4.2 Management of Risk: General Remarks 95funds left to repay the B notes after the repayment of the A notes). If the A notes have been
issued by an operating subsidiary and the B notes by a holding company, the B notes will
even be structurally subordinated (section 6.3.5 ) to the A notes (as the holding company
relies on assets distributed by its operating subsidiary).
Credit risk transfer, assignment. The subsequent transfer of credit risk from a
lender to another financial institution can influence the position of the borrower
(the firm).
Credit risk transfer can have an adverse effect on the position of the borrower
by causing moral hazard problems even if the lender-borrower relationship re-
mains formally intact (for example, the relationship remains formally intact if the
lender has used credit derivatives or insurance to transfer risk instead of selling the
claim outright). The behaviour of the lender towards the borrower may change at
least in three ways. First, the original lender may be expected to reduce its credit
risk monitoring (and the lender’s role as an agent of the firm, see Volume I).^37
Second, the existence of credit risk protection might influence a lender’s behav-
iour with respect to distressed borrowers, because loss protection changes the
risk/return profiles of various alternative actions (and increase counterparty com-
mercial risk for the firm, see Volume II).^38 Third, once the lender has transferred
its credit risk, it may be in the lender’s interests to cause an event that prematurely
triggers payment.^39
Even the behaviour of potential future lenders may change. Some market par-
ticipants may interpret the transfer of risk as a negative signal about a borrower’s
creditworthiness.
Furthermore, where the claim has been assigned to a third party that took the
lender’s place, the assignee may be less constrained in its actions towards the bor-
rower.
For example, German banks constrained by the need to protect their brand sold their troubled
mortgage loan portfolios to Lone Star, a private-equity firm based in Dallas. It soon turned out
that Lone Star could liquidate the mortgages in a more ruthless way (see Volume I).^40
Because of the potential signalling effect and/or potential moral hazard problems,
some powerful corporate borrowers may: be reluctant to accept the free transfer-
ability of their loans (see section 8.3.4 and Volume II);^41 require a clause in the
loan contract which prohibits the lender from purchasing protection;^42 and refuse
to provide visible credit enhancements.
(^37) BIS, CGFS, Credit risk transfer, January 2003 p 21.
(^38) Ibid, p 21.
(^39) Ibid, p 41.
(^40) See Balzli B, Pauly C, Vollstrecker aus Texas, Der Spiegel 31/2006 pp 58–60: “Die
neuen Gläubiger wollen die billig erworbenen Kredite nicht verwalten, sondern
möglichst schnell verwerten - ohne Rücksicht auf Verluste.”
(^41) BIS, CGFS, Credit risk transfer, January 2003 p 21.
(^42) BIS, CGFS, Credit risk transfer, January 2003 p 41.