Swap history: Difference between revisions

Banks thought — not ''that’s'' a sweet idea. But they encountered legal and financial reporting complications, however: Unsecured loans attract a lot of [[regulatory capital]] if you’re the sort of entity like a bank who has to hold regulatory capital. Was there some way the banks could offset the receivable on the loan they had made against the amount they had borrowed, to reduce the risk of the overall transaction and therefore reduce the regulatory capital charge?

It turned out there was. It is called “[[netting]]”, but it is a complicated legal mechanism<ref>Well, it was in 1981, like.</ref>, especially in the insolvency of your counterparty. All kinds of local insolvency rules might interfere with your right to “net” these strange, exotic contracts called [[Sw-æp]]s.  

So, the [[Bank of International Settlements]] hastily made up some rules to make sure banks were diligently applying netting treatment. You must have a [[legal opinion]] assuring you that netting would work in insolvency in all relevant jurisdictions. This seemed harmless enough in 1981, rather like [[Locomotive Act|requiring someone with one of these new-fangled automobiles to walk in front of it waving a red flag to warn unsuspecting passers by]]. And that day a cottage indutry was born which, to this day, wastes hundreds of millions of pounds in compliance each year.