On and Off Balance Sheet Securitisation
and Banking FirmbyAtsuyuki Fukaura*

School of Economics
Nagasaki University
Afukaura@net.nagasaki-u.ac.jp* This paper is prepared when the author has stayed in Sheffield Hallam University in 1997-1998.
He appreciates very much to SHU for its hospitality. He expresses his special thanks to
Mr.C.Twinn(House of Common, Bank of England), Prof. R. Spence, Miss Chris Gilligan (SHU) for
their useful comments and discussions. Of course the remaining errors are the sole responsibility.

ABSTRACTIn this paper we have been exploring the theoretical foundations for on /off balance securitisation.
We found that the net benefit of on-balance securitisation depends on (1) the effect based on the
improved capital/asset ratio and (2) the effect based on the imperfect information. Although theformer decreases the profit, the latter wholly cancels it out. This suggests that we should not regard
securitisation as financial innovation to improve the capital/asset ratio.
Another finding is that there is a substantial difference between on-balance and off-balance
securitisation, in the sense of whether or not banks can convert loans into cash without any changes
in the liability side, for example, banks can liquidate the asset and get a perfect disposal fund.
Further, we succeeded to show off-balance securitisation is valid only for banks with excellent
asset management ability.

2

On and Off Balance Sheet Securitisation
and The Banking Firm
I

Introduction

Interest in securitisation has rapidly been growing not only in US but also in otherdeveloped countries. Generally, securitisation is considered to be a mirror image of the declining the
traditional banking. Some people consider that the development of securitisation may bring drasticchange or reconstruction of the current financial system, in which banks play a dominant role1.
This kind of discussion is not wrong. However, it only focuses on one side of the matter. It
is a widely accepted argument that financial intermediation is an activity that produces information
about lenders and borrowers. In this sense, banks are typical financial intermediaries and the skill to
produce information (financial intermediation skill) is important for them. On the other hand, to issue
attractive securities, which represent claims on the stream of future income, the issuer must inquire
into the probability of the investment project raising profits. As well as banks the security-issuer also
must learn highly sophisticated information-producing technology.
This means that information-producing technology is the fundamental and common
prerequisite both for intermediation and security issuing. If we ignore resource re-allocation costwithin banks, traditional banks have great potential for being the forerunners of securitisation . In
other words, the development of securitisation provides banks with a new business chance.
Typical securitisation occurs as follows; banks issue the securities backed by a loan. The
security represents claims on the future interest revenue. This is why such a security is called as an
asset-backed security 2. If banks are lending to profitable investment projects, then the asset backed
security as well as the deposit links the ultimate lenders and the project. In other words, banks canwiden the fund raising channel and write off the loan asset, which results in the improvement of thecapital/asset ratio. According to popular belief, the latter is the most distinguished benefit of
securitisation. Especially in the financial system with heavy non-performing loans, securitisation is
expected to be the special medicine, which makes banks’balance sheets slimmer.
The main purpose of this paper is to consider the effects of securitisation on banks’profit
structures, especially focusing on two types of securitisation, "on-balance sheet securitisation"and"off-balance sheet securitisation"3 .
This paper consists of two parts. The first part deals with the simple loan backed / onbalance securitisation and derives some fundamental propositions. We start from describing the basicmodel developed by Twinn(1995) . In section II, we discuss the benefits banks can enjoy. In
section III and IV, the model is extended to the more realistic one, by introducing the S.P.V.(special
purpose vehicle). The S.P.V. is the key agent in off-balance securitisation, especially, in cases where
the non-financial firms securitise their asset. The final section consists of concluding remarks andsome policy implications.
II. On-balance securitisation
II-1 Twinn model
The Twinn model is explained initially because it is very simple and operational. The
following relation can specify the balance sheet of the representative bank that securitises the part ofits loan.
G + L = S + D+ K,(1)

