The counterparty credit risk appetite in the Polish over-the-counter derivatives market

Abstract

Objective: The article aims to study the selected approach used to manage the counterparty credit risk, namely the application of the pre-settlement risk limits in the Polish over-the-counter derivatives market between financial institutions and non-financial counterparties. Since market practice differs in terms of hedging the same risk exposures of non-financial counterparties, the main goal is to identify and analyse key factors determining the risk appetite of financial institutions reflected in the pre-settlement limit amount.

Research Design & Methods: I based the theoretical considerations on the literature analysis. I utilized secondary data analysis and desk research, in particular concerning legal regulations both on the European and Polish levels. It considers credit policies and the counterparty credit risk rules of selected banks listed on the Warsaw Stock Exchange that offer derivative instruments for non-financial counterparties in order to hedge against specific market risks. I investigated all required information and data obtained and proceeded by banks for treasury limits. For this purpose, I analysed credit application forms and treasury limit applications. Next, I investigated the principles for managing counterparty credit risk as well as appropriate credit policy. A case study presents key differences in banking services provided for a non-financial counterparty willing to hedge market risks.

Findings: I applied a holistic approach to the counterparty credit risk policy and identified key factors affecting the counterparty credit risk appetite within financial institutions, reflected in the pre-settlement limit granted to non-financial counterparties in the Polish over-the-counter derivatives market. These determinants concern areas such as specific hedging instruments, given counterparty and financial institutions, as well as the regulatory environment.

Implications & Recommendations: The pre-settlement risk limits serve not only to cover credit exposure but also to support and enhance the entire market risk management process and day-to-day operations in financial institutions. One may also regard the implemented treasury limit setup, risk factors, margining policy, etc., in the context of competitive advantage that financial institutions may gain and thus attract more derivative business. Hence, it is crucial to recognize determinants influencing the treasury limit amount.

Contribution & Value Added: Although the main analysis of counterparty credit risk concentrates on interbank operations, mainly due to their high systemic importance, the management of the pre-settlement risk in the over-the-counter derivatives market between the financial institution and non-financial counterparty should be considered in more detail due to its growing importance. This article intends to systematize knowledge on this topic. The case study utilising international and domestic experiences shows different approaches to mitigate financial risks. The question of which approach to risk management is more effective remains open.