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Innovations in credit risk transfer: implications for financial stability

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  • Darrell Duffie

Abstract

Banks and other lenders often transfer credit risk to liberate capital for further loan intermediation. This paper aims to explore the design, prevalence and effectiveness of credit risk transfer (CRT). The focus is on the costs and benefits for the efficiency and stability of the financial system. After an overview of recent credit risk transfer activity, the following points are discussed: motivations for CRT by banks; risk retention; theories of CDO design; specialty finance companies. As an illustration of CLO design, an example is provided showing how the credit quality of the borrowers can deteriorate if efforts to control their default risks are costly for issuers. An appendix is provided on CDS index tranches.

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Bibliographic Info

Paper provided by Bank for International Settlements in its series BIS Working Papers with number 255.

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Length: 40 pages
Date of creation: Jul 2008
Date of revision:
Handle: RePEc:bis:biswps:255

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Related research

Keywords: credit derivatives; credit risk transfer; financial innovations; financial stability;

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References

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  1. Gorton, Gary B. & Pennacchi, George G., 1995. "Banks and loan sales Marketing nonmarketable assets," Journal of Monetary Economics, Elsevier, Elsevier, vol. 35(3), pages 389-411, June.
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  4. Peter M. DeMarzo, 2005. "The Pooling and Tranching of Securities: A Model of Informed Intermediation," Review of Financial Studies, Society for Financial Studies, vol. 18(1), pages 1-35.
  5. Froot, Kenneth A & Scharfstein, David S & Stein, Jeremy C, 1993. " Risk Management: Coordinating Corporate Investment and Financing Policies," Journal of Finance, American Finance Association, American Finance Association, vol. 48(5), pages 1629-58, December.
  6. Gale, Douglas, 1992. "Standard Securities," Review of Economic Studies, Wiley Blackwell, Wiley Blackwell, vol. 59(4), pages 731-55, October.
  7. Franklin Allen, Douglas Gale, 1988. "Optimal Security Design," Review of Financial Studies, Society for Financial Studies, vol. 1(3), pages 229-263.
  8. Gregory R. Duffee & Chunsheng Zhou, 1997. "Credit derivatives in banking: useful tools for managing risk?," Finance and Economics Discussion Series, Board of Governors of the Federal Reserve System (U.S.) 1997-13, Board of Governors of the Federal Reserve System (U.S.).
  9. Acharya, Viral V. & Johnson, Timothy C., 2007. "Insider trading in credit derivatives," Journal of Financial Economics, Elsevier, Elsevier, vol. 84(1), pages 110-141, April.
  10. Peter DeMarzo & Darrell Duffie, 1999. "A Liquidity-Based Model of Security Design," Econometrica, Econometric Society, Econometric Society, vol. 67(1), pages 65-100, January.
  11. Cebenoyan, A. Sinan & Strahan, Philip E., 2004. "Risk management, capital structure and lending at banks," Journal of Banking & Finance, Elsevier, vol. 28(1), pages 19-43, January.
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Cited by:
  1. Affinito, Massimiliano & Tagliaferri, Edoardo, 2010. "Why do (or did?) banks securitize their loans? Evidence from Italy," Journal of Financial Stability, Elsevier, Elsevier, vol. 6(4), pages 189-202, December.
  2. Markus K. Brunnermeier, 2008. "Deciphering the Liquidity and Credit Crunch 2007-08," NBER Working Papers 14612, National Bureau of Economic Research, Inc.
  3. Cerasi, Vittoria & Rochet, Jean-Charles, 2014. "Rethinking the regulatory treatment of securitization," Journal of Financial Stability, Elsevier, Elsevier, vol. 10(C), pages 20-31.
  4. Carbó-Valverde, Santiago & Marques-Ibanez, David & Rodríguez-Fernández, Francisco, 2012. "Securitization, risk-transferring and financial instability: The case of Spain," Journal of International Money and Finance, Elsevier, Elsevier, vol. 31(1), pages 80-101.
  5. Kara, Alper & Marqués-Ibáñez, David & Ongena, Steven, 2011. "Securitization and lending standards: evidence from the wholesale loan market," Working Paper Series, European Central Bank 1362, European Central Bank.
  6. Giovanni Calice & Christos Ioannidis & Julian Williams, 2012. "Credit Derivatives and the Default Risk of Large Complex Financial Institutions," Journal of Financial Services Research, Springer, Springer, vol. 42(1), pages 85-107, October.
  7. Bengtsson, E., 2013. "Fund Management and Systemic Risk - Lessons from the Global Financial Crisis," CITYPERC Working Paper Series 2013-06, Department of International Politics, City University London.
  8. Markus K. Brunnermeier, 2009. "Deciphering the Liquidity and Credit Crunch 2007-2008," Journal of Economic Perspectives, American Economic Association, vol. 23(1), pages 77-100, Winter.
  9. Patrick Honohan, 2008. "Risk Management and the Costs of the Banking Crisis," The Institute for International Integration Studies Discussion Paper Series iiisdp262, IIIS.
  10. Kero, Afroditi, 2013. "Banks’ risk taking, financial innovation and macroeconomic risk," The Quarterly Review of Economics and Finance, Elsevier, Elsevier, vol. 53(2), pages 112-124.
  11. Shim, Ilhyock & Zhu, Haibin, 2014. "The impact of CDS trading on the bond market: Evidence from Asia," Journal of Banking & Finance, Elsevier, vol. 40(C), pages 460-475.
  12. Ivan Zelenko, 2009. "Innovations financières pour les pays émergents," Revue d'Économie Financière, Programme National Persée, Programme National Persée, vol. 95(2), pages 157-171.
  13. Pagès, H., 2012. "Bank monitoring incentives and optimal ABS," Working papers, Banque de France 377, Banque de France.
  14. Ekin Ayse Ozsuca & Elif Akbostanci, 2012. "An Empirical Analysis of the Risk Taking Channel of Monetary Policy in Turkey," ERC Working Papers 1208, ERC - Economic Research Center, Middle East Technical University, revised Dec 2012.
  15. Fender, Ingo & Mitchell, Janet, 2009. "Incentives and Tranche Retention in Securitisation: A Screening Model," CEPR Discussion Papers, C.E.P.R. Discussion Papers 7483, C.E.P.R. Discussion Papers.
  16. Kiff, John & Kisser, Michael, 2014. "A shot at regulating securitization," Journal of Financial Stability, Elsevier, Elsevier, vol. 10(C), pages 32-49.
  17. Massimiliano Affinito & Edoardo Tagliaferri, 2010. "Why do (or did?) banks securitize their loans? Evidence from Italy," Temi di discussione (Economic working papers), Bank of Italy, Economic Research and International Relations Area 741, Bank of Italy, Economic Research and International Relations Area.
  18. Patrick Honohan, 2008. "Bank Failures: The Limitations of Risk Modelling," The Institute for International Integration Studies Discussion Paper Series iiisdp263, IIIS.

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