Credit markets continue to evolve in light of lessons learned from the 2008 financial crisis, more stringent regulation, and technological improvements.
Whatever ultimate impact the foregoing changes have on credit markets, they are likely driving two important trends.
The first trend is commercial banks playing a smaller role in the economy. A good reflection of this trend is the shrinking share of banks as investors in loans made by multiple lenders (i.e., leveraged/syndicated loans). As Steve Miller reports, bank participation in leveraged loans relative to that of non-banks hit a record low in the third quarter of 2012, down to 13%. The following chart from the story shows significantly reduced bank participation in the leveraged loan market since 2009 (and also that this trend is the culmination of a phenomenon underway for nearly two decades).
A second important trend in credit markets is the reduced use of credit derivatives. The September 2012 quarterly report by the Bank for International Settlements contains the following chart that shows the decline in the notional value of credit default swap (CDS) derivatives since 2008.
CDS trading is also decreasing. As Stephen Folely recently reported in the Financial Times, so far in 2012 "trading in individual corporate CDS is down 23 per cent."
Additional regulatory requirements are likely driving the steady decline of CDSs, which will soon not offer banks the capital relief they once did--quite the opposite. But the ability to transfer credit risk through other means is also likely behind the decline. The willingness of investors to buy bonds backed by corporate debt (i.e., collateralized loan obligations) at prices attractive to issuers decreases the benefit of transferring that same risk through the use of derivatives.
If these trends hold, we can expect that banks and credit derivatives will play a smaller role in the financial system of the future. The key question is what will take their place.
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