In financial markets, a clearing bank is one that provides settlement and custody service to different financial institutions operating in that market. This results in the creation of tri-party agreements where the two parties engage the clearing bank to settle.
This is seen in the Repo market in which most transactions are tri-party. In this market Bank of New York Mellon is the custodian who operates as a clearing bank.
There are other services provided by this institution to the market as well as the participants in it.
They are:
- daily revaluation of assets
- daily remargining of collateral
- allocation of collateral to its lender based upon risk tolerance
Basically a clearing bank ensures that the collateral is available to the cash provider even if the dealer defaults.