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

A bank wants to reduce its credit exposure to a large corporate borrower while keeping the borrower unaware of the arrangement and retaining the loan on its books with full customer relationship. Which tool best fits this objective?

A credit default swap referencing the borrower fits best. The bank buys protection and keeps the loan and the client relationship, while the borrower need not be told. Loan sales, novation and syndication all move the asset or involve the borrower directly.

  1. ALoan sale with notification to the borrower
  2. BNovation of the loan to another bank
  3. CCredit default swap referencing the borrowerCorrect
  4. DSyndication of the loan at origination

Explanation

A CDS lets the bank buy protection on the borrower's credit without transferring the loan or informing the borrower. Loan sales and novation transfer the asset and typically require borrower involvement or notice. Syndication spreads the loan at origination and also involves the borrower.

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