The global banking crisis has been a boon for providers of interest rate derivatives as an increasing number of corporations consolidate their banking and treasury services providers to secure the credit lines they need and to protect themselves from risky counterparties. The latest research from the consulting firm Greenwich Associates indicates that over 40% of the global volume in interest rate derivatives is allocated to dealers on the basis of lending relationships.

A Financial Quid Pro Quo

In seeking out providers of credit, corporations are not only consolidating relationships with existing banks but are also seeking out secondary sources of credit as well to augment their core lenders. It is interesting to note that this is occurring at the same time as banks are taking a hard look at their existing lending relationships.

Needless to say, corporations are using their hedging needs such as interest rate derivatives, foreign exchange, capital markets functions and other treasury management services as bargaining chips for their credit needs. In this quid-pro-quo the banks are finding out that they can’t have it both ways. If they want the derivatives business they will have to provide the credit.

The flip-side is that banks are taking the posture that given the increasing amount of credit (counterparty) risk, that risk premium is being built into the price charged, resulting in wider bid-ask spreads.

Reasons for Using Derivatives

The most popular reasons for the strategic use of derivatives are managing debt capacity and balance sheet restructuring or rebalancing. Following that is merger and acquisition transactions, managing credit risk and tax or accounting reasons. A small number of uses are hedging exposure to stock option plans and managing pension plan risks.

Cheers and Jeers

Regardless of where one happens to be, it seems the fear of counterparty risk is second only to pricing in the derivatives market. For example, in the same Greenwich Associates research, not quite 30% of derivative users in the United Kingdom have cut back on the volume they execute through a single dealer. In the United States, counterparty risk ranks ahead of historical measures such as speed of quoting and quality of sales coverage.

The major players in this market vary somewhat by geography but tend to be the world class commercial banks in their particular venue; North American banks in North America, German, British and French banks in Europe, Japanese banks in Japan and so forth. However, here are some banks that transcend borders and are active and effective in whatever location they have a presence.

After the number of dealer banks had shrunk due to narrow spreads and overly competitive pricing, the list is once again expanding, reflecting wider spreads and better economic potential.

Interest Rate Derivatives- A Source of Credit: The Users and Providers of Derivatives are on a Two-Way Street

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