Banks’ New Trick Could Mean Trouble for Everyone

If you’re unfamiliar with synthetic risk transfers, there’s a chance you’ll hear all about them when the next financial crisis hits. They’re the latest way for big banks to game rules designed to safeguard the system, and they’re growing fast. So far, regulators seem all but oblivious.

Financial resilience depends largely on one line in banks’ balance sheets: equity. Also known as capital, it’s funding from shareholders who, unlike creditors, have agreed to absorb losses. The more equity banks have, the better they’re able to keep lending in difficult times. Bank managers, however, prefer to use more debt, because it comes with various government subsidies and boosts key profitability measures in good times.