A growing number of studies on the US subprime market indicate that, due to asymmetric information, credit risk transfer activities have perverse effects on banks’ lending standards. We investigate a large part of the market for securitized assets (“prime mortgages”) in Italy, a country with a regulatory framework analogous to the one prevalent in Europe. Information on over a million mortgages consists of loan-level variables, characteristics of the originating bank and, most importantly, contractual features of the securitization deal, including the seniority structure of the ABSs issued by the Special Purpose Vehicle and the amount retained by the originator. We borrow a robust way to test for the effects of asymmetric information from the empirical contract theory literature (Chiappori and Salanié, 2000). Overall, our evidence suggests that banks can effectively counter the negative effects of asymmetric information in the securitization market by selling less opaque loans, using signaling devices (i.e. retaining a share of the equity tranche of the ABSs issued by the SPV) and building up a reputation for not undermining their own lending standards.
Prior to the financial crisis, securitization was one of the defining features of the financial landscape. Banks went from being delegated monitors of borrowers, monitored in turn by depositors (Diamond and Dybvig, 1983), to being essentially underwriters of their own loans and investors in other banks’ securitized assets. Securitization was thought to have stimulated loan supply, increased the liquidity of banks’ balance sheets, allowed a broader range of investors to access a class of assets hitherto limited to banks and, by increasing risk diversification, to have improved financial stability (Duffie, 2007). The originate-to-distribute (OTD) model was also considered to have helped to satisfy a growing demand for safe assets (Caballero and Krishnamurthy, 2009). In fact, in 2006 the volume of asset-backed securities (ABS) issuance amounted to around 4 trillion dollars in the United States and the European Union, a value comparable to that of gross corporate bond issuance.