If the credit risks disappear from the banks, where do they go? Today I intend to speak a little bit about the risks involved in credit derivatives, which so far mainly concern the international market. Here in Sweden the use of credit derivatives is still limited, although increasing. Then I intend to mention the opportunities I see in Sweden. But let me first run through how credit derivatives are used and how the market has developed in recent years. 1  How do credit derivatives work? A credit derivative is a financial contract between two parties. It insures the buyer of the contract against the credit suffering a credit event during a predetermined period. The credit event quite simply defines what the insurance covers, in roughly the same way as the conditions in a normal home insurance. I shall return to this shortly. Take, for instance, a company like TeliaSonera. Then imagine a bank that has loaned money to this company. This may involve a lot of money as TeliaSonera is a large company. Although Telia’s ability to pay is good when the loan is taken, the bank is exposed to the risk that it may deteriorate in the long term. If the bank considers the credit risk to be too high, it may choose to "sell" part of it to another investor. Then the bank can use the credit derivatives market. For the bank, which in this case is the seller of credit risk, the credit derivative functions roughly like a normal insurance.
How are credit derivatives used in Sweden? As you may know, Sweden currently has one of the world’s most developed derivative markets. This is seen in relation to the size of the economy and the turnover on the stock market. But when it comes to credit derivatives, the situation is different. Here the trade is much more limited. This is primarily due to our corporate bond market being so small. And without corporate bonds, it has been difficult to trade in credit derivatives. The major Swedish banks base their core activities on long-term customer relations. Credits to small and medium-sized companies are predominant. The banks’ exposures to companies traded actively in the credit derivatives market are relatively small. Moreover, the banks have had plenty of capital and the need to sell credit risk to outsiders has been limited. The number of deals in credit derivatives has increased in recent years, but the total exposures remain small, on the whole. The major part of the trade has been on behalf of customers. This means that the banks mediate deals for customers, for instance, insurance companies, which for various reasons want to buy or sell credit risk. If we look ahead, there is reason to believe that credit derivatives will gain increased significance. This is partly related to the new capital adequacy rules, Basel II. The Basel rules, the old and the new, regulate how much capital a bank needs to cover the risks in its credit portfolio.