Managing Credit Risks

Credit derivatives are hailed as the next big thing in credit risk management for banks. Lian Wee Cheow and Chua Kim Chiu look at the scope of their potential and some obstacles in their way.

The effective management of credit risk is vital to the success of a bank. By allowing banks and other financial institutions to transfer credit risk from one party to another, credit derivatives have helped to enhance the efficiency and flexibility of credit risk management in these institutions.

The advent of credit derivatives has also allowed participants such as banks and investors to isolate credit risk as a key component, thus separating the risk from the intrinsic influences of the underlying lending relationship. In so doing, participants can now view credit as a tradable commodity, resulting in an increased focus on active credit portfolio management.

On the other side of the equation, there is also...

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