In this Paper we study the impact of credit risk transfer (CRT) on the stability
and the efficiency of a financial system in a model with endogenous
intermediation and production. Our analysis suggests that with respect to
CRT, the individual incentives of the agents in the economy are generally
aligned with social incentives. Hence, CRT does not pose a systematic
challenge to the functioning of the financial system and is generally welfare
enhancing. We identify issues that should be addressed by the regulatory
authorities in order to minimize the potential costs of CRT. These include:
ensuring the development of new methods of CRT that allow risk to be more
perfectly transferred, setting regulatory standards that reflect differences in the
social cost of instability in the banking and insurance sector; promoting CRT
instruments that are not detrimental to the monitoring incentives of banks