Banks Love Significant Risk Transfers — and That Has Regulators Worried

Banks have been in a bind. They want to make more loans so they can better compete against non-banking lenders and boost profits, but they have been hindered by tighter rules imposed after the 2008 financial crisis that require them to hold aside extra money to cover potential losses on the loans they have already made. This leaves less fresh capital available to pursue new lending or expand the company.

Increasingly, the banks are turning to a financial instrument, the significant risk transfer, or SRT, that cuts the amount of risk on their books, freeing up money they had held in reserve and allowing them to make new loans and investments. SRTs are essentially an insurance policy for banks, who pay third parties such as hedge funds to agree to cover some of the banks’ losses if the loans in question don’t get repaid.