1

See, for example, Edward and Mishkin(1995) and Mishkin(1997).
Distinguish it to a loan sale. In a loan sale, securities are not issued .For an introductory explanation of ABS,
see O.E.C.D.(1995), Fukaura(1997), for example. In the practical sense, security backed by banks loan is not an
A.B.S. However, because an ABS is normally defined as security backed not by the expected capacity to repayof the originator but by the future cash flow stemmed to assets, secutiries backed by the cash flow from future
repayments by the borrowers is regarded as an A.B.S. in the theoretical or broad sense.
3
Hereafter, we simply say "on-balance securitisation” and "off-balance securitisation".
23

where,G : gilt
L : loanS : loan-backed securities
D : deposit
K : capital
We call this on-balance securitisation because the issued securities( S ) remain on the liability side.
Profit is defined as
Π = rG G + rL L - rS S - rD D - rK K,

where K = δ(L - S)

(2)

ri is the interest rate for each asset.
We assume G is the short term gilt and rK > rG . This is a very important assumption as weshow later. Further the gilt and capital markets are competitive where banks are the price takers. On
the other hand, in the markets for L,S,D, banks have price setting power. Therefore, the demand andsupply functions are identified as
DS = exp(α0 + α1 rD )Ld = exp(β0 - β1 rL)
Sd = exp(ϕ0 + ϕ1 rS)

α1 >0
β1 >0
ϕ1 >0

Substituting (3)-(5) into (2)

gives

(3)
(4)
(5)

Π = exp(α)(rG - rD ) + exp(β)( rG (δ-1) + rL - δrK ) + exp(ϕ)( rG (1-δ) - rS + δrK )4(6)

The first order conditions for rD , rL ,rS are∂Π/∂rd = - exp(α) + exp(α)(rG - rD ) α1 = 0
rG - rD * = α1-1(7)∂Π/∂rL = exp(β) - exp(β) ( rG (δ-1) + rL - δrK ) β1 = 0
rL* = rG (1-δ) + δ
rK + β1-1 = r +∂Π/∂rS = -exp(ϕ) + exp(ϕ)( rG (1-δ) - rS+ δrK ) ϕ 1 = 0
rS* = rG (1-δ) + δrK - ϕ1-1 = r where r = rG (1-δ) + δ
rK 5.

β1-1

ϕ1-1

(8)

(9)

Proposition 1 summarizes some characters of our economy.
PROPOSITION 1:
1. rL* - rD* >0.
2. rL* is increasing and approaching to r as the loan demand becomes elastic.
rS* is decreasing and approaching to r as the security demand becomes elastic, too.
When both markets are perfect, rL* = rS* = r .
3. The perfect deposit market gives rG = rD*.
PROOF:

4

The required reserve is not considered. The reserve, R=φD whereφis the legal reserve ratio, does not make any
substantial change to our discussions because it just makes the first term of (6) (1-φ) exp(α)(rG - rD ).
5
The higher δmakes r increase and approach to rK(>rG). In the Twinn model capital is expensive to hold thenthe higher capital/asset ratio requires banks to receive the higher normal profit.

4

1. rL*-rD* = (rG -rK)δ+ β1-1+ α1-1 >0 . The interest spread is positive.
2. rL*can be represented by the weighted average of rG and rK , adjusted by the elasticity terms, β1 andϕ1. β1 is positive so rL*> r. Further, they diverge to infinity (converge to r ) in the elastic(inelastic)
market. Then, we have∂(rL*-r) /∂β1 = - β-2 < 0, ∂2 (rL*-r) /∂β1 2 = 2 β-3 > 0 and rL* > r .
Similarly,∂(r-rS*) /∂ϕ1 < 0, ∂2 (r-rS*) /∂ϕ12 > 0 and rS* < rIn perfect market we directly have rG = rD* and rL* = rS* = r. Note r > rG because r is the weighted
average of rG and rK. See the Fig -1.
3. Trivial from (7).

QED

rL *

rS *

r

r

rD *

rG
β1

ϕ1

α1

Fig.1
It is interesting to consider the interest spread between rS* and rD*. From (7) and (9), wehaverS* - rD* = (r - rG) + (α1-1- ϕ1-1 ) .
Thus when the security demand is more inelastic and the deposit is more elastic, a small spread
results. However, in an economy where securitisation is popular, the demand for security is
supposed to be highly elastic. So in what follows, we consider only the case of rS* - rD* > 0.
However, later we will also prove the net profit of securitisation does not depend on the sign of (rS* rD*) .
II-2 imperfect market effect6
The above discussion leads to the next proposition.
PROPOSITION 2:
Suppose banks securitise loans. Then profits when banks are in an imperfect market are larger
than when they are in a perfect market.
PROOF:
Bank profits in an imperfect market is given by (6). Some rearranging yieldΠ = exp(α)( rG - rD *) + { rG (1-δ) + δ
rK }{exp(ϕ) - exp(β)} - rS *exp(ϕ) + rL *exp(β)(10)

From proposition 1, bank profits under perfect competition is written as

6

In what follows, in the case we refer to the optimum, we assume all markets are clear. Then we simply write

exp(α) as D etc.

