THE EFFECT OF CREDIT DERIVATIVES USAGE ON THE RISK OF EUROPEAN BANKS

Abstract

Banks are the major participants in the derivatives credit markets. It was generally believed by top regulators that credit derivatives make banks sounder. After the international financial crisis, the positive view of the role of credit risk transfer has changed and credit derivatives have been blamed as one of the responsible of the subprime credit crisis. There are very few empirical works regarding this subject, but in particular in the case of the European banking sector. We use as measures of risk the Z-score, the two components, ZP1 and ZP2, and other proxies of credit risk like the risk-weighted assets and non-performing loans (NPL) ratio. In summary, our results show that European banks that use credit derivatives for hedging experience an improvement in their level of financial stability, while those who opt for a speculative position test negative. Accordingly and based on these data, the cause of the current crisis in Europe could not be directly attributed to the use of credit derivatives.

Keywords

• banking sector
• credit derivatives
• Z-score
• financial credit crisis.