The Federal Reserve plans to continue its supervisory focus on fundamental risk management related to counterparty credit risk, and it will conduct an analysis of how the largest banks cope with the default of their largest hedge fund counterparties, Fed Vice Chairman for Supervision Michael Barr said today. Speaking at a credit risk conference in New York City, Barr pointed to the 2022 collapse of Archegos Capital Management and the subsequent losses experienced by several banks, which he said revealed gaps in how banks manage their exposure to investment funds. Banks have since made important progress in improving counterparty credit risk management practices, such as by improving their information disclosures from clients, he said.
As for what the Fed expects from banks, first they should know their customers exceedingly well, both at onboarding and throughout the evolution of the relationship, Barr said. Second, banks should have tools to identify the unique risks they face as these risks materialize across products, business lines and clients, and use those risk measures to maintain appropriate margins through the credit cycle. Third, banks should set prudent risk limits and respond to signals of risk appropriately, he said.
Barr added that alongside this year’s stress test results, the Fed will publish the aggregate results of several exploratory analyses, including an analysis of the resilience of the globally systemically important banks to the simultaneous default of their five largest hedge fund counterparties. “We will conduct that analysis under two different sets of financial market conditions to learn about how such exposures may vary across different types of stresses,” he said. “We expect the information yielded from that analysis will deepen our supervisory understanding of counterparty credit risk at the banks. As we noted, the exploratory analysis will not affect bank capital requirements.” Read more.
