Credit risk transfer activities and systemic risk

How banks became less risky individually but posed greater risks to the financial system at the same time

W.B. Wagner, R.G.M. Nijskens

Research output: Contribution to journalArticleScientificpeer-review

Abstract

A main cause of the crisis of 2007–2009 is the various ways through which banks have transferred credit risk in the financial system. We study the systematic risk of banks before the crisis, using two samples of banks respectively trading Credit Default Swaps (CDS) and issuing Collateralized Loan Obligations (CLOs). After their first usage of either risk transfer method, the share price beta of these banks increases significantly. This suggests the market anticipated the risks arising from these methods, long before the crisis. We additionally separate this beta effect into a volatility and a market correlation component. Quite strikingly, this decomposition shows that the increase in the beta is solely due to an increase in banks’ correlations. Thus, while banks may have shed their individual credit risk, they actually posed greater systemic risk. This creates a challenge for financial regulation, which has typically focused on individual institutions.
Original languageEnglish
Pages (from-to)1391-1398
JournalJournal of Banking and Finance
Volume35
Issue number6
DOIs
Publication statusPublished - 2011

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Financial system
Systemic risk
Credit risk transfer
Credit risk
Loans
Decomposition
Share prices
Financial regulation
Credit default swaps
Obligation
Systematic risk
Risk transfer

Keywords

  • securitization
  • credit derivatives
  • systemic risk
  • subprime crisis

Cite this

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abstract = "A main cause of the crisis of 2007–2009 is the various ways through which banks have transferred credit risk in the financial system. We study the systematic risk of banks before the crisis, using two samples of banks respectively trading Credit Default Swaps (CDS) and issuing Collateralized Loan Obligations (CLOs). After their first usage of either risk transfer method, the share price beta of these banks increases significantly. This suggests the market anticipated the risks arising from these methods, long before the crisis. We additionally separate this beta effect into a volatility and a market correlation component. Quite strikingly, this decomposition shows that the increase in the beta is solely due to an increase in banks’ correlations. Thus, while banks may have shed their individual credit risk, they actually posed greater systemic risk. This creates a challenge for financial regulation, which has typically focused on individual institutions.",
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Credit risk transfer activities and systemic risk : How banks became less risky individually but posed greater risks to the financial system at the same time. / Wagner, W.B.; Nijskens, R.G.M.

In: Journal of Banking and Finance, Vol. 35, No. 6, 2011, p. 1391-1398.

Research output: Contribution to journalArticleScientificpeer-review

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