Financial Innovation in Retail and Corporate Banking

Financial Innovation in Retail and Corporate Banking

New Horizons in Money and Finance series

Edited by Luisa Anderloni, David T. Llewellyn and Reinhard H. Schmidt

This valuable book discusses in detail, through a blend of theory and empirical research, the processes of innovation and the diffusion of new financial instruments.

Chapter 9: Credit Derivatives versus Loan Sales: Evidence from the European Banking Market

Mascia Bedendo and Brunella Bruno

Subjects: business and management, corporate governance, economics and finance, corporate governance, financial economics and regulation, money and banking

Extract

Mascia Bedendo and Brunella Bruno INTRODUCTION 1 Credit risk transfer (CRT) techniques such as securitisation, loan sales and credit derivatives (CDs) have been an important part of a wave of financial innovation during recent years. A fuller appreciation of these instruments and their implications for the banking industry requires some understanding of their role within the general framework of financial innovation. There are various ways of looking at innovation. As far as the motivations for financial innovation are concerned, no general – or at least generally accepted – explanation exists, although there is a wide body of literature that addresses this issue. Given the multiplicity of theories, motivations for loan sales and CDs can be studied according to different perspectives. Adopting a taxonomic framework, loan sales and CDs help financial institutions to perform important functions, such as those of transferring credit risk and enhancing liquidity. Looking at the conditions that have stimulated financial innovation, improvements in both transaction and information technologies are considered fundamental incentives for both CDs and loan sales. Moreover, improvements in the ability to collect and elaborate information have made it easier to sell and buy assets subject to ‘lemon-market’ problems (that is, asymmetrical information between the seller and the potential buyer) such as loans. Finally, according to various authors, regulatory constraints represent one of the most important motivations for transferring credit risk (both via CDs and loan sales). This chapter aims at comparing the role of CDs and loan sales in transferring credit risk away from banks,...

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