Bank for International Settlements working paper finds banks use CDS hedging to offset countercyclical buffer driven capital increases

The Bank for International Settlements published a working paper examining how banks adjust to higher capital requirements and finding that, beyond raising equity or cutting lending, banks materially increase credit default swap (CDS) hedging when borrower-country countercyclical capital buffers (CCyBs) rise. The results suggest eligible credit risk transfer via CDS can be a first-order response that reduces banks’ risk-weighted assets and may weaken the transmission of macroprudential tightening. The study links EU trade-repository single-name CDS positions reported under the European Market Infrastructure Regulation (EMIR) with syndicated loan exposures from November 2017 to April 2024 to construct a bank–firm “uninsured loan ratio”. Using within-bank comparisons of similar borrowers across countries with different CCyB rates, it estimates that a 1 percentage point increase in the CCyB reduces the uninsured share of a loan by roughly 50–54 percentage points at implementation, with a smaller response around announcement dates. The effect is strongest for banks with larger pre-existing loan exposures to the country raising its CCyB, and is reported as robust across alternative samples, including restricting to CDS-active banks and excluding observations with no net hedging; the paper also documents that greater index-CDS activity is associated with less single-name hedging, consistent with proxy hedging.