Based on a sample of U.S. commercial banks from 2002 to 2012, this paper shows that bank loan securitization has a significant and positive impact on both Z-scores and the likelihood of bank failure, indicating a short-term risk reduction and a long-term risk increase effect. We also find disparate impacts between mortgage and non-mortgage securitization. Loan sale activities are found to have a similar impact to securitization.
Short-term safety or long-term failure? Empirical evidence of the impact of securitization on bank risk
Loan securitization (securitization hereafter) is arguably one of the main triggers of the 2007-09 global financial crisis. A commonly held view argues that securitization leads to a lower credit standard and less incentive for banks to monitor loans (Keys et al., 2010). Securitizers may also have incentives to securitize better-quality loans in the portfolio to pursue higher reputations or ratings and receive reductions in regulatory capital retention (Acharya et al., 2013), thus increasing bank risk on the balance sheet. However, the impact of securitization on bank risk is still inconclusive in the literature. Early studies suggest that securitization allows originators to transfer potential risk to security investors, along with the underlying assets (Pennacchi, 1988), and achieve increased portfolio and geographic diversification (Hughes et al., 1999; Deng et al., 2007 ; Berger and DeYoung, 2001). Despite the strong prior, there is limited studies, to the best of the authors' knowledge, that directly studies the impact of bank securitization and risk. In this paper we fill this gap and reconcile previous conflicting theories on the impact of bank securitization on risk. We find that the involvement of securitization leads to reduced bank risk in the short-term, while increase the likelihood of bank failure in the long run.