5Πp = exp(β){ rG (δ-1) + r - δrK } + exp(ϕ){ rG (1-δ) - r + δrK }= { rG (1-δ) - r + δ
rK }{exp(ϕ) - exp(β)} = ( r - r ) {exp(ϕ) - exp(β)} = 0
Combining (10) and (11) yields Π> Π P = 0.

(11)

QED

Proposition 2 simply means that perfect competition forces firms to give up excess profit.
The author discussed in Fukaura(1997) that the advantage of securitisation is derived from thedifference in transaction costs between the (ultimate) lenders and the (ultimate) borrowers. Needlessto say, the transaction costs represent market imperfection, i.e., asymmetric information. As thefinancial intermediary, banks bridge them by producing information on investment potentiality andon the availability of funds. On the other hand, in securitisation, this information must be imputed in
the structure of the securities itself. In securitisation, as well as traditional intermediation, theadvantages banks can enjoy depend on the degree of the information asymmetry.
Theoretically, the margin between r and rL *(rS*) reflects the information produced by banks
under imperfect market as well as banks’monopolistic power. For banks, securitisation is thealternative to traditional intermediation, however, it must be noted both are based on information
producing technology.
II-3 Capital/asset ratio effect
Generally, securitisation is said to be beneficial because the capital/asset ratio is improvedby writing off the asset (= loan). The capital asset ratio is defined as
δB = K / L
δ = K / (L - S)

before-securitisation
after-securitisation

Certainly, L > S > 0 then δ > δ‘.
However, securitisation also requires liability adjustment. Consider these two balance
sheets.
G+L=
G+L=

D0
S + D1+K+K

before-securitisation
after-securitisation

D0 is divided to S and D1 after securitisation. However, the cost of S(= rS* ) is normallygreater than rD * . This means, by writing off the loan through securitisation, banks will face a more
expensive fund than before, seteris paribus. We must check how this affects bank profits. Simple
calculations provide the next proposition.
PROPOSITION 3 :On-balance securitisation improves the capital/asset ratio. However, it decreases profit.
PROOF:
Substituting K=δB L, G=D+K-L and D0 = S+D1 = exp(β) into (6) yields banks’beforesecuritising profit ,Π B = rG G - rK K - {exp(α) + exp(ϕ)} rD + exp(β)rL= exp(α)( rG - rD ) + exp(β){(δB -1)rG -δB rK + rL} + exp(ϕ)( rG - rD ).

(12)

On the other hand, banks’after-securitising profit is already given by (6). Then we have
Π B- Π

= exp(β)(δB - δ)( rG - rK ) + exp(ϕ){δ(rG - rK) + rS - rD } .

(13)

The first term represents the profit change by the increase of the capital/asset ratio and thesecond term is the effect caused by securitisation itself. Some manipulations lead to6Π B- Π= ( rG - rK ){ exp(β)(δB - δ) + exp(ϕ)δ} + exp(ϕ)(rG - rD *)(14)

From the definitions of δB and δ, we obtain
K = δ(L - S) = δB L
L(δB - δ) = - δS 7

(15)

From (7) ,(14), (15), we getΠ B - Π = exp(ϕ)( rG - rD*) = exp(ϕ)/α > 0.

