Banks fail to weigh the costs of credit risk

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Banks fail to weigh the costs of credit risk

Credit provision is once again becoming a dangerous game. Tight bond spreads on high-grade, high-yield or emerging-markets paper are one obvious warning sign that investors? desperate chase for yield has overcome any sensible discrimination about underlying credit risk. But the clearest indication that institutions have failed to learn from the last recession and credit crunch is in the syndicated loan market.

Just two years ago many of the so-called retail, or, to use a more pejorative term, stuffee banks were pulling out of the syndicated loan market or significantly scaling back their commitments.

Loan and credit losses had scared them. Even though this was precisely when the banks should have been able to extract a much better return on their risk, structural absurdities prevented them from achieving this. The face-value terms of many deals were still ludicrously generous, reflecting more the desire of commercial banks to pick up other business than the true underlying risk of borrowers.

A few smarter banks found ways of picking up a better return. The commercial and investment banks in the upper echelons of the syndicate were offloading exposures at low prices either in the grey market ? the unofficial secondary market for loans not yet closed ? or through credit derivatives.

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