be effective in curbing the pro-cyclicality caused by changes in repo and securities lending haircuts during a financial crisis. Though not exactly asking the FSB to scrap its proposals, the Europeans clearly indicate that they believe the proposals are only a first draft in need of substantial revision.