##ated structural implications which may have gradually affected the efficiency of the financial markets since their outset. • first, credit derivatives and, more generally, structured credit markets have affected banks ’ perceptions of risk and propensities to lend when granting credit. however, it is not enough to consider in this regard the enhanced potential to clearly separate credit and liquidity risks and thus to enhance specialisation. as we have clearly witnessed over the last couple of years, by apparently transferring the credit risk associated with the issuance of credit, some banks may have eroded issuing criteria and thus contributed to an overvaluation of assets. • second, credit derivatives and structured credit markets have transformed the way banks operated. innovations in credit portfolio management practices have had profound implications for the banking business model. many banks have moved from the “ buy - and - hold ” model to the “ originate - and - distribute ” model, whereby they distribute credit risks they originated to other market participants. in this respect, banks have increasingly performed the role of active portfolio credit risk manager in addition to credit provider. in particular, they have increasingly found structured credit products an attractive mechanism for reducing exposure concentrations in their loan books, while also allowing them to meet the needs of their corporate customers. these evident advantages of the new way of operating, together with the possibilities offered for capital regulatory arbitrage, seem to have overshadowed the disadvantages, such as the excessive focus on returns and short - termism. • third, credit derivatives and structured credit markets have transformed the financial system at large, whereby the risk re - allocation activity may have become just as important as – and in some cases a full substitute for - the more traditional capital allocation. whilst the aggregation and structuring of credit risks and their subsequent transfer to market participants with different investment horizons, asset / liability structures and risk appetites made evident the virtues of the model, it downplayed the now evident fact that the recipients of the risks were often vulnerable in terms of managing liquidity, interest rate and systemic credit risks. overall, these three structural implications of credit derivatives and structured credit markets may in a normally functioning financial system bring about increased opportunities and productivity in the banking intermediation business. whether this partially explained the fast growth of bank credit in the euro area during the years before the crisis, possibly above the level that can be explained on the basis of its traditional determinants, is a conjecture that remains to be substantiated. what is clear is that, going forward,

we cannot afford to ignore the downside risks embodied in the nature of credit derivatives and we need to take the necessary steps to appropriately weigh the advantages against such risks. 2 ) financial stability perspective from the investors ’ point of view, credit derivatives represent an asset class that allows investors to assume risks in exchange for a corresponding remuneration that suits their investment profile. at the same time, banks use credit risk transfer instruments, including securitisation, to distribute lending - related credit risk exposures to such investors. however, the development of the market for credit derivatives also embodies features affecting the balance of risks of the different actors in the financial landscape. to begin with, the following features related to market structure should be taken into account : 1. concentration in cds trading is very high and has probably further increased since july 2007 with the exit of several major players. such a high degree of concentration increases liquidity risk in the market. a recent report by the ecb 1 focusing on a sample of leading european banks active in the cds market found that the top ten counterparts for each large surveyed bank accounted for between 62 - 72 % of its cds gross market value exposure. 2. the cds market is highly interconnected, making it susceptible to contagion. one of the central lessons of the past two years is that – despite the appearance of netting positions falling outside the banking sector – credit risk has not been effectively transferred outside of the financial sector, with a number of contractual arrangements preventing a true separation of credit risks from the lending institutions. furthermore, counterparty risk has taken as a result a prominent role, as indicated at least since 2005 by the counterparty risk management policy group in the so - called “ corrigan report ”. 3. cds have increasingly become an important tool in the pricing of credit in other markets. while this pricing mechanism has been shown to function well in normal times, during episodes of financial turbulence the transmission of information may be impaired, with spillovers for the access to credit, the cost of funding and, due to the increasing interlinkages between markets, the functioning of other market segments, notably equities. these risks related to market structures are not the only concerns from the point of view of financial stability. the opacity of the credit derivatives market, and especially of structured synthetic instruments, has been a potential source of concern long before the start of the crisis, as underlined by the corrigan report. the complex interaction between cash instruments and credit derivatives