Arbitraging the Basel Securitization Framework: Evidence from German ABS Investment
70 Pages Posted: 25 Nov 2014 Last revised: 12 Sep 2018
Date Written: September 12, 2018
This paper provides evidence for regulatory arbitrage within the class of asset-backed securities (ABS) based on individual asset holding data of German banks. I find that banks operating with tight regulatory constraints exploit a non-monotonic relation between yield spreads and rating-contingent capital requirements for ABS. Unlike unconstrained banks, they systematically pick the securities with the highest yield spreads and the lowest ex post performance while keeping constant or even decreasing capital requirements. This regulatory arbitrage allows constrained banks to increase the ratio of yield spread to required capital by a factor of four. Differences in sophistication, market power, or incentives to retain securitizations are unlikely to explain the riskier ABS investments of constrained banks.
Keywords: Regulatory arbitrage, asset-backed securities, risk-taking, ratings inflation
JEL Classification: G01, G21, G24, G28
Suggested Citation: Suggested Citation