Odd Lots The Hottest Way for Banks to Get Risk Off Their Balance Sheets
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Aug 22, 2024 
Michael Shemi, North America structured credit leader at Guy Carpenter, dives into the booming market of synthetic risk transfers. He explains how banks are using these innovative financial instruments to manage regulatory capital and mitigate risks. The conversation includes insights into the evolution of credit risk transfer, the differences between U.S. and European markets, and how recent trends are reshaping financial stability. Shemi also touches on the lessons learned from the 2008 crisis, highlighting the importance of transparency in today’s banking landscape.
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Synthetic Securitization
- Banks use various tools like loan sales, participations, and securitizations to manage balance sheet constraints.
- Credit risk transfer (CRT) or synthetic risk transfer (SRT) is one such tool, focusing on synthetic securitization.
Purpose of Regulatory Capital
- Banks hold regulatory capital to absorb unexpected losses, not expected losses, which are priced into loans.
- Regulatory capital acts as a proxy for unexpected losses beyond what banks already provision for.
US vs. Europe CRT Market
- The US CRT market lagged behind Europe's due to regulatory differences, stronger US bank balance sheets, and less need for active balance sheet management.
- European banks, facing capital constraints and trading at discounts to book value, had a clearer business need for CRT.