Credit derivatives have contributed to dramatic changes in the process of credit intermediation, and the benefits of these changes seem compelling. They have made possible substantial improvements in the way credit risk is managed and facilitated a broad distribution of risk outside the banking system. By spreading risk more widely, by making it easier to purchase and sell protection against credit risk and to actively trade credit risk, and by facilitating the participation of a large and very diverse pool of non-bank financial institutions in the business of credit, these changes probably improve the overall efficiency and resiliency of financial markets. With the advent of credit derivatives, concentrations of credit risk are made easier to mitigate, and diversification made easier to achieve. Credit losses, whether from specific, individual defaults or the more widespread distress that accompanies economic recessions, will be diffused more broadly across institutions with different risk appetite and tolerance, and across geographic borders. Our experience since the introduction of these new instruments - a period that includes a major asset price shock and a global recession - seems to justify the essentially positive judgment we have about the likely benefits of ongoing growth in these markets. Despite the benefits to financial resilience, the changes in the credit markets that are the subject of your conference have also provoked some concerns and unease, even among those on the frontier of innovation and the most active participants in these markets.
Timothy F Geithner: Implications of growth in credit derivatives for financial stability Remarks by Mr Timothy F Geithner, President and Chief Executive Officer of the Federal Reserve Bank of New York, at the New York University Stern School of Business Third Credit Risk Conference, New York City, 16 May 2006. *  *  *  Thank you for giving me the opportunity to speak to you today. We're in the midst of a period of rapid growth and innovation in the market for credit derivatives, and the developments in this market have important implications for broader financial market functioning and stability. A vital and efficient financial system such as ours is defined by its ability to identify new ways to allocate capital and share risk, but often the pace of innovation in the instruments themselves outstrips the pace of improvement in the risk management and control infrastructure. The credit derivatives market is no exception to this general observation. In my remarks today, I'll focus on some of the implications of these changes in the credit derivatives market for the stability of the overall financial system. As with any attempt to explore the broader implications of rapid growth in a new market, I'll say more about what we do not know than about what we do know. I'll also highlight the need for continued progress in addressing the challenges posed by the rapid growth in this market.