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Market dynamics associated with credit ratings: a literature review

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Over the past few years there has been rapid growth in credit risk transfer instruments, including credit derivatives, and increasing use of these instruments by a diverse range of market participants: banks, insurance and reinsurance companies, mutual funds, as well as companies and hedge funds. This has led the authorities that participate in the Financial Stability Forum to examine this issue and the possible repercussions of recent developments. In this respect, there are two conflicting views: some people consider that the greater dispersion of credit risk across a wider spectrum of agents may contribute to the stability of financial systems; for others, however, the spreading of credit risk may give rise to new sources of instability if the new holders of this risk are unable to accurately assess and manage it. In order to increase their knowledge of these products, in the second half of 2003 the French supervisory authorities – the Commission de Contrôle des assurances (Insurance Supervisory Commission), the Commission des Opérations de Bourse (Stock Exchange Commission), and the Commission Bancaire (Banking Commission) – conducted a survey of credit institutions, insurance and reinsurance companies, and asset management companies. The survey’s findings, which constitute the first joint assessment of credit risk transfers undertaken by the French authorities, are presented in this article. These findings, which only relate to agents in the financial sector, are not a cause for particular concern from the point of view of financial stability. Indeed, the vast majority of risk transfers take place between major banks, especially in the case of credit derivatives, and mainly involve large US banks. This concentration of players is not specific to credit derivatives — it is reproduced with respect to derivatives across the board. However, the situation is more diverse where structured products are concerned. Here the involvement of insurance and reinsurance companies and mutual funds is more significant, although the bulk of transactions take place on highly-rated instruments. In terms of the transactions themselves, the results of the survey highlight the importance of new types of risk associated with these instruments: legal and documentation risk, and also illiquidity risk for non-standardised products. Given that the use of these products is likely to expand, market participants need to be well aware of the risks associated with them and endeavour to improve their assessment and management of these risks. Moreover, greater progress in terms of financial transparency is desirable in this area. All in all, this should help to make this market more mature, more liquid and therefore less risky.

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  • ., 2004. "Market dynamics associated with credit ratings: a literature review," Financial Stability Review, Banque de France, issue 4, pages 77-93, June.
  • Handle: RePEc:bfr:fisrev:2004:4:2
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    Cited by:

    1. Leena Mörttinen & Paolo Poloni & Patrick Sandars & Jukka Vesala, 2005. "Analysing banking sector conditions - how to use macro-prudential indicators," Occasional Paper Series 26, European Central Bank.
    2. Frank Dierick & Fatima Pires & Martin Scheicher & Kai Gereon Spitzer, 2005. "The New Basel Capital Framework and its implementation in the European Union," Occasional Paper Series 42, European Central Bank.
    3. Grothe, Magdalena, 2013. "Market pricing of credit rating signals," Working Paper Series 1623, European Central Bank.
    4. André Geis & Arnaud Mehl & Stefan Wredenborg, 2004. "The international role of the euro - evidence from bonds issued by non-euro area residents," Occasional Paper Series 18, European Central Bank.
    5. Henrik Enderlein & Johannes Lindner & Oscar Calvo-Gonzalez & Raymond Ritter, 2005. "The EU budget – how much scope for institutional reform?," Public Economics 0509005, EconWPA.
    6. Reinhard Petschnigg, 2005. "The institutional framework for financial market policy in the USA seen from an EU perspective," Occasional Paper Series 35, European Central Bank.
    7. Martin Sullivan, 2009. "Credit Ratings and UK Defined Pension Fund Portfolio Values," Working Papers 0909, Department of Accounting, Economics and Finance, Bristol Business School, University of the West of England, Bristol.
    8. Jesper Berg & Annalisa Ferrando & Gabe de Bondt & Silvia Scopel, 2005. "The bank lending survey for the euro area," Occasional Paper Series 23, European Central Bank.
    9. Adalbert Winkler & Roland Beck, 2006. "Macroeconomic and financial stability challenges for acceding and candidate countries," Occasional Paper Series 48, European Central Bank.
    10. Reiner Martin & Moreno Roma & Isabel Vansteenkiste, 2005. "Regulatory reforms in selected EU network industries," Occasional Paper Series 28, European Central Bank.
    11. Ferri, Giovanni & Lacitignola, Punziana & Lee, Jeong Yeon, 2013. "Foreign ownership and the credibility of national rating agencies: Evidence from Korea," Journal of Comparative Economics, Elsevier, pages 762-776.
    12. Véronique Genre & Daphne Momferatou & Gilles Mourre, 2005. "Wage diversity in the euro area - an overview of labour cost differentials across industries," Occasional Paper Series 24, European Central Bank.
    13. Heiko Schmiedel & Andreas Schönenberger, 2005. "Integration of securities market infrastructures in the euro area," Occasional Paper Series 33, European Central Bank.
    14. Borio, Claudio & Zhu, Haibin, 2012. "Capital regulation, risk-taking and monetary policy: A missing link in the transmission mechanism?," Journal of Financial Stability, Elsevier, pages 236-251.
    15. Daniela Russo & Terry L. Hart & Chryssa Papathanassiou, 2004. "Governance of securities clearing and settlement systems," Occasional Paper Series 21, European Central Bank.
    16. Antonio Cesare, 2006. "Do Market-based Indicators Anticipate Rating Agencies? Evidence for International Banks," Economic Notes, Banca Monte dei Paschi di Siena SpA, pages 121-150.
    17. Finnerty, John D. & Miller, Cameron D. & Chen, Ren-Raw, 2013. "The impact of credit rating announcements on credit default swap spreads," Journal of Banking & Finance, Elsevier, vol. 37(6), pages 2011-2030.
    18. Baba, Naohiko & Packer, Frank, 2009. "Interpreting deviations from covered interest parity during the financial market turmoil of 2007-08," Journal of Banking & Finance, Elsevier, vol. 33(11), pages 1953-1962, November.
    19. Karl Whelan & Filippo Altissimo & Evaggelia Georgiou & Teresa Sastre & Maria Teresa Valderrama & Gabriel Sterne & Marc Stocker & Mark Weth & Alpo Willman, 2005. "Wealth and asset price effects on economic activity," Open Access publications 10197/210, School of Economics, University College Dublin.
    20. Christian Thimann & Regine Wölfinger & Thierry Bracke & Rita Bessone Basto & Ole Hollensen & Stephan von Stenglin & Santiago Fernández de Lis & Pierre-François Weber & Marco Committeri & Rolf Pauli & , 2005. "Managing financial crises in emerging market economies - experience with the involvement of private sector creditors," Occasional Paper Series 32, European Central Bank.
    21. Maria Gabriella Briotti, 2005. "Economic reactions to public finance consolidation - a survey of the literature," Occasional Paper Series 38, European Central Bank.
    22. Antonio Di Cesare, 2006. "Do market-based indicators anticipate rating agencies? Evidence for international banks," Temi di discussione (Economic working papers) 593, Bank of Italy, Economic Research and International Relations Area.
    23. Angela Maddaloni & Darren Pain, 2004. "Corporate ‘excesses’ and financial market dynamics," Occasional Paper Series 17, European Central Bank.
    24. Guido Wolswijk & Jakob de Haan, 2005. "Government debt management in the euro area - recent theoretical developments and changes in practices," Occasional Paper Series 25, European Central Bank.

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