Credit Derivatives and Structured Credit: A Guide for Investors

7

The Impact of the Development in Credit Derivatives

Because banks occupy a central position in the credit derivatives markets, they are at the heart of any changes. We have observed many times in earlier chapters that banks could gain much from increased use of credit derivatives. Quite apart from these advantages for the banks, the impact of the growing use of credit derivatives by banks and other players in the capital markets must also be examined. They profoundly affect banks’ strategies, business models and environment.

The purpose of this chapter is to examine the fundamental changes currently taking place in the financial markets and analyze them objectively. The essential questions about credit derivatives can be divided into three main groups:

1. The new role of banking institutions in a market-driven credit industry: do banks continue to act in their traditional role as lenders, or are they gradually moving towards a business model that could be described as a ‘risk transformation factory’?
2. The central, but delicate issue of regulations for the capital markets, which are now globalized and deregulated: more especially, is the exponential growth in credit derivatives indicative of a major financial crisis in the making, in the sense that they are like a virus contaminating the entire economic system with credit risk? Are credit derivatives and other financial derivatives really the ‘weapons of mass destruction’ of the financial world so vilified by some market observers, ...