Loan securitization, bank risk, and efficiency

The 2007-09 financial crisis highlighted the devastating impact of securitization on the stability of the banking system. However, studies on securitization are far from sufficient to show the impact on a bank’s performance. To better understand the impact of securitization in order to prevent such crisis to happen again, I study bank loan securitization in this Ph.D. thesis. This thesis aims to provide empirical explanations to answer two dilemmas in securitization literature. First, ambiguous results are presented in the impact of securitization on bank risk. Classic theories suggest that loan securitization allows securitizers to transfer the potential risk to outside investors and diversify the large exposure to a single shock by sharing this potential riskiness with all investors linked by securitized assets, which in turn decreases bank risk and increases the stability of financial system. However, recent evidence reveals that securitizers have the intention to ignore potential risk and take on more risk, introducing more risk into the financial system and increasing the level of bank riskiness. Second, securitization introduces a higher flexibility for banks to allocate their resources and increases bank efficiency accordingly. However, securitization process is closely linked to a large amount of upfront and managerial costs, which can lead to an additional burden to banks and decrease securitizers’ efficiency. This thesis develops a synthetic empirical analysis and shows a short- and long-term impact of securitization on bank risk, and a positive impact on a bank’s efficiency score. Details information are as follows. In the first chapter, I provide an introduction of the thesis. In chapter two, I present a comprehensive introduction on securitization, including both background history, literature, and related empirical issues. I also provide detailed information on securitization transaction in practice. In the empirical method review, this thesis highlights the self-selection problem in securitization. For example, the impact of securitization on bank performance may simply depend on a bank’s choice of whether to securitize their loans or not. In order to address such a problem, estimation methods including Heckman model, instrumental variable analysis, propensity score matching and Difference-in-Difference analysis, are discussed. From chapter three, I present empirical studies on the impact of bank securitization activities in the U.S. I first study the conflicts of the impact of securitization on bank risk. Risk transfer and diversification theories suggest that securitization reduce bank risk, while commentators blame the lending standard decrease as the main driver of the subprime crisis. Therefore, I conduct several methodologies to study the impact of securitization on bank risk in chapter three and the impact of securitization on the likelihood of bank failure in chapter four. The thesis studies the impact of securitzation on bank efficiency scores in Chapter five. The reported results suggest that bank loan securitization is associated with an efficiency increase effect. The reported results suggest that loan securitization allows banks to shift off undesirable risk through the true sale process, which in turn decreases bank’s capital requirement due to a decreased risk of capital. Bank liquidity can also be increased by transferring the illiquid loans into marketable securities. Both effects increase a bank’s financial flexibility and efficiency. The diversification of securitization also allows securitizers to allocate more of their resources efficiently. During the cross-variation analysis, results support the arguments above. In chapter six, I review all empirical results and provide explanations on the results. First, a short- and long-term explanation of the impact of loan securitization is provided. That is, bank loan securitization could reduce bank risk within a short term through risk transfer and diversification effect but increases the likelihood of bank failure in the long run, because securitizers are more likely to lower the lending standard or pursue regulatory arbitrage. Recent development of the securitization studies and practice are also presented. The last chapter concludes the study and point out the possible extensions of the study. This thesis provides extensive empirical results that adds to the extant studies on securitization.