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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 reduce its credit exposure while keeping the client relationship and without notifying the borrower. Which mechanism best fits this objective?

A single-name credit default swap fits best. The bank buys protection on the borrower, shifting default loss to the protection seller while still holding the loan and the client relationship, and the borrower generally does not need to be told or give consent.

  1. ASelling the loan outright through an assignment that requires borrower consent
  2. BBuying credit protection through a single-name credit default swap on the borrowerCorrect
  3. CSyndicating the loan to a group of lenders with public disclosure
  4. DIncreasing the loan interest rate to compensate for default risk

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 client relationship, typically without the borrower's knowledge. Outright assignment usually needs consent and moves the relationship. Repricing does not transfer risk.

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