Last Updated : 09 November 2011 at 01:05 IST
US banks have huge exposure to European debt market
US banks have an exposure of $767 billion to the European debt market as per recent data by the Bank of International Settlements (BIS). This includes $518 billion in Credit Default Swaps (DCS) and $181 billion in direct lending. With these banks stating that their exposure has been covered, it raises the question who insures the insurer?
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NEW YORK (Commodity Online): US banks have an exposure of $767 billion to the European debt market as per recent data by the Bank of International Settlements (BIS). This includes $518 billion in Credit Default Swaps (DCS) and $181 billion in direct lending. With these banks stating that their exposure has been covered, it raises the question who insures the insurer?
A Credit Default Swap (CDS) is like an insurance whereby the insuring institution provide a guarantee to the buyer of the CDS to pay the debt in the event the debt holder defaults. In exchange, the buyer of the CDS pay a fee until the expiration of the CDS. But a CDS is different from an insurance in the sense that an outside party can buy a CDS.
At the end of Q3, the banks had reported that they held a net exposure of just $45 billion to Europe. What the US banks argue is that they have hedged against possible losses from CDS exposure. But so did many who had taken a CDS against US home mortgages with AIG prior to it's subsequent crash in 2008.
“Risk isn’t going to evaporate through these trades. The big problem with all these gross exposures is counterparty risk. When the CDS is triggered due to default, will those counterparties be standing? If everybody is buying from each other, who’s ultimately going to pay for the losses?” argued Frederick Cannon, director of research at New York-based investment bank Keefe, Bruyette & Woods Inc, Bussinessweek quoted.
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