But this maintenance of liquidity and the smooth functioning of markets has become central to financial stability because even as regulated institutions have become more sound, they and other participants have come to rely more on markets for their own risk management. Hence dislocation can have serious consequences.
Importantly, in the current situation where margin- and haircut-setting is left to the discretion of market participants, margins and haircuts are strongly procyclical. [10] In exuberant times, low volatility and risk-aversion as well as competitive pressure lead to low margins and haircuts, supporting the build-up of leverage.