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Detrimental Effects of Retention Regulation: Incentives for Loan Screening in Securitization under Asymmetric Information

Author

Listed:
  • Masazumi Hattori

    (Director and Senior Economist, Institute for Monetary and Economic Studies, Bank of Japan (E-mail: masazumi.hattori @boj.or.jp))

  • Kazuhiko Ohashi

    (Professor, Hitotsubashi University (E-mail: kohashi@ics.hit-u.jp))

Abstract

We consider an economy in which a lender finances his loans to borrowers by issuing a securitized product to investors, and where the credit quality of the product may depend on whether the lender screens the borrowers. In the presence of asymmetric information between the lender and the investors about the credit quality of potential borrowers, overvaluation of the low-quality securitized product may occur, inducing lender to not screen the borrowers and hence to issue a securitized product of low credit quality. This is likely to occur when the investors finds it difficult to distinguish the good state from the bad state, or when the seed of recession creeps toward the booming economy. A retention regulation that requires the lender to hold a minimum ratio of his own securitized products is not necessarily effective in solving this incentive problem. Even worse, in a certain situation, the retention regulation discourages the lender's screening effort and reduces welfare.

Suggested Citation

  • Masazumi Hattori & Kazuhiko Ohashi, 2011. "Detrimental Effects of Retention Regulation: Incentives for Loan Screening in Securitization under Asymmetric Information," IMES Discussion Paper Series 11-E-17, Institute for Monetary and Economic Studies, Bank of Japan.
    • Handle: RePEc:ime:imedps:11-e-17
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    File URL: http://www.imes.boj.or.jp/research/papers/english/11-E-17.pdf
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    Citations

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    Cited by:

    1. Chen, Zhizhen & Liu, Frank Hong & Opong, Kwaku & Zhou, Mingming, 2017. "Short-term safety or long-term failure? Empirical evidence of the impact of securitization on bank risk," Journal of International Money and Finance, Elsevier, vol. 72(C), pages 48-74.
    2. Guo, Guixia & Wu, Ho-Mou, 2014. "A study on risk retention regulation in asset securitization process," Journal of Banking & Finance, Elsevier, vol. 45(C), pages 61-71.

    More about this item

    Keywords

    originate-to-distribute; securitization; asymmetric information; financial regulation; screening; verification; retention;
    All these keywords.

    JEL classification:

    • G14 - Financial Economics - - General Financial Markets - - - Information and Market Efficiency; Event Studies; Insider Trading
    • G21 - Financial Economics - - Financial Institutions and Services - - - Banks; Other Depository Institutions; Micro Finance Institutions; Mortgages
    • G24 - Financial Economics - - Financial Institutions and Services - - - Investment Banking; Venture Capital; Brokerage

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