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

A bank holds a portfolio of corporate loans and wants to remove credit risk from its balance sheet while keeping the borrowers unaware of the transaction and retaining the loan relationship. Which tool is MOST suitable?

Buying credit default swap protection is the most suitable tool. It moves credit risk to the protection seller without borrower consent or notice, and the bank keeps the loans and the client relationship, unlike assignment or novation, which change the lender of record.

  1. ALoan syndication with assignment requiring borrower consent
  2. BBuying a credit default swap referencing the borrowers, while keeping the loans on the booksCorrect
  3. CIssuing equity to increase its capital buffer
  4. DSelling the loans through novation to a third party

Explanation

A CDS buyer transfers credit risk to the protection seller without needing borrower consent and without transferring the loan, so the relationship stays with the bank. Assignment and novation generally involve the borrower and change the lender of record. Issuing equity adds capital but does not transfer credit risk.

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