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” s patti kosher marketplace. Here today to talk about counterparty risk reason because that is is at the heart of what is going on in europe right now and it at the heart of what s roiling. The markets in europe and asia and in the us and giving us all a bit of a problem. So what exactly is counterparty risk.
Let s get up on the board here counter party risk. Okay. Now counterparty risk right. Now involves basically the bank s it s all about the banks.
But in order to explain this let s simple prosaic perhaps. Yeah. Let s have a bunch of school kids okay so here s a here s alan alright. A good lad and here s his friend.
John. Okay. John. John yes.
John likes her sweets. Okay. And he he likes to eat. That s through two things of sweets basically.
He likes to eat sweets every single day..
And if he doesn t eat them. He gets a you know he gets a bit agitated. But yo selects. He s a bit of a hoarder he hoards the sweets or so and you know he wasn t physically a rainy day as he calls it but because of this you know john s father obviously wants to make sure that his son doesn t you know swell up to a great size.
So it kind of restricts his the money that he gives him a little bit so it means that john is constantly running into this what we were essentially called and finance liquidity issues. Okay hasn t got enough money to buy all the sweets that he needs so when that happens. What he does is he goes to his friend alan all right so here s john situation. He s got this big big bank bag of sweets that he keeps so it keeps them underneath his bed and alan s always saying.
Why don t you eat those sweets and toss a cactus that s my store as my speak secret supply. But i still need money to to buy more sweets sounds like alright how much do you need. It s just 10. So i was like okay.
Yeah. Oh. I ll give you 10 to buy your sweets. But here s what i want you to do i want you to put these sweets up your reserve sweets.
I want you to put them up. That s kind of like it in an escrow account. So if you don t pay me back in a week. When you and me the money then i m getting those sweets back so john s like um alright.
Then so what they do is they go when they find a friend of those who can run the escrow account from them and that s julia who she is nice lady girl..
So julia says all right i ll be i ll be the escrow account. I ll hold those sweets for you while their john s borrowing that money and you know when he pays the money back. I ll give the i ll give the sweets back to john quite simple okay. That s the way it happens and so for ten bucks.
All right john hands his sweets over to julia come the end of the week. John hands back the 10 which he s got from his dad. I don t know how he managed to do it. But he managed to convince them to come up with the money and then julia returns.
The sweets back to john s very very simple that s essentially what happens in the banking business. All right you have banks that do don t just take savings and loans and some of them don t even do that they need lots of lots of money to do the business that really makes them the real money or this fee based money to do the trades to work in mergers and acquisitions to pay. These huge staff of analysts and all the rest of it all that stuff requires immediate money immediate cash. They maybe don t have on the balance sheet.
They have to keep money on the balance. You remember to keep solvent. These days because they re commercial banks and so they have to borrow that money from somewhere. So where do they go well they go to each other and there s this big money go round with are all borrowing money from each other all the time and they re always putting up this this collateral.
Which usually is securities of some kind and you know it can be pretty much anything treasury bonds regular corporate bonds mortgage bonds whatever they put up this collateral in return for the loans that they get so those banks are just like schoolboys anyway. So what s happening right. Now is that the banks are looking at each other and wondering you know whether or not their counterparties. The people that they are lending money to are actually good for it.
I mean take our school boys for example..
Say. Yeah. John s father s in the news. His company s having a few problems and it s everyday lee is on the front page of the news alan s gonna be looking at john going you know what john i m not sure whether i trust you to be able to pay me that 10 back because your dad s having some problems there.
And i don t know whether you gonna be able to get the money from him okay to give me that 10 bucks back so i m not entirely sure that i want to i want to take it and i want to you know borrow that money from you or if sorry linda that money. John said. Well what about this cloud. I ll give this i ll give you all my sweets as collateral everything.
I ve got like i ve actually got more than one big bag of sweets. I ve got several i ll give you the whole lot collateral. Ten bucks back i was like you know i don t know i mean it s a couple of problems of that cloud or potential problems. You ve had those that those sweets in the bag for a long time.
I don t know if you ve been like we re telling them through they could be old. They could be made with corn syrup may not be that good for your health. So you know i know i don t actually know i don t think you re a particularly good counterparty same things happening with the banks. They re looking at their counterparties.
Jp morgan. Say might be looking at you know a spanish bank and saying i don t know how much exposure you have to you know greek debt for example. How many greek bonds you ve got. I don t know whether i like the fact that you good you do so much business with greece or the fact that spain itself is in a few problems.
I don t know whether racks they want to do business with you i don t know whether i trust you to pay me back..
Suppose like okay. I ll give you more collateral. I don t know i like your collateral. I don t know what it s coming from i don t know how much of it is greek debt.
I know how good spanish debt is right now. I don t like your collateral either so what the net net net. What s happening is that the counterparties are refusing to deal with each other in many cases. The banks are looking at each other going i don t know how exposed they are to to to greece or to spain or portugal.
Or any one of these troubled countries i don t know how likely it is that the euros gonna survive me with the euro is gonna go under i don t like the collateral that they re putting up because who knows what s in that bag who knows how exposed the companies that you know that say it s corporate debt that they re that they are putting up as collateral. Who knows how expose each of those companies aren t to greece sort of spain or portugal or even to the whole eurozone. Which looks kind of threatened right now so i don t know whether i want to do business with you banks all over europe are now starting to look at each other with a lot more suspicion that backing away from each other and if this sounds familiar. It s exactly what happens whenever a lehman.
Brothers and bear stearns went down the reason that those those two companies had a liquidity crisis was because nobody wanted to business with them they were not confident that their counterparties were going to be able to pay them back huge counterparty risk. And that nobody did business with each other and the whole financial system grounds to a halt. Which is one of why the fed stepped in with these big liquidity packages. But people are really worried that the same thing is gonna happen in europe that the banks are going to stop doing business with you that with each other all together then what that that s what that s gonna do is it s gonna make the asian banks start looking at each other in a weird way and looking at the european banks and thinking about not lending to each other and also the us banks.
So we could be going although back to our original credit crisis all the way back to the foundations of another financial crisis and that s not is what s roiling all the markets all over the world and leaving everybody. ” ..
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