COVID Impact to Equity Margin Loans—A Practical Approach to Measure Risk with the Client Behavior Assumptions

Abstract

Equity margin loan deals are loans to counterparties secured by collateral in the form of equities. Credit exposure arises when the equity collateral falls below the value of loan. During the life of the deal, the counterparty has to give more shares (or cash) to banks or brokerage houses in case of a fall in the share price, so that the level of the collateral amount stays approximately the same and does not deteriorate. The objective of this paper is to attempt to review the risks associated to margin loan deals and propose some suggestions to factor in certain margin call delays or liquidation uncertainties under the stressed COVID-19 situation. Moreover, we also showed a sample practical approach to measure the tail risk of margin loan which included the counterparty’s likely behavior under stress and used a callable bond pricing logic to assess the likely time and moral hazard problem of the counterparty to walk away from margin loans.