Working Paper

Netting, financial contracts, and banks: the economic implications

Abstract: Derivatives and certain other off-balance sheet contracts enjoy special legal protection on insolvent counterparties through a process referred to as 'close-out netting.' This paper explores the legal status and economic implications of this protection. While this protection benefits major derivatives dealers and derivatives markets, it is less clear that other market participants or markets in general are better or worse off. While we are not able to conclude whether or not these protections are socially optimal, we outline the wide range of issues that a general consideration of the pros and cons of netting protection should take into cognizance, and analyze some of these issues critically. Ultimately the question becomes one of quantifying complex trade-offs.

Keywords: Derivative securities; Contracts;


Bibliographic Information

Provider: Federal Reserve Bank of Chicago

Part of Series: Working Paper Series

Publication Date: 2004

Number: WP-04-02