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

Under the traditional originate-to-hold model a bank keeps loans on its balance sheet until maturity. Under the originate-to-distribute (OTD) model the bank sells the loans into securitisations. Which risk is most commonly cited as being heightened by the OTD model?

OTD weakens originators' incentives to screen and monitor borrowers. Because the loans are sold and credit losses fall on investors, the originator has less skin in the game, creating a moral hazard and adverse selection problem that can lower underwriting standards.

  1. AReduced diversification of the originator's funding sources
  2. BWeaker incentives for originators to screen and monitor borrowers carefullyCorrect
  3. CHigher interest-rate risk retained by the originator on all loans
  4. DInability of the originator to recycle capital into new lending

Explanation

When credit risk is passed to investors, the originator bears less of the loss and has less incentive to screen and monitor, a moral hazard problem. OTD generally improves funding diversification and capital recycling, and transfers rather than increases retained rate risk.

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