New York Fed President Timothy Geithner last month said the 10 largest bank holding companies in the U.S. had about $600 billion of potential credit risk from their derivatives holdings. That represents about 175 percent of so-called tier-one capital, the funds banks need to satisfy legal requirements for safety and soundness.
This could be a problem.
An excellent article was written in Bloomberg yesterday, that discusses this issue in greater detail.
Credit Derivatives Market Expands to $17.3 Trillion
March 15 (Bloomberg) -- The global market for credit derivatives grew 39 percent to $17.3 trillion in the second half of 2005 on demand for contracts to bet on corporate credit quality or insure against defaults.
Credit-default swaps, which pay compensation in the event of borrowers defaulting on their debt, expanded 105 percent in the full year, leading gains in the overall market for contracts based on underlying assets. Growth slowed from the 123 percent increase in 2004, the International Swaps and Derivatives Association said today in Singapore at its annual meeting.
Regulators are concerned that credit derivatives are growing too quickly for banks to control. The Federal Reserve Bank of New York has demanded action to tackle a backlog of contracts left unsigned for months on concern the undocumented transactions threaten the stability of the financial system.
``There's been a certain amount of regulator scrutiny, which may have had some effect'' on growth rates, ISDA Chairman Jonathan Moulds told reporters in Singapore. ``I don't think it's dramatically significant.''
Credit derivatives are the fastest-growing part of the $270 trillion market for derivatives, obligations based on interest rates, events or underlying assets, according to figures from the Bank for International Settlements. The market expanded more than fivefold in two years, according to ISDA.
The trade group represents 700 banks, securities firms and institutional investors that use derivatives.
New York Fed
New York Fed President Timothy Geithner last month said the 10 largest bank holding companies in the U.S. had about $600 billion of potential credit risk from their derivatives holdings. That represents about 175 percent of so-called tier-one capital, the funds banks need to satisfy legal requirements for safety and soundness. Tier-one capital is composed of common stock and retained earnings.
Fourteen of Wall Street's biggest banks committed to cut the number of unsigned trades by 70 percent before July, according to the New York Federal Reserve this week.
Credit-default swaps were designed to protect creditors against non-payment of debts, and some investors now use them to bet on a company's credit quality. Contract buyers pay an annual fee and receive the full amount insured if a borrower defaults. Under the current system, buyers are obliged to deliver the defaulted loans or bonds to the insurer.
When Delphi Corp. collapsed in October, investors held insurance entitling them to more than 10 times the value of the auto-parts maker's bonds. Shortages of notes needed to settle the contracts caused prices for the defaulted bonds to soar.
Interest-Rate Swaps
Contracts to swap between fixed and floating interest payments, the biggest part of the market, increased 6 percent to $213.2 trillion, ISDA said. The growth rate was slower than the 10 percent expansion in the first half, the New York-based group said.
The market for equity derivatives, which let investors speculate on or guard against changes in stock prices, grew 15 percent to $5.6 trillion in the second half, ISDA said. In the full year, the amount expanded 34 percent, compared with 28 percent in 2004.
The figures are based on a survey of as many as 98 firms and include transactions that take place outside exchanges in the so- called over-the-counter market. They reflect the notional amount -- the value of the securities underlying the contracts.
