A type of transformation which involves a bank’s credit risk. It is typically conducted by investing in securities that have a lower credit standing and thus a higher yield than the bank’s funding instruments. In simple terms, credit intermediation is a bank’s attempt to generate returns through credit mismatches between assets and liabilities. A bank can take advantage of arbitrage opportunities and irregularities in the market through credit transformation transactions. For example, bank may carry out credit transformation by lending to AA borrowers while issuing AAA liabilities. Also, banks may use derivatives as a key tool of their credit transformation strategies. To that end, they use securitization with embedded credit derivatives in addition to name-specific credit default swaps to reduce risk (and total capital) in their credit investment portfolios. They concentrate on handling every tranche as a derivative.

The credit transformation process is one type of the credit intermediation process (which consists also of size transformation and maturity transformation). The credit transformation is a dynamic process and requires constant fine-tuning in response to market conditions and evolution.