Credit Risk Transfer and Financial Sector Performance

Abstract

In this paper we study the impact of credit risk transfer (CRT) on the stability and the e¢ ciency of a …nancial system in a model with endogenous intermediation and production.Our analysis suggests that with respect to CRT, the individual incentives of the agents in the economy are generally aligned with social incentives. Hence, CRT does not pose a systematic challenge to the functioning of the …nancial system and is generally welfare enhancing.However, we identify issues that should be addressed by the regulatory authorities in order to minimize the potential costs of CRT. These include: ensuring the development of new methods of CRT that allow risk to be more perfectly transferred, setting regulatory standards that re ‡ect di¤erences in the social cost of instability in the banking and insurance sector; promoting CRT instruments that are not detrimental to the monitoring incentives of banks.JEL classi…cations: E44, G21, G22, G28

Credit risk transfer and financial sector stability

“…We analyzed incentive problems arising from CRT in a previous version of this paper(Wagner and Marsh, 2004). However, we found no qualititative changes to the stability results presented here.…”

“…We have analyzed this channel in a previous version of this paper(Wagner and Marsh, 2004), however, without finding changes to the stability implications of CRT.4 We have analyzed similar effects in a previous version of this paper(Wagner and Marsh, 2004), finding that, perhaps surprisingly, a reduction in the certification value does not necessarily undermine intermediation.…”

Credit Risk Transfer and the Default Risk of Large Complex Financial Institutions

“…In particular, since the author considers a dynamic risk management problem with infinitesimal small shocks, there are no banking defaults in equilibrium and hence the banking sector turns out to be perfectly stable. Wagner and Marsh (2004) [35] study the impact of CRT on the stability and the efficiency of a financial system in a model with endogenous intermediation and production. These authors demonstrate that the CRT market, under certain conditions, is generally welfare enhancing.…”

Credit Risk Transfer in Banking Markets with Hard and Soft Information

“…8 Pennacchi (1988) was the first to motivate credit transfer by regulation. Alternatively, the desire for CRT could arise from bankruptcy costs (as in Wagner and Marsh, 2004) or from bankers' risk aversion (as in Morrison, 2005).…”