Risk amplifiers will endanger credit market, report warns

High levels of speculation, leverage and securitisation mean the credit market is riskier than it appears, according to research published this month by the UK independent financial research company Clear Capital.

The company said credit derivatives volumes were growing far faster than could be justified by the need to manage credit risk, implying high and growing levels of speculation. Derivatives volumes are growing two to three times as fast as underlying credit issuance, and interest rate volatility is actually falling, according to data provided by the Bank for International Settlements that was cited in the Clear Capital report.

UK banks are also making a higher proportion of loans to other financial institutions than to the rest of the economy – the bulk of the loans go to issuers of mortgage-backed securities (MBS) and private equity houses. High degrees of leverage mean a small disturbance could be amplified very easily and rapidly, the report said.

The existence of the risk amplifiers mean a relatively small shock could trigger a credit downturn, and that the impact would be faster and more widespread. While banks carry high levels of regulatory capital, MBS issuers could be in danger, with little of the risk currently priced in, Clear Capital said.

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