Hans Reckers: Interaction of market and credit risk
Welcome address by Dr Hans Reckers, Member of the Executive Board of the Deutsche
Bundesbank, at the Conference on the Interaction of Market and Credit Risk, Berlin,
6 December 2007.
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Ladies and gentlemen
I would like to warmly welcome you to our conference on the interaction of market and credit
risk, which is being held jointly by the Research Task Force of the Basel Committee on
Banking Supervision, the Deutsche Bundesbank and the Journal of Banking and Finance.
As a board member of the Deutsche Bundesbank, I am proud that our institution is hosting
this conference of distinguished researchers, bank practitioners, regulators, and central
bankers.
I am especially proud that the Deutsche Bundesbank offered to host this conference more
than one year ago when it was not at all clear that the interaction of market and credit risk
would be receiving as much attention as it is today. Given recent events in the financial
markets, the interaction of different risk types has become quite topical.
The conference topic was not chosen as a result of outstanding forecasting power. Rather,
the main motivation of the Research Task Force to form a working group on the interaction of
market and credit risk was the diversification benefits between market and credit risk - which
have not really made it into the headlines. Instead, another aspect of the interaction of
market and credit risk has become newsworthy. It is the question of how an economy is
affected if credit risk starts to be traded or, in other words, if credit risk transforms into market
risk. The uncertainty of who finally bears the risk can have more severe effects than market
participants would have expected, say, one year ago.
I will not talk too much about the ongoing turbulence in detail because I am sure that the
reasons behind it deserve a rigorous analysis. Instead, let me give you some information on
how this conference came into being. At the risk of boring the members of the working group
on the interaction of market and credit risk, I think it may help participants from academia, the
industry and regulatory authorities to relate the topic of the conference to the interests of
these three groups.
Traders in the front office have considered market and credit risk jointly for a long time, not
only regarding counterparty risk but also for the purpose of capital arbitrage, for instance. By
contrast, ten years ago this was hardly the case for the banking book, for which credit risk
was mostly the only risk type considered.
About a decade ago, the trading of credit risk - either by securitisation or credit derivatives -
started to grow rapidly. The chance to sell or buy credit risk, instead of holding loans until
maturity, placed banks under increased pressure to know the present values of their assets
well before maturity. This posed a challenge to risk modeling as present values depend in a
complex way on market factors like interest rates or exchange rates. Therefore, it is not
surprising that the growth of credit trade was accompanied by rapid technological progress,
for instance, by the development of new credit portfolio models. It is difficult to say which
came first or - in other words - whether these new risk measurement techniques were the
egg and the increased credit trade the hen or vice versa.
Technological progress has continued up to the present day. The interaction of market and
credit risk is being taken into account by more and more sophisticated models.
The increased trade of credit on the one hand offers an opportunity to further diversification
of credit risk over the whole financial system and to contribute to financial stability. On the
other hand, it can also be seen as a development incurring new risks, be it by an inadequate
recognition of risks inside a single bank, be it by new adverse risk-taking incentives or by the
imperfection of hedges, be it, finally, by new effects that no one had discovered before.
These developments are a first reason for bank managers, regulators and central bankers to
improve their understanding of the interaction of market and credit risk.
In addition to these developments, some industry representatives were concerned that
diversification effects between market risk and credit risk were being ignored by regulators,
which could lead to too high minimum capital requirements. A deeper understanding of
diversification effects and their relevance for risk aggregation in banks is a second reason to
have a conference on the interaction of market and credit risk.
At the end of 2005, the Research Task Force project group on the interaction of market and
credit risk received the mandate, first, to collect and summarise information on the state of
the art of measuring the interaction of market and credit risk, and second, to set up and to
conduct its own research projects in a rather broad field. As this was a vastly unexplored
research area, the new working group has become one of the most research-oriented groups
of the Research Task Force.
Ladies and Gentlemen, this conference contributes to bringing together three groups
involved with the interaction of market and credit risk: bank practitioners, regulators, and
researchers. The need to make them exchange their ideas and knowledge is obvious. The
interaction of market and credit risk is simply too complex to be recognised without a proper
methodological framework. Both bank practitioners and regulators therefore need input from
researchers. Researchers, in turn, need to learn from regulators' and bankers' experiences.
Finally, bank practitioners and regulators are in close contact either way, and should be so.
Thus, it comes as no surprise that hosting this conference ties in very well with several of the
Bundesbank's activities that aim at bringing industry, regulators and research together. Such
events are, for instance, the RTF conference on concentration risk in autumn 2005 or the
annual series of Bundesbank Spring Conferences and Autumn Conferences, all on
sciencerelated topics. This series now enjoy a fairly high reputation.
Ladies and Gentlemen, as my time is almost over, let me take the opportunity to thank
Philipp Hartmann from the ECB and Klaus Düllmann from the Bundesbank who have
assumed the burden of being main organisers of this conference. I would also like to thank
the scientific committee who did a great job of selecting 13 papers out of more than 80
submissions, and Hiroaki Kuwahara from the Basel Secretariat for his support in preparing
this workshop. Last but not least, my thanks go to Ms Bothe and her team and all the other
people who have contributed to this workshop in one way or another.
Once again, I would like to extend a warm welcome to you at the workshop and hope you
have two days of lively and enriching discussion.