infonet-economy

This article analyzes the impact of the introduction of centrally cleared credit risk transfer on a loan originating bank's lending discipline in the primary loan market. Under Basel III, a bank can transfer credit risk via central clearing at favorable regulatory conditions. Central clearing, however, reduces the lending discipline because the fact that only standardized contracts can be centrally cleared allows the originating bank to profitably grant and hedge a low quality loan. The impact on the lending discipline crucially depends on the regulatory design of central clearing such as capital requirements, disclosure standards, risk retention, and access to uncleared credit risk transfer. I also show that the lending discipline is an important determinant of the impact of central clearing on system risk.