Abstract
Credit default swaps (CDS) are among the very few financial instruments that some regulators and practitioners want banned. We study whether and when CDS trading impacts bank lending. We first show that the bank CDS position is positively related to the portfolio borrower CDS market. Then we find that, overall, firms receive larger loans after they become CDS referenced. However, this is only the case when the lead bank is active in CDS trading. CDS-referenced borrowers do not obtain larger loans when their lead banks do not trade CDS. Stock returns are higher for CDS-using banks than for non-CDS banks in tranquil times but lower during crisis periods, suggesting that CDS can induce procyclicality in banking performance. Our findings demonstrate the critical role that bank lenders play in transmitting the real effects of CDS.
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