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

Under the originate-to-distribute (OTD) model, a bank originates loans mainly to sell them into securitisations rather than hold them. Which risk is most commonly cited as being heightened by this model?

OTD weakens originators' incentives to screen and monitor borrowers, a moral hazard problem, because credit losses are passed to investors. The other options describe retained-loan risks, which the OTD model is designed to reduce rather than increase.

  1. AWeaker incentives for originators to screen borrowers carefully because credit risk is transferredCorrect
  2. BHigher interest rate risk on the originator's balance sheet from long holding periods
  3. CLower liquidity for the originator's funding because loans are retained
  4. DGreater concentration of borrower credit risk on the originator's books

Explanation

Because the originator passes the loans on, its exposure to later losses is reduced, which weakens the incentive to screen and monitor borrowers (moral hazard). The other options describe consequences of holding loans, which OTD avoids.

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