Interesting, if short, paper today from the BIS on the impact of credit risk transfer. In a way, this is just a warning shot across the bows of the credit risk transfer industry and a timely reminder not to treat the current, benign, conditions as if they were normal.

The paper highlights the important parts of the risk transfer – that a lot of the risk is moved from the bank’s balance sheet to other financiers, including hedge funds, that may have a higher appetite for risk. Overall, the greater dispersal of the risks improves systemic stability. The problem he highlights, though, is often missed.

Essentially, the lack of transparency on the part of those taking the risk on means that, for large mounts of the buyers of this risk, there is no published information on how much they have taken on. Hedge funds, for example, typically do not publish their portfolio structure, so banks selling them credit risk may not know that they already are heavily exposed to the type of risk they are buying. This will increase the risk that they, in turn, will default – possibly leaving the bank to front up for risk they thought they had transferred.

The BIS’s choice to publish this piece is interesting, and probably means that the regulators are going to be starting to look seriously at this area over the next few months – particularly in the US as the sub-prime problems work their way through the system.

If you have transferred risk to hedge funds or other unregulated entities, expect to get some questions about the due diligence you have