Following the U.S. Treasury's announcement last week requiring the world's banks to maintain stronger capital and liquidity standards by the end of next year to prevent a re-run of the global financial crisis, 15 large banks that control the majority of derivative trading worldwide have committed themselves to maintaining greater transparency in a $600 trillion market that needs stricter oversight in the interest of the global financial system.
As part of a series of voluntary steps by the banks to expand the use of clearing houses for the over-the-counter market in derivatives, the international banking group on Tuesday made the commitment for targets in expanded central clearing systems to the Federal Reserve Bank of New York.
Bank of America Corporation (
BAC), Citigroup Inc. (
C), Deutsche Bank AG (
DB),
Goldman Sachs Group Inc. (
GS) and
JPMorgan Chase (
JPM) were included in the banking group.
The derivatives are designed to reduce the risk of loss from an underlying asset. The value of a derivative is derived from an underlying investment or commodity, such as currency rates, oil futures or interest rates.
The Congress is considering setting up a new network of clearing houses to provide transparency for trades by focusing on the banks trading in derivatives to adhere to new capital requirements and other rules.
The new clearing houses will hopefully help regulators monitor a broader set of derivative market data easily. This will also help reduce the systemic risk profile significantly.
The Securities and Exchange Commission and the Commodity Futures Trading Commission have already started implementing their rules to eliminate differences for derivatives and other investments.
Credit default swaps account for an estimated $60 trillion of the global derivatives market. The rapid collapse of the swaps was primarily responsible for the downfall of Lehman Brothers and significantly affected
American International Group (
AIG).
The U.S. government was forced to pass a $700 billion package through the Troubled Asset Relief Program (TARP) last year to rescue the struggling institutions, which was facing massive losses due to the subprime crisis and housing collapse.
We think the new move along with stronger supervision will somewhat limit the profitability of the financial institutions, but would bring stability to the overall sector.
