Complexity in Structured Finance and Difficulties Faced by Market Participants - A Critical Assessment of the Role of the Complexity in Financial Crisis

Abstract

This study aims to investigate the remarkable rise and fall of structured finance by emphasising the role of complexity. This study first examines how structured finance become more complicated over the last two decades. Complexity in structured finance arises from the pooling of assets, the detailed deal-specific structuring and documentations necessitated by tranching and the involvement of third parties. Besides, we have defined the term 'complexity' more narrowly to provide a better understanding of the essence of the complexity. Further, this study examines the motive for the financial institutions to issue more complex structured finance securities and finds that the increased complexity has been used as a mechanism to distract market participants. Finally, the complex structure of securities along with the perverse incentives and gluttonous behaviour of the market participants have undoubtedly impelled financial market towards the
more complex condition and ultimately thrust towards the collapse.

Keywords: Structured Finance, Financial Complexity, Financial Crisis, Credit Rating Agency, Investment Bank, Securitization

JEL Classification: G21, G24, G28, F650, G180