Credit Derivatives and Commercial Banks' Risk Management/DERIVES DE CREDIT ET GESTION DES RISQUES DES BANQUES COMMERCIALES

By He, Jing | Canadian Social Science, August 31, 2010 | Go to article overview

Credit Derivatives and Commercial Banks' Risk Management/DERIVES DE CREDIT ET GESTION DES RISQUES DES BANQUES COMMERCIALES


He, Jing, Canadian Social Science


Abstract:

This paper illustrates the value of credit derivatives with two examples. A commercial bank can use credit derivatives to manage the risk of its loan portfolio. However, credit derivatives pose risk management challenges of their own. This paper discusses five of these challenges. Credit derivatives can transform credit risk in intricate ways that may not be easy to understand. They can create counterparty credit risk that itself must be managed. Complex credit derivatives rely on complex models, leading to model risk. The settlement of a credit derivative contract following a default can have its own complications, creating settlement risk. For the credit derivatives market to continue its rapid growth, commercial banks must meet these risk management challenges.

Keywords: Credit Derivative; risk management

Résumé: Ce document illustre la valeur des dérivés de crédit avec deux exemples. Une banque commerciale peut utiliser des dérivés de crédit pour gérer le risque de son portefeuille de prêts. Toutefois, les dérivés de crédit représentent aussi des défis de gestion. Cet article examine cinq de ces défis. Les dérivés de crédit peut transformer le risque de crédit d'une façon complexe qui n'est pas facile à comprendre. Ils peuvent créer des risques de crédit de contrepartie qui doivent être gérés eux-mêmes. Les dérivés de crédit complexes reposent sur des modèles complexes, conduisant à un risque de modèle. Le règlement d'un contrat den dérivés de crédit suite à un défaut peut avoir ses propres complexités, créant le risque de règlement. Pour que le marché de dérivés de crédit puisse poursuivre sa croissance rapide, les banques commerciales doivent répondre à ces défis de gestion des risques. Pour que le marché de dérivés de crédit puisse continuer sa croissance rapide, les banques commerciales doivent faire face à ces défis de risques de gestion.

Mots-clés: dérivés de crédit; gestion des risques

1. CREDIT DERIVATIVES ARE USEFUL FOR RISK MANAGEMENT

The growth of credit derivatives suggests that market participants find them useful for risk management. Figure 1 shows the growth trajectory for credit derivatives from two surveys of derivatives dealers: the ISDA Market Survey, which goes back to 2001, and the BIS Semiannual Derivatives Statistics, which goes back to 2004. The BIS survey is more accurate, because it adjusts for double counting of inter-dealer trades, but both show a similar pattern of rapid growth. Notional amounts of credit derivatives outstanding have roughly doubled each year for the past five years.

Credit derivatives have been used by a wide variety of market participants. No single data source provides definitive information on the activity of different types of market participants. But by combining several available data sources, a relatively clear picture emerges. I will refer to two data sources: the BIS Semiannual Derivative Statistics, the 2005 report on Credit Risk Transfer by the Joint Forum.

The most comprehensive data source is the BIS Semiannual Derivative Statistics (Bank for International Settlements, 2007). About 55 dealers contribute to this survey which breaks out credit derivative notional amounts by the type of counterparty. Table 1 shows this data for December 2006. The largest category is reporting dealers, reflecting the inter-dealer nature of the market. In any dealer market, dealers rely on inter-dealer trading to adjust their risk profile in response to trading flows from end-users. According to dealers, only 5 to 10 percent of their notional amount of derivatives represents hedges of their own credit exposures; the balance reflects inter-dealer trading and accommodation of customer demands (Joint Forum, 2005).

Banks and security firms that are not reporting dealers make up one-fifth of the total. Some of this captures non-dealer banks investing on their own account in credit derivatives. Some likely captures banks acting as fiduciaries for private banking or high-net-worth investors.

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Credit Derivatives and Commercial Banks' Risk Management/DERIVES DE CREDIT ET GESTION DES RISQUES DES BANQUES COMMERCIALES
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