BSP Seeks to Curb Banks' Role in High-Risk Instruments; Credit-Derivatives Singled Out

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MANILA (Dow Jones) Concerned about domestic banks rising exposure to risk through credit derivatives, mostly with sovereign debt as underlying assets, the Bangko Sentral ng Pilipinas is seeking to regulate further their participation in such high-yielding, high-risk instruments.

Assistant central bank governor Nestor Espenilla suggested to finance executives that the nations banks may be saddled with heavy losses in the event the government defaults on its debt.

There is little question the Philippine government will honor its debt obligations and the central bank isnt trying to limit banks holding of these assets, Espenilla told a closed-door financial seminar. But, he said, the central bank is concerned that banks are taking on increasing amounts of such derivatives and not making adequate provisions against the risks.

Im not at liberty to say the total amount, but its big. And this is the subject matter of some of the regulations we might come out with, Espenilla said at the seminar sponsored by the Asian Institute of Management and the Asian Development Bank Institute, which was closed to the media.

Espenilla said the Philippines has a very small outstanding amount in terms of traditional derivatives such as currency forwards amounting to roughly P1 billion, but banks were increasingly exposed to credit derivatives, in particular creditlinked notes whose underlying assets are Philippine government debt.

Credit-linked notes, part of the usually highyielding credit derivatives family, are created by combining one or more existing securities into a pool. Using the pool as collateral, new securities with payment contract features different from the underlying securities are created. These notes are basically an insurance against any defined credit event such as a failure to pay, bankruptcy, or repudiation or moratorium.

An investor in a creditlinked note in this case a Philippine bank effectively accepts the transfer of risk of the underlying loan or bond from creditors seeking to buy protection. If no credit event occurs during the life of the contract, the note gets fully paid. If, however, a credit event occurs, the note holder may receive reduced interest and principal payments or get paid with the defaulted obligation of the debtor.

In principle, these (sovereign debts) should have been issued overseas and held onto by outside investors, but if you follow the cycle, the risk is actually turned around and returned to us by way of credit derivatives being sold to local banks, said Espenilla, who heads the central banks supervision, reports and studies office. …