The Bank of England’s prudential arm is sounding the alarm on a growing trend among UK banks: the use of unfunded Significant Risk Transfers, a capital optimization tool that essentially lets lenders offload loan portfolio risk without putting up collateral. The Prudential Regulation Authority says these transactions carry meaningfully higher counterparty and rollover risks than their funded equivalents, and it’s preparing to do something about it.
What SRTs actually are and why unfunded ones are riskier
Significant Risk Transfers enable banks to offload junior credit risk from loan portfolios to third-party investors by means of credit derivatives such as credit default swaps. This allows banks to release regulatory capital while retaining the more secure senior credit exposure and control over the underlying assets.
Funded SRTs require the protection seller to post full collateral. That money sits there, ready to cover losses. Unfunded SRTs skip that step entirely. The bank relies on the creditworthiness of the protection seller, often an insurer or supranational entity, without any collateral backing the deal. If the protection provider defaults or can’t pay when called upon, the bank is left holding risk it thought it had transferred.
