Synthetic risk transfers: Market growth, structures, and supervisory challenges

Synthetic risk transfer (SRT) transactions enable banks to offload credit risk from a pool of assets to a third party, typically private investment funds, while retaining ownership of the underlying loans.

This contrasts with traditional securitisation, where asset ownership is transferred off-balance sheet.

Banks primarily engage in SRTs for capital and credit risk management, seeking to reduce regulatory capital requirements and optimize their balance sheets.

Investors, including pension and hedge funds, are drawn to SRTs as they offer exposure to bank-originated loan portfolios without the need to own, fund, or service the individual loans.

Most SRTs are fully funded, with investors providing upfront collateral to mitigate counterparty credit risk, making them generally less complex than pre-Great Financial Crisis credit risk transfer instruments.

The market has seen increasing participation from both large and smaller banks, indicating a broadening appeal for these risk management tools.

The economic significance of the SRT market has expanded considerably over the past decade.

Assets protected by SRTs average around 1.1% of banks' consolidated total assets, ranging from 0.9% to 1.8% across jurisdictions.

Corporate loans are the largest asset class benefiting from SRT protection, with some European banks receiving protection for over a third of their corporate loan books.

The Basel Framework sets requirements for synthetic securitisations, but individual jurisdictions often impose additional criteria for risk transfer recognition and capital relief.

Supervisors may restrict capital relief if it is not commensurate with actual risk transfer.

Concerns persist regarding limited transparency in SRT financing activities and insufficient disclosure of SRT impacts on bank capital, prompting ongoing supervisory efforts to address these blind spots.