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Credit Default Swaps and Bank Regulatory Capital
[Securitization without risk transfer]

Author

Listed:
  • Chenyu Shan
  • Dragon Yongjun Tang
  • Hong Yan
  • Xing (Alex) Zhou

Abstract

While credit default swaps (CDSs) can be used to hedge credit risk exposures or to speculate, we examine another use of them: banks buy CDS referencing their borrowers to obtain regulatory capital relief. Such capital relief activities have unintended consequences, as banks extend riskier loans when they buy CDS to boost capital ratios. While capital-induced CDS-user banks achieve higher profitability during normal times, they perform worse and request more government support in crisis periods than other banks that use CDS for trading or speculation. Our findings suggest that banks’ CDS trading for capital relief purposes may make these banks riskier.

Suggested Citation

  • Chenyu Shan & Dragon Yongjun Tang & Hong Yan & Xing (Alex) Zhou, 2021. "Credit Default Swaps and Bank Regulatory Capital [Securitization without risk transfer]," Review of Finance, European Finance Association, vol. 25(1), pages 121-152.
  • Handle: RePEc:oup:revfin:v:25:y:2021:i:1:p:121-152.
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    File URL: http://hdl.handle.net/10.1093/rof/rfaa021
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    Citations

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    Cited by:

    1. Zhao, Ran & Zhu, Lu, 2024. "Credit default swaps and corporate ESG performance," Journal of Banking & Finance, Elsevier, vol. 159(C).
    2. Li, Jay Y. & Tang, Dragon Yongjun, 2022. "Product market competition with CDS," Journal of Corporate Finance, Elsevier, vol. 73(C).
    3. Wu, Wei-Shao & Fok, Robert C.W. & Chang, Yuanchen & Chen, Chao-Jung, 2022. "Credit default swaps and corporate performance smoothing," Journal of Corporate Finance, Elsevier, vol. 75(C).
    4. Peter Sinka & Peter J. Zeitsch, 2022. "Hedge Effectiveness of the Credit Default Swap Indices: a Spectral Decomposition and Network Topology Analysis," Computational Economics, Springer;Society for Computational Economics, vol. 60(4), pages 1375-1412, December.

    More about this item

    Keywords

    Credit default swaps; CDS; Capital relief; RWA ratio; Bank risk-taking;
    All these keywords.

    JEL classification:

    • G21 - Financial Economics - - Financial Institutions and Services - - - Banks; Other Depository Institutions; Micro Finance Institutions; Mortgages
    • G28 - Financial Economics - - Financial Institutions and Services - - - Government Policy and Regulation

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