  Securities borrowing and lending are critical to proper functioning of
securities markets. To alleviate securities owners' exposure to borrower
default risk, overcollateralization and indemnification are provided by the
borrower and the lending agent respectively. Haircuts as the level of
overcollateralization and the cost of indemnification are naturally
interrelated: the higher haircut is, the lower cost shall become. This article
presents a method of quantifying their relationship. Borrower dependent
haircuts satisfying the lender's credit risk appetite are computed for US
Treasuries and main equities by applying a repo haircut model to bilateral
securities lending transactions. Indemnification is designed to fulfill a
triple-A risk appetite when the transaction haircut fails to deliver. The cost
of indemnification consists of a risk charge, a capital charge, and a funding
charge, each corresponding to the expected loss, the economic capital, and the
redundant fund needed to arrive at the triple-A haircut.
