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Counterparty Risk And Potential Losses From Otc Derivatives

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by Zubin Jelveh
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Nov 20 2008 4:27pm EDT

Counterparty Risk and Potential Losses from OTC Derivatives

In February, Barlcays estimated that if one major institution went down, there would most likely be between $36-$47 billion in losses due to counterparty risk in the credit default swap market as risk was repriced. A similar CDS study by BNP Paribas put the figure at $150 billion in potential losses.

But the repricing of risk extends just beyond the CDS market, IMF economists Miguel A. Segoviano and Manmohan Singh argue in a new working paper. Using data on banks' counterparty positions before the Bear Stearns collapse, the pair calculate the potential loss to the financial system from a repricing of risk across the entire OTC derivatives market:

in the case of a single institution failure, the total loss could be as high as $300-$400 billion depending on the [institution]; but when cascade effects are taken into account, the total loss could rise to over $1,500 billion.
And that's just the potential losses from the derivatives and not the underlying assets. The IMF said in October it expects banks around the world to need $675 billion in order to recapitalize.

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