Banks are increasingly using an obscure but rapidly growing corner of Wall Street called "synthetic risk transfer" (SRT) to offload the default risk of loans while keeping the loans on their balance sheets. These deals allow banks to ease the amount of capital they must set aside for regulatory purposes, freeing up capital for new lending or more profitable ventures. Investors, primarily insurance companies, hedge funds, and private credit funds, buy these SRTs and agree to cover a portion of losses if the underlying loans go bad, in exchange for a fee.
The global market for SRTs has seen significant growth, expanding by 20 to 25 percent annually since 2017. In 2023, the market reached a record $24 billion, with $16.6 billion in deals involving 44 banks by September 30 of that year. Analysts at Man Group predict the market could double in size over the next five years. Large asset managers like Blackstone have nearly quadrupled the capital they deploy to SRTs since 2022, attracted by returns that typically exceed 10 percent.
Insurance companies are playing an increasingly prominent role in this market. For example, Erste Group Bank AG recently sold an SRT linked to over $11.7 billion (€10 billion) in loans, primarily to a small group of insurers, to free up capital for an acquisition. European policymakers are even considering improving terms for insurers to invest in SRTs as part of broader capital market reforms. While SRTs help banks manage risk, the underlying risk doesn't disappear; it simply transfers to investors who are willing to take it on, hoping to manage it for profit.
