Banks engage in regulatory capital arbitrage mainly through securitizations and credit derivatives. These vehicles offer improved opportunities for banks to manage their risks and liquidity. Securitizations allow banks to transfer the risk of an underlying loan pool to capital markets, retaining their role in the origination of loans, but transferring more of the ultimate funding to the capital markets.
Credit derivatives are another vehicle for shifting some of the risk of the underlying loan pool, while avoiding disclosure of an effective loan sale and possibly harming a customer relationship. There are two problems with the use of securitization and credit derivatives.