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FRM Part II · FRM Exam Part II · An Introduction to Securitisation

Post-crisis securitisation reforms, including risk retention rules, were introduced mainly to address which weakness in the originate-to-distribute model?

Risk retention rules target misaligned incentives. When originators sold off essentially all credit risk, they had little motivation to maintain sound underwriting. Requiring them to keep a portion of the exposure, or skin in the game, aligns their interests with investors.

  1. AExcessive capital held by originators against securitised pools
  2. BMisaligned incentives, as originators with no retained exposure had little reason to maintain underwriting standardsCorrect
  3. CLack of any available credit ratings for senior tranches
  4. DLimits on the number of tranches that could be issued

Explanation

Under originate-to-distribute, originators passed on nearly all credit risk and so had weak incentives to screen borrowers. Risk retention (skin in the game) requires the originator or sponsor to keep a portion of the risk to realign incentives. The other options do not describe the problem the rules target.

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