Syndicated loans and CDS positioning

The bank for International Settlements (BIS) has published a paper that shows how banks in Europe use Credit Default Swaps (CDS). They have analysed whether and how banks use the CDS market to buy or sell protection on the default of firms they lend to (via syndicated loans). Read more about the BIS-paper on our website.
Contribution
The main novelty of our paper is the combination of different detailed datasets capturing the amounts lent by banks to non-financial corporations in the syndicated loan market, the amounts of default protection bought and sold by banks in the CDS market, and balance sheet data for banks. We are the first to perform a cross-country analysis on the usage of CDS. Our broadest sample contains 1,022 banks from 28 countries that lend to 14,660 different firms from 144 countries. Finally, our data allows us to identify ways in which CDS can distort the syndicated loan market.
Findings
We document that banks use the CDS market for position taking (i.e. to “double up” to some extent on their credit risk exposures to a particular firm). Using standard statistical tools, we find that banks tend to hedge a larger share of loans to relatively riskier firms, and that banks with  higher leverage, more wholesale funding, and lower return on assets tend to insure less of their exposures. We find no evidence that banks use the CDS market to lower regulatory risk-based capital ratios, or in other words to seek capital relief, as some argue. Domestic exposures are less likely to be doubled-up than cross-border exposures. Finally, our results show that the main lender in a syndicate tends to insure more of its credit risk than its partners and therefore has less at stake if the firm defaults. This exacerbates the uneven distribution of information and can distort market functioning.
Abstract
This paper analyzes banks’ usage of CDS. Combining bank-firm syndicated loan data with a unique EU-wide dataset on bilateral CDS positions, we find that stronger banks in terms of capital, funding and profitability tend to hedge more. We find no evidence of banks using the CDS market for capital relief. Banks are more likely to hedge exposures to relatively riskier borrowers and less likely to sell CDS protection on domestic firms. Lead arrangers tend to buy more protection, potentially exacerbating asymmetric information problems. Dealer banks seem insensitive to firm risk, and hedge more than non-dealers when they are more profitable. These results allow for a better understanding of banks’ credit risk management.
Source: https://www.bis.org/