Incentives and Tranche Retention in Securitisation: A Screening Model

National Bank of Belgium Working Paper No. 177

50 Pages Posted: 23 Sep 2010

See all articles by Ingo Fender

Ingo Fender

Bank for International Settlements (BIS)

Janet Mitchell

National Bank of Belgium - Department of Financial Stability; Centre for Economic Policy Research (CEPR)

Multiple version iconThere are 3 versions of this paper

Date Written: October 16, 2009

Abstract

This paper examines the power of different contractual mechanisms to influence an originator's choice of costly effort to screen borrowers when the originator plans to securitise its loans. The analysis focuses on three potential mechanisms: the originator holds a "vertical slice," or share of the portfolio; the originator holds the equity tranche of a structured finance transaction; the originator holds the mezzanine tranche, rather than the equity tranche. These mechanisms will result in differing levels of screening, and the differences arise from varying sensitivities to a systematic risk factor. Equity tranche retention is not always the most effective mechanism, and the equity tranche can be dominated by either a vertical slice or a mezzanine tranche if the probability of a downturn is likely and if the equity tranche is likely to be depleted in a downturn. If the choice of how much and what form to retain is left up to the originator, the retention mechanism may lead to low screening effort, suggesting a potential rationale for government intervention.

Keywords: Securitisation, Retention Requirements, Tranching, Screening Incentives

JEL Classification: D82, D86, G21, G28

Suggested Citation

Fender, Ingo and Mitchell, Janet, Incentives and Tranche Retention in Securitisation: A Screening Model (October 16, 2009). National Bank of Belgium Working Paper No. 177, Available at SSRN: https://ssrn.com/abstract=1681488

Ingo Fender (Contact Author)

Bank for International Settlements (BIS) ( email )

Centralbahnplatz 2
CH-4002 Basel
Switzerland

HOME PAGE: http://www.bis.org

Janet Mitchell

National Bank of Belgium - Department of Financial Stability ( email )

14 Blvd de Berlaimont
B-1000 Brussels
Belgium
+32 2 221 3459 (Phone)
+32 2 221 3104 (Fax)

Centre for Economic Policy Research (CEPR)

London
United Kingdom

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