The Design of Market Risk Management Applied to Collateral

Abstract

importance of collateral management in market operations. This development stems, on the one hand, from increased risk aversion among financial market participants and, on the other hand, from regulatory incentives.

Collateral management involves the implementation of a haircut mechanism to assess market-related risks. This haircut is considered an essential precautionary tool for protecting against collateral-related risks.

Treasury bonds can serve as collateral to protect against the risk of bank default. In adverse scenarios, these Treasury bonds are sold and exchanged by central banks in the money market. Their price in this market can fluctuate significantly compared to their issuance price, leading to a possible decline in the value of sovereign assets. In this context, central banks are exposed to market risk.

To safeguard against this risk, some central banks apply a uniform haircut rate to protect against potential market risks. However, this haircut rate may not accurately reflect the appropriate level.

Therefore, our objective is to propose avenues for improving the determination of the haircut by a central bank positioned in Africa. To achieve this, we adopt a quantitative approach that will estimate this haircut based on each maturity and tranche. Our study relies on a database covering the period from 2006 to 2015, including yield rates of Treasury bonds for various maturities. We will also utilize risk management tools, particularly those dedicated to bonds, to support our analysis.

The results of this study revealed that th aforementioned bank has established a haircut rate that only applies to long-term maturities. Therefore, it is essential for the central bank to reassess the established haircut rate and establish specific haircuts for each residual maturity.

Keywords: Collateral, Haircut, Treasury Bonds, Central Bank, Commercial Banks.

JEL Classification: M21

Paper type: Empirical Research