On thin ice

Following the near-collapse of Bear Stearns, even trades conducted with interbank dealers can no longer be considered risk-free. With so much of the derivatives market in the hands of a few dealers, what would happen if a major counterparty were to go bust? What are banks doing to manage this risk? By Duncan Wood

Taking an aspirin is an easy way to treat a headache. The potentially unpleasant side-effects - heartburn, indigestion, nausea - are rarely considered. Similarly, a bank suffering the pain of excess credit exposure often gulps down a credit default swap (CDS) without reading the warning on the packet: credit derivatives can produce painful, unanticipated build-ups of counterparty risk.

That warning could be ignored with impunity while CDS counterparties - predominantly other banks - were raking