Credit derivatives: a new source of financial instability?

Credit derivatives are tools for the full or partial transfer of credit risk. The shocks of H2 2001 have neither seriously affected the rapid growth of these risk transfer transactions nor the increasing diversification of participants on the credit derivatives market. Nevertheless, banks, as well as insurers and reinsurers, must factor the risks inherent in these products into their day-to-day risk management, and especially into their internal control systems. And while financial institutions’ robust and apposite risk management systems will continue to form the first line of defence against the risks associated with using credit derivatives, the supervisory authorities have erected a second line by introducing specific prudential requirements for these products. This double line of defence against the multiple risks generated by the use of credit derivatives must be further fortified to cope with new developments and risks, even though the market appears to have weathered recent events, including 11 September, Enron’s bankruptcy and the Argentine crisis, relatively well. In any case, these risks are spurring market participants to make credit derivatives more efficient and secure across all financial sectors, at both the domestic and the international level, as part of ongoing efforts to bolster financial stability.