The Effect of Credit Risk Transfer on Financial Stability
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.
BAUR Dirk;
JOOSSENS Elisabeth;
2006-01-25
JRC31346
EUR 21521 EN,
https://publications.jrc.ec.europa.eu/repository/handle/JRC31346,
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