At first glance, it would appear that the holding of collateral to mitigate credit risks faced by a bank, would be a very good idea, and that is the case. However, there are a number of other pros and cons to consider when thinking about holding collateral to mitigate credit risk. So the first advantage of holding collateral is that if the counterparty does go bankrupt, then we can take ownership of those assets that were pledged to us to reduce the loss that we suffer, therefore reducing credit risk. Secondly, as a result of facing less credit risk from counterparties, we may be able to offer better pricing to those types of counterparties, increasing the bank's competitiveness. If a bank faces less risk, it's gonna demand less return from transactions with counterparties, so as a result, we can offer better prices to those clients and increase the volume of transactions. Furthermore, since most regulatory capital requirements are risk-based, if a bank is able to reduce its risk exposure through holding collateral, and the collateral that is held meets regulatory requirements, using collateral to reduce credit risk may also result in a requirement to hold less regulatory capital. Finally, trades that would otherwise have been inaccessible to a bank, simply through being too high risk, may be open to the bank if collateral is held to reduce the counterparty risk faced. There are also some considerations to think about on the negative side for holding collateral, and the first of those is that holding collateral is operationally complex. A bank will need to employ staff and develop systems to ensure that it can can correctly calculate credit risk exposures, that it can correctly call for collateral from counterparties when it is possible to do so through arrangements in place between a bank and its counterparties, and also that there are procedures in place to deal with a situation where the counterparty has not delivered collateral as they were supposed to.

Secondly, if a counterparty does go bankrupt, then the liquidators of that bankrupt firm will do everything within their power to get hold of as many assets for the remaining creditors of that bank as possible. And if the documentation in place regarding that collateral is not sufficiently robust, then it may not be the case that assets that have been pledged to you will end up being yours in the event of a bankruptcy of a counterparty. So this idea of legal risk or legal documentation not being sufficiently robust to allow the counterparty holding the collateral to perfect a claim over those assets. Finally, calculations of credit exposure can be complex, and as a result the bank will have to develop appropriate systems to calculate those credit exposures. And if there are any weaknesses in those exposures or weaknesses in getting trade data into those calculation engines, then a bank may be facing more credit risk than it thought it was.