But at yearend 2011 and last June we brought our Monetary Policy Report to you in the midst of heavy external turbulence, with market expectations that did not rule out the occurrence of worst-case scenarios in the near future. Today, as in last March, we are presenting our Report in a calmer environment, but where the risks are still there. Our baseline scenario assumes that stress episodes will be repeated in the world markets. Why is that? Simply because the situation in developed economies with their complex macroeconomic, financial and fiscal problems is far from being resolved. There is a long road ahead. The classical economic policy conundrum is time consistency, as the costs are paid upfront for promised benefits for the future. Plus, in the case of the Eurozone, a difficult collective action problem, due to difficulties in spreading the cost among those involved. Thus, policy decisions are pushed back while the problems needing resolution only aggravate over time. We may add that the bigger emerging economies, including China, Brazil and India, are showing signs of a sharper than expected deceleration. Their weight in world trade, and particularly with Chile, makes us worry about their evolution. Although the copper price has been fairly stable, a further deceleration of the Chinese economy could have significant effects on the rest of the world and drive us to a complex situation, especially if it triggers a reduction in our terms of trade. Let us stop for a moment to examine the current account of the balance of payments.
The bank can sell its credit risk on the company, entirely or partially, without needing to cancel the loan or to have any discussion at all with the company. At the same time, the buyer of the credit risk (the seller of the credit derivative) does not need to tie up more than a fraction of the capital that would have been required to take over the credit directly. Moreover, the buyer of the credit risk can in turn easily sell the risk to another party, wholly or partially. Reinsurance thus becomes both simpler and cheaper to manage than with regard to traditional credit insurance. Large investors such as mutual fund companies and insurance companies often want to have a particular amount of credit risk in their portfolios. The credits can actually reduce their total risk, as the prices of the credits do not have such large covariation with other prices, for instance, the prices of shares and real estate. A certain share of credits provides a more diversified portfolio, which gives lower risk for a given expected return. Credit derivatives also makes it possible to divide up credit risks into small parts and to trade these parts at a low cost. This is not possible with traditional credit insurances. As the trade is so extensive, the pricing of credit risk becomes much improved. From the economy’s point of view, it is essentially positive that the credit risk is spread to institutions outside of the bank system.