Credit Risk Transfer

March 2005


The attached report responds to a request by the Financial Stability Forum (FSF) for the Joint Forum to undertake a review of credit risk transfer (CRT) activity. The report was prepared by the Joint Forum's Working Group on Risk Assessment and Capital on the basis of a number of interviews and discussions with market participants. The report was issued on a consultative basis in October 2004. This final version reflects comments and suggestions received during the consultation process, but does not seek to provide a comprehensive update of the market information contained in the report. The key points raised during the consultation process are described at the end of this Summary.

The September 2003 FSF discussions noted the importance of considering the financial stability issues that could be associated with CRT activity and highlighted three issues in particular: (1) whether the instruments/transactions accomplish a clean risk transfer, (2) the degree to which CRT market participants understand the risks involved, and (3) whether CRT activities are leading to undue concentrations of credit risk inside or outside the regulated financial sector. Additionally, the FSF asked whether there is a need for enhanced reporting to supervisors and improved public disclosures by regulated institutions, as well as whether there is a need for further information on credit risks that are transferred to nonregulated institutions. These questions are addressed below.

The Working Group has undertaken efforts to coordinate with similar projects that have been initiated within the European Union. In particular, the Working Group has benefited from direct participation by individuals closely involved in the efforts of the European Central Bank's Bank Supervision Committee (BSC) and the Committee of European Insurance and Occupational Pension Supervisors (CEIOPS). The Working Group also has been in contact with a representative of the Committee of European Securities Regulators (CESR) to ensure mutual knowledge of the respective projects. On the basis of these liaison activities, the Working Group believes that the products of these various efforts will be complementary.

By way of background, it is clear that credit risk transfer, including such transactions as loan guarantees, has a long history. In recent decades, loan syndication and securitisation activities experienced significant growth. The present report, however, focuses more narrowly on the newest forms of CRT, in particular on those activities associated with credit derivatives. The first credit derivatives transactions took place among a handful of pioneering banks in the early 1990's, with significant growth occurring since the latter part of that decade.

The report concludes that CRT activity (defined as indicated in the context of credit derivative-related transactions) has been developing at a rapid rate characterised by significant product innovation, an increasing number of market participants, growth in overall transaction volumes, and perceived continued profit opportunities for financial intermediaries. The report further concludes that continued development of the CRT market offers potential benefits in the form of more liquid and efficient markets for the transfer of credit risk. In this context, the Working Group believes that the most important high-level issues associated with these developments relate to the need for market participants to continue improving risk management capabilities and for supervisors and regulators to continue improving their understanding of the associated issues. Accordingly, the report contains a series of recommendations for market participants and supervisors in the areas of risk management, disclosure, and supervisory approaches. The recommendations specifically address the additional questions raised by the FSF in relation to reporting and disclosure.

The remainder of this summary focuses first on the three specific issues highlighted above. It then briefly discusses some of the financial stability aspects considered in the report and concludes with a summary of the recommendations included in the report.