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Incentives and tranche retention in securitisation: a screening model

Listed author(s):
  • Ingo Fender
  • Janet Mitchell

This paper examines the power of different contractual mechanisms to influence an originator’s choice of costly effort to screen borrowers when the originator plans to securitise its loans. The analysis focuses on three potential mechanisms: the originator holds a “vertical slice”, or share of the portfolio; the originator holds the equity tranche of a structured finance transaction; the originator holds the mezzanine tranche, rather than the equity tranche. These mechanisms will result in differing levels of screening, and the differences arise from varying sensitivities to a systematic risk factor. Equity tranche retention is not always the most effective mechanism, and the equity tranche can be dominated by either a vertical slice or a mezzanine tranche if the probability of a downturn is likely and if the equity tranche is likely to be depleted in a downturn. If the choice of how much and what form to retain is left up to the originator, the retention mechanism may lead to low screening effort, suggesting a potential rationale for government intervention.

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Paper provided by Bank for International Settlements in its series BIS Working Papers with number 289.

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Length: 43 pages
Date of creation: Sep 2009
Handle: RePEc:bis:biswps:289
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  1. Ingo Fender & Janet Mitchell, 2005. "Structured finance: complexity, risk and the use of ratings," BIS Quarterly Review, Bank for International Settlements, pages -, June.
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  5. Benjamin J. Keys & Tanmoy Mukherjee & Amit Seru & Vikrant Vig, 2010. "Did Securitization Lead to Lax Screening? Evidence from Subprime Loans," The Quarterly Journal of Economics, Oxford University Press, vol. 125(1), pages 307-362.
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  21. Alan D. Morrison, 2005. "Credit Derivatives, Disintermediation, and Investment Decisions," The Journal of Business, University of Chicago Press, vol. 78(2), pages 621-648, March.
  22. Atif Mian & Amir Sufi, 2008. "Summary of "the consequences of mortgage credit expansion"," Proceedings 1074, Federal Reserve Bank of Chicago.
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  26. Janet Mitchell, 2005. "Financial intermediation theory and implications for the sources of value in structured finance markets," Working Paper Document 71, National Bank of Belgium.
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