53 Pages Posted: 20 Mar 2017 Last revised: 7 Oct 2017
Date Written: October 6, 2017
We develop a framework to explore the interaction between loan origination and securitization. In the model, banks privately screen and originate loans and then issue securities that are backed by loan cash flows. Issued securities are rated and sold to investors. We show that the availability of credit ratings (or other public information) increases the allocative efficiency of cash flows by reducing costly retention, but reduces lending standards and can lead to an oversupply of credit. These findings are in contrast to regulators' view of credit ratings as a disciplining device. Moreover, improved screening does not solve the problem; as banks' screening technology becomes more precise, their lending standards collapse and some (though not all) bad loans are deliberately originated. We use the model to explore several commonly proposed policies and provide conditions under which they increase efficiency. Finally, we consider extensions to allow for ratings shopping and manipulation.
Keywords: Loan Origination, Securitization, Credit Supply, Ratings
JEL Classification: G01, G21, G28
Suggested Citation: Suggested Citation
Daley, Brendan and Green, Brett S. and Vanasco, Victoria Magdalena, Securitization, Ratings, and Credit Supply (October 6, 2017). Stanford University Graduate School of Business Research Paper No. 17-26. Available at SSRN: https://ssrn.com/abstract=2937297