BoE puts banks' derivatives collateral bill at up to $800 billion

LONDON Mon Oct 1, 2012 12:39pm EDT

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LONDON (Reuters) - Banks will have to find as much as $800 billion as collateral for derivatives trading from January just as the pool of cash or bonds they can use to support these activities is shrinking, the Bank England said in a research paper on Monday.

These new requirements form part of regulations introduced after world leaders pledged at the height of the 2007-09 financial crisis to curb risks in the financial system.

The rules force banks to put money aside as "collateral" to cover potential losses on derivatives such as credit default swaps and interest rate swaps that make up this $650 trillion sector.

The UK central bank is one of the few official bodies to have tried to put a figure on the impact of the new derivatives rules. Its estimate is lower than some financial industry projections of a trillion dollars or more.

Its paper outlined how the rules will bump up the demand for high quality assets like government bonds that can be used as collateral.

But the availability of government bonds for collateral has fallen as the credit ratings on some euro zone government debt have been sharply downgraded, making them less acceptable.

On top of this, other regulatory changes, like new bank liquidity requirements and capital rules for insurers known as Solvency II will also push up demand for collateral.

As a result, banks will have to pick and choose their activities much more than they did in the past and lending could suffer.

But the Bank of England also said the impact of the collateral rules for derivatives would generally be felt over time as only new trades would be affected.

Also, the demand for collateral may not be so heavy as banks may respond by cutting back on derivatives trading.

In certain derivatives markets, though, the impact of the new rules could kick in more quickly.

"The impact in the interest rate swap market is expected to be relatively more rapid as a significant portion of notional outstanding is made up of contracts with short maturity, that is less than one year," the Bank's paper said.

(Reporting by Huw Jones. Editing by Jane Merriman)

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