Credit Derivatives Not Panacea for Credit Problems, Says Report

The pace of innovation and the volume of activity in credit derivatives are heating up, but the instruments are not yet ready to become a significant force in risk management for banks, according to a report by Standard & Poor’s. ‘As promising as the credit derivative technology is, it is not yet a panacea for credit problems of banking systems around the world,’ said credit analyst Tanya Azarchs. ‘It has not, as is commonly believed, helped banks avoid meaningful amounts of losses in the current credit cycle.’ The reasons are three-fold: Much of the activity is dealer trading-related; the preponderance of credit protection available is on investment-grade names, which are not where the greatest risks are found; and for structured transactions, the risks are generally retained by banks. Credit derivatives, in their increasingly complex forms, will clearly pose challenges to accounting standards, regulators, and analysts, the report concluded.