Until recently, British Petroleum was a terrific counterparty. Its credit rating was deservedly stellar, and it threw off a lot of cash. It was an active oil trader, and many banks were happy to transact with it. But that was then.

Fitch Ratings just downgraded BP's credit rating six notches to near junk status. Standard & Poor's and Moody's also lowered their ratings. The price of BP credit default swaps have soared. The issue was of enough concern that it sparked the Federal Reserve Board to study whether Wall Street was dangerously exposed. According to Reuters, the probe concluded that the risk was manageable.

Many banks have been taking incremental steps to protect themselves. Some have bought insurance via CDSs. Bank of America Merrill Lynch asked oil traders recently to limit the duration of oil trades with BP to one year. At least one other firm that trades multi-year electricity swaps did the same. Credit Suisse has reportedly lowered the threshold that would trigger margin to be paid by BP. As of now, it is not considered a systemic risk. If bankruptcy suddenly becomes likely, the situation could change, but perhaps not much.

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