(in growth rates)
Sources: ECB annual national and financial accounts. 2005 data are preliminary ECB estimates.
0 1 2 3 4 5 6 7 0 1 2 3 4 5 6 7 shares and other equity
quoted shares unquoted equity
1996 1997 1998 1999 2000 2001 2002 2003 2004 2005
56 In common with most derivatives, credit derivatives can also be used – often by sophisticated financial intermediaries such as hedge funds – as a source of revenue, thus increasing credit risk exposure.
THE FINANCIAL LANDSCAPE OF THE EURO AREA In the course of the past decade, banks have
increasingly made recourse to the sale of loans to shed credit risk and to increase funding, initially mainly regarding residential mortgages, but more recently also for loans to non-financial corporations. In addition, over the past few years banks have been able to retain loans in their portfolio and, at the same time, to sell their credit risk exposure via credit derivatives. This included credit default swaps (CDSs) or the sale of bonds embedding hedging products (see sub-sections 4.2.1 and 4.2.2). The possibility of hedging loans has in turn contributed to the significant expansion of syndicated loans (see sub-section 4.2.3). From a corporate financing perspective, corporations have become increasingly aware of the possibilities open to them and have benefited from easier access to credit from banks, which are now able to mobilise significant amounts of financing in a very short period of time. Market participants from a variety of large key financial institutions were contacted in the course of a fact-finding mission which confirmed the relevance of the current financial innovations in reshaping the dynamics of corporate financing (see Box 6 for more details). Market participants also stressed the increasing sophistication of corporate treasurers and chief financial officers. The increasing familiarity with new products has put corporations in a better position to exploit fully funding possibilities, for example by switching from bond to bank funding, or by changing the leverage of firms (for example via share buybacks) according to market conditions. SECURITISATION OF BANK LOANS57
In recent years, the dramatic increase in the use of securitisation techniques is probably the most significant example of how financial innovation can affect corporate credit in the euro area. In broad terms, standard securitisation involves the pooling of (financial) assets and their subsequent sale, usually via a special purpose vehicle (SPV), which issues asset- backed securities (ABS) that are often bought by institutional investors to finance the purchase
of pooled assets. ABS can be split into tranches of different seniority, thereby catering for diverse credit risk profiles, which are in turn characterised by different credit ratings. Often the originator of the assets – in this case the bank – retains the tranche bearing the highest risk to signal the alignment of its interest to that of its investors. In addition, this creates an incentive for the originator to continue to monitor the credit quality of the underlying assets.
When the assets are effectively moved off the bank’s balance sheet, as in the case above, this is called a true sale or a cash securitisation. When purely the risk of the assets is sold, but the assets themselves remain on the balance sheet of the originator, this is called a synthetic securitisation. A synthetic securitisation is normally carried out with the use of credit derivatives, such as CDS, which are often embedded in bonds (normally called synthetic credit default obligations).
Banks have securitised an increasingly wide range of financial assets in recent years, and this has given birth to an equally wide range of different sorts of ABS. The most commonly securitised assets were initially mortgages.58
In recent years, more sophisticated forms of securitisation have been developed, and banks can now securitise a large portion of their corporate and consumer credit portfolio. Non- financial companies can also directly resort to securitisation techniques.
Focusing on the drivers of securitisation, it is worth mentioning that technological advances have enabled the development of sophisticated financial transactions that require complicated calculations and processing of financial data. The dramatic improvements in data storage 57 A large literature on securitisation and structured finance has
evolved in recent years. See for instance BIS (2004, 2005a and 2005b) and Schwarcz (1994) for a comprehensive discussion of securitisation.
58 In practice, two types of mortgage-backed securities (MBS) are distinguished: securities backed by residential mortgages (RMBS), and securities backed by commercial mortgages (CMBS).
have also contributed to these developments, as the accuracy of the pricing of these financial products depends to a large extent on data availability.
From an economic standpoint, the demand for structured products has grown rapidly, as they allow investors to invest in assets that have a very specific, sometimes even tailor-made, risk-return profile. The very low interest rate environment has stimulated securitisation for at least two reasons. First, low interest rates have increased the credit demand of the private sector, which has enabled banks to increase their issuance of loans, thus increasing considerably the amount of assets eligible for securitisation. Second, the demand for structured products has also increased due to the search for yield, especially on the side of institutional investors, as ABS have a relatively favourable risk-reward trade-off. For instance, the demand for ABS has increased in particular from institutional investors that need to achieve a certain minimum return (such as hedge funds or pension funds).59
Banks have an incentive to securitise assets to realise immediately the cash value of the
originated assets, or simply as a tool for raising liquid funds.60 In this respect, the new rules
on regulatory capital (Basel II) may create an incentive for banks to use sophisticated techniques in order to manage their exposure and diversify credit risk. From the viewpoint of corporations, securitisation has most likely increased the availability of funds, as banks have become more willing to lend funds. 4.2.1 BROAD DEVELOPMENTS IN SECURITISATION In recent years the size of the market for structured products (including true and synthetic securitisation) has expanded rapidly (at about 30% per annum in the euro area, see Chart 16), as has the range of ABS. In the Eurosystem’s official statistics, most of the securities issued by SPVs are included in debt securities issued by non-monetary financial corporations, which have indeed been growing very strongly in recent years (see Chart 17). Regarding the so-called true securitisation, the UK is the leading country in Europe in terms of securitisation transactions (see
Chart 16 Total funded structured finance