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10 May 2001

CREDIT DERIVATIVES TO HELP BUILDING SOCIETIES MANAGE LOAN RISK

Building societies will now be able to use credit derivatives to protect themselves against credit risk, following a legislative change put forward by the Treasury today.

Building societies are already allowed to use derivatives to protect themselves against interest rate risk, currency risk and fluctuations in house prices.  Today, the Treasury agreed to a proposal by the Building Societies Commission to use its powers to add credit risk to the list of prescribed risk factors.

Credit derivatives are a relatively new product that can be used to protect financial institutions against losses on a loan or debt security, should a borrower default.  The Building Societies Commission now considers the credit derivative market to be sufficiently developed to offer building societies broad and flexible protection - which is already available to other financial institutions - if they wish.  Credit derivatives will initially be used only by societies which already have sophisticated treasury management capability or are experienced in using other kinds of derivatives.

NOTES TO EDITORS

  1. Credit derivatives provide a new and useful method of limiting and controlling the credit risk (risk of borrower default and ultimate loss) in a portfolio of loans, debt securities or other financial assets. Credit derivatives were developed in the international bond market, but the same method is also applicable to domestic risks and to pools of retail-size assets, such as mortgages.
  2. Section 9A of the Building Societies Act 1986 seeks to ensure derivatives are only used for appropriate risk management purposes, and not for speculation. It sets out a list of risk factors where the use of derivatives is permissible, which can be amended by statutory instrument, using the negative resolution procedure.
  3. The request for access to credit derivatives came from a number of the larger established building societies, with the support of the Building Societies Association.
  4. The Building Societies Commission concluded that borrower default should be added to the list of prescribed factors, using the statutory instrument power in the relevant section of the Building Societies Act.
  5. Statutory instrument (SI) 1826 was laid in Parliament today.
  6. For further information, contact Liane Farrer, Treasury Press Office, on 020 7270 5192.