Transparency over Risk Retention

According to a recently released white paper, analysts at the Bank of International Settlements (BIS) suggest that the securitization of loans does not necessarily lead to lower credit standards and therefore, risk retention rules may not be needed, other than for some large transactions where moral hazard may be more likely to exist.

The research from the BIS explores the presence of asymmetric information in the securitization market by assessing the correlation between securitization (risk-transfer) and default probability from credit-register data. The analysts find that "the selection of which loans to securitize based on observables is such that it largely offsets the negative effects of asymmetric information, rendering the overall unconditional quality of securitized loans significantly better than the non-securitized ones."

From this finding, the paper draws the conclusion that "despite the presence of asymmetric information, credit-risk transfer does not lead to lax credit standards" and derives the policy implication that, in some cases, "[risk] retention rules may not be advisable: since the main distortions stem from adverse selection, endogenously chosen levels of retention may allow banks to better signal the quality of their securitized loans."

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