So is credit an issue?
In its March quarterly review, the Bank for International Settlements discusses the impact of the credit crunch. One section focuses on the turbulence on dollar, sterling, euro and yen swaps.
BIS points out that credit concerns played a role in the market drying up. “An important aspect of the turbulence was a shortage of dollar funding for many financial institutions: frequently reported were efforts by European financial institutions to secure dollar funds to support US conduits for which they had committed backup liquidity facilities. At the same time, the usual suppliers of dollar funds to the inter-bank market were looking to conserve their liquidity, due to their own growing needs and increased concerns over counterparty credit risk,” it says.
Later, the bank adds: “While transaction costs and political risk are largely negligible in today’s G10 currency markets, credit/counterparty risk may have increased significantly in the second half of 2007.” The emergence of concerns over counterparty credit seemingly strengthens the argument for using a central clearer.
However, BIS also points out that volumes in exchange-traded, short-term interest rate products fell significantly during Q4 2007. This may suggest that the main issue was not so much one of credit, but rather a lack of knowledge of where the market was. Perhaps that only strengthens the argument for using a central clearer, at least in swaps.