A Short Introduction to Capital-Relief Trades

Capital-relief trades are opaque, little-disclosed transactions that make a bank look stronger by reducing its “risk-weighted” assets. That boosts key ratios that measure the bank’s capital as a percentage of those assets, even as capital itself stays at the same level.

In a capital-relief trade, a bank can keep a risky asset on the balance sheet, using credit derivatives or securitizations to transfer some of the risk to a hedge fund or other investor. The investor potentially gets extra yield and the credit risk of smaller borrowers in a way it would be hard for them to get otherwise, while the bank gets to remove part of the asset’s value from its closely watched “risk-weighted asset” count.

Banks say the trades help them manage their risk, even if they don’t go as far as a bona fide asset sale, and are just one tool among many they are using to meet new capital requirements.

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Critics fear the trades can spread risk to unregulated parts of the financial system—just as similar trades did before the financial crisis.

Rapoport, Michael and Tracy, Ryan. "The Hot Thing for Wall Street Banks: Capital-Relief Trades" The Wall Street Journal., Tuesday, August 18, 2015, C1, Accessed on August 18, 2015, http://www.wsj.com/articles/the-hot-thing-for-wall-street-banks-capital-relief-trades-1439852844