Implications Of The Risk-Based Capital Requirements Of Implicit Recourse In Asset Securitizations In The Banking Industry

<p class="MsoBodyText2" style="text-align: justify; line-height: normal; margin: 0in 0.5in 0pt;"><span style="font-size: 10pt; mso-bidi-font-style: italic; mso-bidi-font-size: 12.0pt;"><span style="font-family: Times New Roman;">We consider implications of the risk-based capital requirements of implicit recourse in asset securitizations. These implications include issues in finance such as risk management and contracting between counterparties. The first part of our analysis deals with asset securitizations where originating institutions provide investors with implicit recourse. We show that the risk-based capital requirements associated with the new regulatory definition of implicit recourse may discourage some banks from offering implicit recourse in their asset securitizations. This suggests that the new regulatory definition of implicit recourse may be a workable compromise between supervisory regulators and originating institutions. We then consider a scenario where banks enter into reinsurance contracting with banks in other regions to mitigate some regional economic risks. These reinsurance contracts may enable banks to improve the performance of their balance sheet assets. Although we find weak correlation among equity returns for regional banks, future high correlation among bank portfolios could pose a problem to regulators because when a bank gets into financial distress this may spill over to other network banks. Widening yield spreads in asset securitizations might serve as an early warning signal of financial distress. Thus, regulators might devote more supervisory resources on originating institutions when their asset securitization yield spreads widen.</span></span></p>

Characteristics of Securitizations that Determine Issuers’ Retention of the Risks of the Securitized Assets

ABSTRACT: We hypothesize and provide evidence that characteristics of banks’ loan securitizations accounted for as sales determine the extent to which banks retain the risks of the securitized loans. We show that banks retain more risk when: (1) the types of loans have higher and/or less externally verifiable credit risk, (2) the loans are closed-ended and banks retain larger contractual interests in the loans, and (3) the loans are closed-ended and banks retain types of contractual interests that more strongly concentrate the risk of the securitized loans. We show that the magnitude and type of retained contractual interests are not risk-relevant in revolving loan securitizations, because banks have more incentive and ability to provide implicit recourse, a non-contractual interest.