What are the policy issues in clearing corporation failure?
While famous events like Barings have captured the media attention, it should be noted that these did not interrupt the smooth functioning of the clearing corporation, which is the center of focus of the regulator. However, it is to be expected that once every few decades, market fluctuations will take place which are large enough to bankrupt clearinghouse. For such infrequent events, it makes a lot of sense for the central bank to supply a line of credit for a few days to a clearinghouse at such a time to tide over the exigency. (The terms credit risk”, default risk”, and coun- terparty risk” all pertain to the same thing. Settlement risk” and Herstatt risk” are default risk on the date of settlement. These terms do not hence imply new kinds of risk). It is all too easy for such a guarantee to be counterproductive. Once such a guarantee is given, there is, what is called, a moral hazard problem. If the clearinghouse thinks that the central bank is there to take care of difficulties, t
