Turbulence in Europe's banks following the implosion of 167-year-old Credit Suisse and runs on regional banks in the U.S. has focused attention on the role played by credit default swaps in all the turmoil.
, the banking supervisory chief at the European Central Bank, highlighted the volatility in Deutsche Bank's securities - including CDS - as a worrying sign of how easily investors could be spooked.
The CDS market is small relative to equities, foreign exchange or the global bond markets, where there are more than $120 trillion bonds outstanding. Average daily volume in foreign exchange is close to $8 trillion, based on Bank for International Settlements data. The buyer of the CDS will pay a fee on a regular basis to their counterparty, which then takes on the risk. In return, the seller of the CDS pays out a certain amount if something goes wrong, just like an insurance payout.
In 2014, a new category of credit event was introduced, so-called "Governmental Intervention", to address investor concerns that CDS would not cover measures taken by governments to support struggling entities, especially banks. Credit Suisse's CDSs were the most actively traded on the corporate front in the last quarter of 2022, with $100 million traded each day, DTCC data shows.CDSs were one of the financial instruments at the centre of the 2008 financial crisis.
The current turmoil does not reflect a steep drop in the value of the securities that underlie the CDS. It is more the perception of risk, rather than actual risk.
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