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The Impact of the Regulation of Centrally Cleared Credit Risk Transfer and Capital Requirements on Banks’ Lending Discipline

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  • Arnold, Marc

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    Abstract

    This article analyzes the impact of the regulatory design of centrally cleared credit risk transfer and capital requirements on a loan originating bank's lending discipline in the primary loan market. Under Basel III, a bank can transfer credit risk via central clearing at favorable regulatory conditions. Credit risk transfer, however, reduces the lending discipline because it allows the bank to profitably grant and hedge a low quality loan. Stricter capital requirements only mitigate this problem if they are combined with a credit risk retention rule for the loan originator. It is shown how the retention rule, the disclosure requirements on the centrally cleared credit risk transfer market, and the capital requirements for hedged and unhedged loan exposures jointly affect a bank's lending discipline.

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    File URL: http://www1.vwa.unisg.ch/RePEc/usg/sfwpfi/WPF-1321.pdf
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    Bibliographic Info

    Paper provided by University of St. Gallen, School of Finance in its series Working Papers on Finance with number 1321.

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    Length: 35 pages
    Date of creation: May 2013
    Date of revision:
    Handle: RePEc:usg:sfwpfi:2013:21

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    1. René M. Stulz, 2009. "Credit Default Swaps and the Credit Crisis," NBER Working Papers 15384, National Bureau of Economic Research, Inc.
    2. Gabriella Chiesa, 2008. "Optimal Credit Risk Transfer, Monitored Finance, and Banks," EIEF Working Papers Series 0811, Einaudi Institute for Economics and Finance (EIEF), revised Sep 2008.
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    10. Cho, In-Koo & Kreps, David M, 1987. "Signaling Games and Stable Equilibria," The Quarterly Journal of Economics, MIT Press, vol. 102(2), pages 179-221, May.
    11. Goderis, Benedikt & Marsh, Ian & Vall Castello , Judit & Wagner, Wolf, 2007. "Bank behaviour with access to credit risk transfer markets," Research Discussion Papers 4/2007, Bank of Finland.
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    13. Carlstrom, Charles T. & Samolyk, Katherine A., 1995. "Loan sales as a response to market-based capital constraints," Journal of Banking & Finance, Elsevier, vol. 19(3-4), pages 627-646, June.
    14. 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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