(16)

QED
We can trace this proposition with the simple numerical example. Assume a bank has thefollowing balance sheets and its loans are securitised. The B/S of the non-bank agent that purchasesthat security changes simultaneously. We must note that the asset sides of the bank(befer and after)
are same. This means the bank can not change their asset management strategy.
Bank(before)GL

10 D 90
90 K 10

Bank(after)
G 10
L 90

Non Bank(before)
D 90

S
D
K

20
70
10

rG=0.15 rS=0.1 rL=0.2
rD=0.05 rK=0.1

Non Bank(after)

L 90

D
S

70
20

L 90

Fig. 2
From (16) , Π P - Π = 20 (0.1 - 0.05) = 1.0. As shown in the balance sheets, securitisation does notbring out any change in the asset side, which also means the revenue is constant. Then we consider
only the liability side(note the risk weight of G = 0) . This is the reason that Π B - Π does not dependon the capital/asset ratio, but only on the deposit rate8.
To ensure the accuracy of our proposition, calculate the funding cost directly before/after
securitisation.
0.05(90) + 0.1(10)0.1(20) + 0.05(70) + 0.1(10)= 5.5 : before= 6.5 : after

Profit is decreased by 1.0, which is equal to the value obtained above, as might be expected.
It is often said that securitisation makes the funding channel more wide, however, we must note thatbanks will face more expensive funds than the deposits. In other words, the opportunity cost of
securitisation depends on the price setting power in the deposit market. The last equation of (16)represents this9.

BRe-arranging (15) gives (δ- δ)/ δ= S/L. The capital/asset ratio is increased in proportion to the securitisedloan. This supports the popular belief directly.
7

8

The non-performing loan problems can be depicted by Fig 2. Consider 20 of L is bad loan. If banks
write it off directly it faces capital shortage(K=-10). Alternatively the RTC(or something) can obtain
the bad loan by the back-finance. S. finances the back finance So we have the same B/S as
Bank(after)in Fig 2. Note the capital/asset ratio is not improved.
9
We referred rS*>rD* just to give an intuitive interpretation. We know from (16) the profit increase does notdepend on rS*.

7

II-4

Net benefit of securitisation

As discussed above, the net benefit of securitisation depends on (1) imperfect market effectand (2) capital/asset ratio effect. Remember (10) shows the imperfect market effect, which increases
the profit, and (16) is the capital/asset ratio effect, which decreases profit. The net effect can bederived easily by subtracting (16) from (10). Remember we can not say simply Π - Π B + Π = Π B
because the capital/asset ratio is different. Instead, we must use the explicit expression of Π B - Πgiven by (13).
Π N =exp(α) (rG - rD*) + exp(β){ rG (δ-1)+ rL*- δ
rK } + exp(ϕ){ rG (1-δ)-rS *+ δrK -(rG-rD*)} .
=exp(α) (rG - rD*) + exp(β){ rG (δ-1)+ rL*- δ
rK } + exp(ϕ){r - rS *+( rD*-rG )}.

(17)

PROPOSITION 4:
Under the imperfect competition, the net profit of securitisation is positive.
PROOF:
The first and second terms of (17) are both positive therefore we should consider the last.
From proposition 1( Fig-1) we knowrS * < rif

ϕ1 < 8andrD* > rG if α1 < 8 andlim rS* →ϕ1→ 8
lim rD* →
α1→ 8

r
(18)
rG

So if the markets are imperfect (ϕ1 , α1 < 8), r - rS *>0 and rD*-rG >0. Therefore,
Π N > 010.

QED

From proposition 4 we have next collorary.
COLLORARY:
The net profit of on-balance securitisation is independent from the spread between rS* and rD*
It looks a little strange that banks gain net profit despite a higher security rate than the deposit
rate. This is because rS* intersects rD* between r and rG (see Fig-2). The last term is written asexp(ϕ){(r - rG )+ (rD*- rS *)}(19)
so even if (rD*- rS ) < 0 , the absolute value of ( r - rG ) is greater than that of (rD*- rS ).
rD *
r

rG
rS *
ϕ1 , α1Fig-3

10

It is straightforward , when all markets are perfect(rL*=rS*= r, rD* = rg), (18) equals to zero.

8

We should note the importance of the assumption rK > rG because this secures the condition r >rG. Conventional wisdom is at least correct only in the sense that the benefit of securitisation depends
on changes in the capital/asset ratio.
III.

