Derivatives counterparty failure equals banking armageddon

The $600 trillion “notional” global derivatives market is the the definition of Too Big To Fail. The large banks argued for years that the notional size of the derivative market was nothing to worry about as these contracts are netted out so net exposure was the number to focus on and that was perhaps 3% of the notional. However, when counterparty risk is taken into account; if one of the few dozen institutions who make up this market were to fail then the true exposure becomes notional size. Global annual GDP is around $60 trillion.

According to the Office of the Comptroller of the Currency, the four US banks with the largest notional derivatives exposures are:

J.P. Morgan Chase holds the top spot with $76.4 trillion, while Bank of America Corp. is second with $46.6 trillion. The next two spots are held by Citibank and Goldman Sachs each with $41.1 trillion.

According to the Bank for International Settlements (BIS), worldwide derivatives contracts total $615 trillion.   The notional value of all derivatives held by banks was $596 trillion at the end of 2007.  So the notional value has actually increased by the end of 2009.

If any of the four large US banks were to be put into receivership, the other banks holding contracts from that failed bank would have to show a massive loss due to the inability of the failed bank to make good on the derivative contracts.


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