The Relation between Bank Credit-Risk Management Procedures and Originate-to-Distribute Mortgage Quality During the Financial Crisis

Abstract

We examine the relation between bank risk management procedures and sales of mortgages during the financial crisis of 2007-2009. Research suggests that banks employing an originate-to-distribute strategy devoted little effort to screening, thereby diminishing their ability to sell loans during the crisis. We find banks with stronger credit risk management suffered a smaller decline in loan sales, had fewer non-performing mortgage loans, and relied less on mechanical screening techniques while granting loans than banks with weaker credit risk management. Numerous additional tests and robustness checks, including a matched sample analysis, are employed to address endogeneity and confirm our main findings. Overall, our evidence implies that the incentive problems associated with the originate-to-distribute business model are less severe in the presence of stronger credit risk management.

Keywords: Originate-to-distribute; risk assessment procedures; financial crisis

JEL Classification: G11; G12; G13; G14; G21; G32