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FRM Part I · FRM Exam Part I · Banks

Under the originate-to-distribute model, a bank makes loans and then securitizes and sells them. Compared with the traditional originate-and-hold model, which is the most significant risk concern associated with originate-to-distribute?

The main concern is weakened screening and monitoring incentives. Because originate-to-distribute banks pass credit risk to investors, they bear less of the loss from poor underwriting, which can lower lending standards. This differs from originate-and-hold, where the bank retains the risk.

  1. AThe bank holds more credit risk on its balance sheet, so it screens borrowers more carefully
  2. BWeaker incentives to monitor and screen borrowers because credit risk is passed to investorsCorrect
  3. CGreater exposure to deposit runs because loans are held longer
  4. DHigher net interest margin from retaining all loan spread income

Explanation

Once loans are sold, the originator bears little of the default loss, which can reduce underwriting standards and monitoring. The first option describes originate-and-hold. The other options do not follow from distribution of loans.

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