The Basel Committee’s Concerns Over Synthetic Risk Transfers
The Basel Committee on Banking Supervision has issued a warning about potential rollover risks in Synthetic Risk Transfer (SRT) markets, particularly concerning the appetite of investors. In times of economic downturns, the organization suggests that the appetite for synthetic risk transfers could decrease considerably, leading to significant risks.
What are Synthetic Risk Transfers?
SRT transactions form a crucial part of the financial system. They involve banks transferring the credit risk of a pool of assets to a counterparty, typically a non-bank, while retaining ownership of the assets. This process allows banks to free up their capital and reduce potential losses from credit events, thereby improving their overall risk management.
Rollover Risks in Times of Stress
However, the Basel Committee has expressed concerns about an excessive reliance on SRTs. In their report, they highlight that during periods of stress, banks may find it increasingly difficult to renew or replace their SRT transactions, leading to ‘rollover’ risks.
Rollover risk is the risk that a bank will not be able to refinance its debt on the maturity date. If investors’ appetite for SRTs lessens during downturns, banks may find themselves unable to transfer the credit risk of their assets. Consequently, they may face increased credit risk exposure and potential losses.
Investigating Links Between Banks and Non-Banks
The report forms part of the Basel Committee’s ongoing efforts to investigate the interconnections between banks and non-banks. It is part of a broader effort to ensure the stability of the global banking system, particularly as non-bank financial institutions become more prominent in the financial landscape.
By identifying potential risks in advance, the Basel Committee aims to provide banks and regulators with the necessary information and tools to mitigate these risks. This way, the financial system can continue functioning efficiently, even during periods of economic stress.
The full report can be accessed Here.
Looking Ahead
The Basel Committee’s report serves as a reminder of the intricate interconnections within the financial system. As the financial landscape evolves, it is vital for banks and regulators to stay informed about potential risks and take appropriate measures to mitigate them. By doing so, they can ensure the continued stability and resilience of the global banking system.