Off

balance securitisation

III-1 The function of the S.P.V.
In the earlier section we concentrated on the Twinn model as the basic model. Justification
for this approach is twofold. First, it is a convenient way to understand securitisation process .
Second, it also models on -balance securitisation, which is the typical way banks securitise assets(loan). In European countries, which have laws and banking systems ill suited to securitisation, banks
often package their mortgages that remain on banks’balance sheet.
Off-balance securitisation has a more complicated set-up. In on-balance securitisation, there
are three agents (i.e., banks , the lender, and the borrower11). In the contrast, in off balance
securitisaton, the asset holder does not issue asset backed securities alone. Instead, a new agent, thecompanies designed only for issuing securities, must be added. This is called the S.P.V.or
L.P.C.( Special Purpose Vehicle, Limited Purpose Cooperation). Hence, it consists of four agents,
three plus the S.P.V..
Accordingly, we need following balance sheets12. The original state is given in section II-3, as
the numerical example,before-securitisation .
bank
G 10 DH 70
C 20 DS 20
LF 70 KB 10

S.P.V.
DS 20

SShouseholdfirm

20 SS 20 P 90
DH 70

P 90 LF 70
LS 20

Fig-4
The real aspect of this economy is summarized in the physical assets( liability ) of the firms(house) .
The remaining entities are all financial assets and liabilities then should be canceled out. However,to cancel out every entity, LS in the firms must be equal to C in banks. Before securitisation, thefirms’borrowing corresponds to banks’loan. After securitisation, the counterpart is the cash. In thissense, banks can liquidate the loan(= getting the cash) and the credit-risk are transferred to thesecurity holders13.
Compare the banks’balance sheet with Fig. 2 ( numerical example, after-securitisation). The
total amount of deposit is constant(=90) ,which means the funding cost is also the same between thetwo schemes. However, the depositors are divided into the household and the S.P.V..Further, note thecapital/asset ratio is same (1/7) if C is cash. The firms’interest bill is not changed 14.

11

The borrowers and the lenders are not explicitly considered in the fundamental model.
To avoid the complexity, we assume the original asset holders are banks as well as the former discussion,
although we lost some of generality. Such banks are called the originator. First, a bank sell the loan to firms
20 units to the S.P.V. so the bank’s cash is increased (C=20) and LF becomes 70.The S.P.V. issues asset backed
securities (SS=20) and the proceeds are deposited at banks(DS=20). The household purchases the securities from
S.P.V. so the household’s asset changes (SS=20 and DH=70). The firms liabilities owes banks(LB=80) and
S.P.V.(Ls=20). Strictly speaking, the firms has a liabilities to household (the security holder), however, in the
typical securitisation scheme the firms must pay their interest to the S.P.V.. It passes through the received
interest to the security holders. So the S.P.V. is often called the conduit. The physical assets are in the liability
side of the household and the asset side of the firms’asset side. This means our firms are producing the goods
and services by utilizing the household’s physical assets. Building model to deal with the non-financial firm’s
securitisation is a theme to be solved. Summing up the banks’and S.P.V.’s balance sheet in Fig -3 leads to thebanks’balance sheet in section II-3. This means off-balance securitisation divides the original balance sheet or it
unbundles the traditional banking service into two.
13
To benefit from the law of large number, the pooled assets should back securities. We can show this byregarding Fig-3 as the balance sheet for the whole economy.
14
it is argued that securitisation breaks the tie between banks and firms, undermining the corporate governance129

By comparing Fig 4 with Fig 3 we know the substantial difference between the on and offbalance sheet securitisation. When banks issue the securities themselves, the liability structure ischanged. On the other hand, when the S.P.V. carries out the banks’liability reshuffle, it brings afavorable change in the asset side. The Non Bank sector in Fig 3 is splitted into the SPV(the issuing
agent), the household (security holder) and the firm(debtor). In Fig 4 the firm’s liability consists ofthe bank borrowing(LF=70) and securitised debt to household(Ls=20). The household purchases Ss
from SPV, not from the bank. The SPV’s new deposit(Ds=20) is often called bank’s “new money” inthe sense that a part of asset is released from the original usage(original bank loan). It is almost sameto the proceeds the bank could get if it directly sells off the loan in the asset market. On the other
hand, in Fig 3, the bank’s asset composition dose not change, which means the banks can not enjoy
new money. In other words, Ls(=20) in Fig-3 is “sleeping”.
In other words, off balance securitisation provides banks an additional investment channel, in
contrast to the widespread argument emphasizing that it widens the fund-raising channel 15.
These discussions are formalized by the next proposition.
PROPOSITION 5:
The loan is converted into cash without any
issues the securities instead of banks.
PROOF: See above discussions.

change in the liability side, only if the S.P.V.

