Counterparty Risk Evolution

2 min read

Counterparty risk associated with financial institutions seems to be the hot topic lately. From San Francisco to Miami, treasury conference attendees were discussing the issue and the conferences devoted working sessions to the topic. We believe that this is not a passing fad; rather, counterparty risk in one’s enterprise needs to be addressed and managed and now is the time to start the process.
Recent trends in the banking industry have refocused this issue for many treasurers as consolidation in the sector has increased concentration risk and a downward shift in bank ratings has increased overall credit risk. The first step in assessing and managing counterparty risk is to identify one’s exposures. Once this has been accomplished, an assessment of the overall exposure level allows one to target a constant or improving risk profile as counterparties are swapped out or added. One trend challenging this process is an increasing level of counterparty concentration due to consolidation in the banking sector. For the past two decades, we’ve seen the number of bank mergers grow substantially and this consolidation has affected the risk profile for many corporate treasurers. Exposures that were thought to be diversified have become less so as repetitive positions in money funds, deposits, foreign exchange, LOCs and other banking relationships are becoming increasingly common. Along with increased concentration risk, underlying credit strength in the largest financial institutions has deteriorated dramatically since 2008, which has caused overall bank ratings to migrate significantly lower. Both of these trends have elevated counterparty risk for most enterprises.

The challenge we find most intriguing occurs after one collects and isolates their financial exposures. Determining overall risk as one considers adding or increasing counterparties can be a challenge. Understanding that counterparty risk is continuously changing, one goal is to calibrate existing risk and adjust exposures as needed by actively managing one’s counterparty relationships. This allows one to rationalize new exposures in the context of improving one’s overall risk profile. The key to accomplishing this challenge is to understand how the counterparty environment has changed. To begin the discussion, this month we offer research that aims to frame the backdrop of the increasing risks in the banking sector and how they impact overall counterparty risk.

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Best Regards,

Ben Campbell
President & CEO

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