A type of risk redistribution (financial transformation) in which financial intermediaries hold assets with higher risk of default than their own liabilities. They can reduce these risks to a minimum level and gain from yield differentials by applying a combination of techniques such as diversification, pooling, screening and monitoring of assets, formation of reserves, and so on.
Risk transformation involves the process of diversifying venues of investment, pooling risks, screening and monitoring borrowers, and creating and maintaining adequate levels of capital and reserves to absorb unexpected losses that may impact the depositors.
