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FRM Part I · FRM Exam Part I · Credit Risk Transfer Mechanisms

A bank holds a large concentrated loan to a single corporate borrower and wants to cut its credit exposure without notifying the borrower or transferring legal ownership of the loan. Which credit risk transfer mechanism best fits this objective?

A single-name credit default swap fits best. The bank buys protection on the borrower, shifting default risk to the seller while keeping legal ownership of the loan and the client relationship, with no need to notify or obtain consent from the borrower, unlike sales or assignments.

  1. AOutright loan sale with novation
  2. BLoan assignment requiring borrower consent
  3. CPurchase of a single-name credit default swap referencing the borrowerCorrect
  4. DSyndication of a new loan facility

Explanation

A single-name CDS transfers the credit risk of the reference entity to the protection seller while the bank keeps the loan on its books and the borrower relationship intact. Sales, assignments and novations transfer legal ownership and typically involve the borrower. Syndication relates to originating new loans, not hedging an existing one.

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