(Bloomberg) -- Regulators need to step up the oversight of banks' use of synthetic risk transfers which may make the financial system more fragile, according to a paper released by a group of International Monetary Fund officials.
"Enhanced disclosure is important for markets," IMF experts including Fabio Cortes and Gonzalo Fernandez Dionis wrote in the paper, Recycling Risk: Synthetic Risk Transfers. "There are significant gaps in data availability necessary for authorities to monitor interconnectedness and leverage and related financial stability risks in an effective and timely manner."
SRTs allow banks to insure loans against default by selling credit-linked notes to pension, sovereign wealth and hedge funds. That means banks are able to bolster their solvency ratios or free up capital to pursue growth. Typically, a lender obtains default protection for between 5% and 15% of the loans' value.
Among the risks the IMF authors cite:
- SRT circularity, where credit funds finance their investments using bank debt, potentially increasing systemic leverage
- Banks rely on a "limited" investor base to keep rolling over their debt
- Blind pools where the names of borrowers are undisclosed
- The opacity of transactions that makes it harder to evaluate exposures
Highlighting the risk of circularity,
"Safeguarding financial stability requires enhanced monitoring of effective risk transfer, investor leverage, and blind pool opacity," the working paper whose authors also include Yiran Li, Silvia L. Ramirez, and Xiaoxiao Zhang.
The note of caution comes as the European Union considers ways to bolster the securitization markets — including reducing the regulatory capital charges tied to some type of loan portfolios included in SRT deals.
Global SRTs are expected to expand 11% annually on average in the next two years, according to a Bloomberg Intelligence survey earlier this year. Synthetic securitizations issued by large banks in Europe surged more than 85% in the first half from a year earlier, a senior official at the European Central Bank said last week.
More stories like this are available on bloomberg.com
