Determinants of the Use of Credit Derivatives by Large US Banks

Abstract

Credit derivatives enable banks to manage credit risk separately from other types of risk, by transferring selected credit risks to third parties. Recently, global credit derivative markets have expanded rapidly, but a relatively small number of banks still accounts for most of the credit derivative business transacted by the US banking sector. An empirical model is developed for the motivation for participation in credit derivative markets and, conditional on participation, the factors that determine the volume of business transacted. Participation in credit derivative markets appears to be subject to entry barriers, which tend to favour the largest banks. Banks that deal in other derivative products are more likely to transact credit derivatives. Banks that transact such business tend to hold less capital, hold riskier loan portfolios, and derive a relatively high proportion of their income from non-traditional sources.