Incentives and Tranche Retention in Securitisation: A Screening Model
Bank for International Settlements (BIS)
National Bank of Belgium - Department of Financial Stability; Centre for Economic Policy Research (CEPR)
CEPR Discussion Paper No. DP7483
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.
Number of Pages in PDF File: 44
Keywords: Borrower screening, Retention requirements, Securitisation, Tranching
JEL Classification: D82, D86, G21, G28working papers series
Date posted: November 17, 2009
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