CFS Working Paper Nr. 98/07 Credit Securitization and Credit Derivatives: Financial Instruments and the Credit Risk Management of Middle Market Commercial Loan Portfolios

Abstract: Banks increasingly recognize the need to measure and manage the credit risk of their loans on a portfolio basis. We address the ubportfolio "middle market". Due to their specific lending policy for this market segment it is an important task for banks to systematically id ntify regional and industrial credit concentrations and reduce the detected concentrati ns through diversification. In recent years, the development of markets for credit securitization and credit derivatives has provided new credit risk management tools. However, in the addressed market segment adverse selection and moral hazard problems are quite severe. A potential successful application of credit se uritization and credit derivatives for managing credit risk of middle market commercial loan portfolios depends on the development of incentive-compatible structures which solve or at least mitigate the adverse selection and moral hazard problems. In this paper we identify a number of general requirements and describe two possible solution concepts