Issuers, though, transferred much of the risk and did so comprehensively, as they needed to demonstrate that they had transferred risk irrevocably before they could get capital relief. But in the absence of adequate monitoring, originators could chase volume at the expense of lending standards. 5  See for example, the Bank of England Financial Stability Report, October 2007. BIS Review 93/2008  7  27 Therefore, two elements at the heart of the benefits of financial innovation – the ability to pool and transfer risk – contributed to an endogenous increase in the level of underlying credit risk. 28 There is also a potential incentive problem arising from the separation of legal ownership from economic exposure – although this is at the moment a possible difficulty for the future. Credit default swaps transfer the risk of economic loss to the seller of protection but the right to trigger covenants or put a firm into administration remains with the underlying asset holder. A protected asset holder, therefore, has little incentive to monitor a company closely and trigger covenants or force it into administration at the first signs that its business may have become unsustainable. And the seller of protection lacks an alternative legal remedy. Companies may therefore continue to operate for longer than they did in the past once they get into trouble. So, the use of credit default swaps may reduce the probability of default but increase loss given eventual default.
Conclusion The short-term outlook for financial stability appears to be favourable. In the long term, high and rising household debt is a source of uncertainty. Admittedly, household financial wealth has also increased, but debt and wealth are unequally distributed across different household groups. Low interest rates and stable macroeconomic developments indicate that the outlook for households is favourable in the short term. In the longer term, the higher household debt burden represents a source of instability in demand and output. 6  BIS Review 39/2005