Syndicated loans and CDS insurance

Authors: Iñaki Aldasoro (BIS) and Andreas Barth (Goethe University and ESRB)

Title: Syndicated loans and CDS insurance

Abstract: Using a unique dataset on bilateral CDS exposures available at the European Systemic Risk Board (ESRB) following the EMIR regulation, combined with loan-level data from the syndicated loan market and balance sheet data for banks, this paper analyzes the usage of credit default swaps. We investigate the extent to which CDS are used for hedging, the purpose they were designed to serve, and the characteristics of the banks that actively use them. We find some evidence pointing to financial institutions using the CDS market to take on additional risk, instead of hedging their pre-existing credit risk. We find that lower charter values decrease the incentives for a bank to insure its credit risk exposures. Our result is robust to controlling for both observed and unobserved, time-varying, firm heterogeneity through time*firm fixed effects and for observed and unobserved, time-constant, bank heterogeneity. We also find that domestic (cross -border) loans tend to be less (more) insured, and that Euro area banks treat their intra-Euro area loans as domestic in terms of their hedging decisions. Finally, we find evidence that lead arrangers of syndicated loans tend to buy more protection; this points to a negative externality CDS impose on the syndicated loan market by exacerbating asymmetric information problems inherent to that market.