Title: The Effect of Credit Risk Transfer on Financial Stability
Publication Year: 2005
JRC N°: JRC31346
Other Identifiers: EUR 21521 EN
URI: http://publications.jrc.ec.europa.eu/repository/handle/JRC31346
Type: EUR - Scientific and Technical Research Reports
Abstract: This paper shows under which conditions debt securitization of banks can increase the systemic risks in the banking sector. We use a simple model to show how securitization can reduce the individual banks’ economic capital requirements by transferring risks to other market participants. This can increase systemic risks and impact financial stability in two ways. First, if the risks are transferred to unregulated market participants there is less capital in the economy to cover these risks. And second, if banks invest in asset-backed securities, the transferred risk causes interbank linkages to grow. This results in an increasing systematic risk for which the economic capital put aside is insufficient. We develop a modified version of the infectious defaults model of Davis and Lo (2001) and use this model to quantify the systemic risk of increased bank linkages in the banking sector.
JRC Directorate:Space, Security and Migration

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