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FRM Part II · FRM Exam Part II · Structured Credit Risk

Which lesson from the subprime crisis is most directly addressed by requiring sponsors of securitizations to retain a portion of the credit risk of the assets they securitize?

Risk retention rules align the incentives of originators and investors. Because the sponsor keeps part of the credit risk, it bears losses if underwriting is poor, which reduces the moral hazard created by the originate-to-distribute model.

  1. AReducing the reliance of investors on external credit ratings
  2. BImproving the transparency of loan-level data
  3. CAligning the incentives of originators with those of investors to reduce moral hazardCorrect
  4. DLowering the correlation between underlying assets in the pool

Explanation

Risk retention (skin in the game) makes originators bear part of the losses, so they have an incentive to maintain underwriting quality. It does not itself reduce rating reliance, disclosure, or asset correlation, which are addressed by other measures.

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