The Impact of Skin in the Game on Bank Behavior in the Securitization Market
48 Pages Posted: 26 Feb 2020
Date Written: January 17, 2020
Based on European RMBS deals with 24 million quarterly loan observations, we examine the effect of risk retention on bank behavior. Using OLS, propensity score matching, and instrumental variable regressions, we examine why retention deals perform better. Analyzing monitoring effort and the workout process, we find that the probability of rating updates or collateral revaluations is higher, and the rating quality is better. Retention loans have a lower probability of becoming non-performing, a lower delinquency amount, and a shorter time in arrears. Moreover, non-performing and defaulted retention loans are more likely to recover. We observe that total losses are lower for deals with retention, which are driven by lower default rates, lower exposures at default, and higher recovery rates. Overall, our results suggest that retention reduces moral hazard and incentivizes banks to exert higher effort, which results in superior securitized asset performance.
Keywords: security design, asset-backed securities, retention, moral hazard, monitoring
JEL Classification: D82, G01, G21
Suggested Citation: Suggested Citation