Banks should report more details on risk-transfer transactions as their increasing use means shocks in debt and equity markets could spread more easily through the economy, a key financial watchdog said on Thursday.
The Joint Forum, a group of high-level financial industry supervisors, acknowledged in a report it found no evidence that the expanding risk-transfer market posed a disruptive threat as it had not led to hidden concentrations of credit risk.
However, as banks are making increasing use of selling risk to investors - often in the form of traded derivative instruments - a shock in either equities or bond markets could spread more easily into credit markets, widening the impact, it said.
"The growth of credit risk transfer activity ensures that such linkages, including linkages with both bond and equity markets, are likewise expanding. This implies, for example, that an event in one market will have a spillover effect into the credit risk transfer market," the report said.
The Joint Forum was established under the aegis of the Basel Committee on Banking Supervision, the International Organisation of Securities Commissions and the International Association of Insurance Supervisors.
Banks have weathered severe market downturns in recent years by increasingly making use of selling risk to investors like pension funds and insurance companies. This has often led to worries that a shock somewhere in the financial system might spread through the economy in a quick chain reaction.
The forum suggested a number of measures to mitigate the chance of such systemic risks - which are thought to escalate quickly because the system lacks administrative, regulatory or software features to halt them.
These ranged from ensuring that firms improve the data they disclose, that they use proper credit risk models and have the know-how to operate them, that documentation be standardised. Supervisors should also work together more closely.
Regulators have welcomed the increasing use of credit derivatives in general as having helped shelter banks from the worst of the downturn but have expressed concerns that they were unable to see who was the final buyer of the risk.