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FRM Part I · FRM Exam Part I · Banks

Which feature of the originate-to-distribute model is most commonly cited as weakening the originator's incentive to screen borrowers carefully?

Weak screening incentives arise because the originator earns fees on the volume of loans made and then transfers the credit risk to investors. This moral hazard reduces the originator's concern about loan quality. Risk retention requirements aim to counter it by making originators keep some exposure.

  1. AThe originator earns fees on origination volume and transfers the credit risk to investorsCorrect
  2. BThe originator must hold the equity tranche of every securitization
  3. CThe originator is required to use deposit funding only
  4. DThe originator's loans are all guaranteed by the government

Explanation

When a bank earns fees on volume and passes default risk to investors, it has less incentive to monitor and screen. This moral hazard was a key criticism after the 2007-2009 crisis. Retaining the equity tranche would instead align incentives, which is the logic of risk retention rules.

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