Could the 2007 Crisis Have Occurred without Credit Derivatives? Citibank Group: Case Study

Abstract

Abstract Financial derivatives have been acclaimed as the greatest innovation of the 20 th century. This popularity is not unconnected to their use as a risk management tool. It is thus disconcerting that such instruments meant to manage risk can be blamed for having exacerbated it, to the extent of causing a global crisis. In the light of the aforementioned, this paper examines the nature and use of credit derivatives (CDs) in a market participant, in particular, a large financial institution eminently involved in the recent financial crisis, “Citibank Group”. We assess the role it has played in the global financial crisis, investigate whether the presence of derivatives in the financial market was a sufficient condition to cause the crisis, and examine the impact of two critical periods (during and post crisis) on the credit risk (CR) in this international bank. Findings reveal that derivatives were a key contributor to Citibank's bankruptcy. Furthermore, the post crisis period had a serious debilitating effect on Citibank compared with the period during the crisis. Separating investment and commercial banking, and insisting that derivatives be traded only in recognized exchanges, were recommended to forestall recurrence of this type of crisis.