The Basel Committee on Banking Supervision is warning that a fast-growing market for banks to offload credit risk to private investment funds needs close monitoring because it is creating new vulnerabilities for the global financial system, Reuters said.

The deals, known as synthetic risk transfers (SRTs), allow banks to sell all or part of the credit risk on a pool of assets to investors such as hedge funds and pension funds, freeing up capital while keeping client relationships intact, the news agency said. 

While SRTs are not new, the Basel Committee said their use has accelerated sharply in recent years, particularly in Europe. New SRT transactions in the European Union more than tripled between 2016 and 2024 after EU regulatory changes gave some synthetic securitizations preferential prudential treatment, according to the report. 

U.S. volumes have also climbed following regulatory clarity in 2023 on how the deals are treated under bank capital requirements, Reuters said.

The Basel Committee’s concern centers on the growing interdependence between banks and the non-bank investors absorbing the risk. The committee warned that heavy reliance on SRTs could leave banks exposed to the health of the “non-financial intermediaries” buying the credit risk and, if those investors falter, could disrupt credit flows. 

“A contraction in credit caused by a protracted freeze in SRT markets could exacerbate an economic downturn and increase stress in the non-financial sector, possibly triggering an adverse deleveraging feedback loop,” the committee wrote.

The committee also flagged specific vulnerabilities, including the possibility that banks may be financing the very investors purchasing the credit risk, the opacity of bespoke deals, and weakening underwriting standards, Reuters said. 

Read more at Reuters

Read the Basel Committee report here