QED

Sometimes concern has been expressed that banks write off the best assets that evade thesoundness of the financial system. However, if banks invest C for high profits, it contributes toenhance the soundness of banks, which is consistent with the global principle of the sound financial
system16.
III-2 Banks’profit
Now we can expect banks’profit (Π S) to be less than Π ,because banks lose the income
from securitised loan and gain nothing from cash holding. Therefore, securitisation does not pay
unless banks can find more profitable investment opportunities.
This can be shown as follows.
Π S = rG G + rCC + rL L - rD D - rK K,
By substituting(20)

S = - C and rS = rC into (2) we have

Π S = exp(α)(rG - rD ) + exp(β){ rG (δS-1) + rL - δSrK} – C(r – rC)(21)

Comparing (21) and (6), it is easy to confirm that the optimal values of rD , rL are same. The
rate the S.P.V. offer the household are also determined according to (6). This is not an unnatural
assumption because the S.P.V. is merely the agent of the banks. Further, note the capital/asset
ratios are same in our numerical example, both equal to 1/7). Then in equilibrium we getΠ S - Π = C(r – rS*) – C(r–r C)(22)

mechanism provided by banks.
15
See Greenbaum and Thakor(1987).
16

Fig-3 is also helpful to understand the bad loan problems. Starting from B/S(a) if 15 of outstanding
loan become worthless, its net worth is now -5 so bank can not pay off all liability. When bad loan is written off
by securitisation, we have B/S (b).This is substantially same as Fig-3.
B/S(a) : G(10)+L(90)= D(90)+K(10)
B/S(b) : G(10)+L(75)+C(15)= D(90)+K(10)10If C is cash(rC = 0), Π S- Π = C(-rS*) < 0, that is, if banks hoard cash, on-balance securitisation does
not pay 17. Now we can reach the new proposition.
PROPOSITION 6 :Off-balance securitisation is desirable if and only if banks have a superior fund managing
ability .
PROOF:The proof is trivial. From (22) we haveΠS > Π

⇔rC > rS *(23)

Accordingly, if banks can use C more profitably in the sense rC is higher than the rate banks
pay(rS*), off-balance securitisation is desirable. That is, (23) reflects the banks’ability of investment,
in other words, the asset management ability. It is the banks with high investment ability that benefit
from off-balance securitisation18.
QED
Some observers have been discussing on securitisation, without the explicit recognition of thedifference between on/off-balance securitisation. They take it for granted that off-balance
securitisations are dominant. However, unless we explain the differences between two schemes, we
can not understand the exact importance of the S.P.V..
It is worth considering the case when banks purchase equity directly instead of lending. The
resulting balance sheets are same as the Fig -5, except C is replaced by Equity. In other words, if the
cash raised from securitisation is invested into the stock market, the bank’s balance sheet in Fig-3 issame as the one in Fig-4. However we should note the firm’s situation.
banks
G 10 D
Equity 10 KB
LF 80

90
10

householdD 90 P 90

firms
P 90 L80
Equity 10

Fig -5
Because the loan has been curtailed, firms must issue the equity. It is easy for the established,
named firms, but impossible for infant firms, small businesses, or venture companies. In this sense,
off-balance securitisation is very helpful to foster potential firms19.
IV Securitisation or intermediation ?
In section II-3, we discussed that on-balance securitisation is not superior in the sense it gives
banks smaller profit. It means the traditional intermediation is more profitable. Further, III-3
discussed that off-balance securitisation is superior in the sense it gives banks larger profits than off-

17

Note exp(α) - exp(β) = C. We assume the market for C is perfect and rC is given.
In his excellent textbook, Bessis(1998) discussed the benefit and cost of securitisation . He analyzed the nonS.P.V. case and concluded that the benefit stemmed from the reduction of the funding cost. This conclusion are
based on the assumption that rs < rD and rC=0( exactly speaking, he ignored the revenue from C.
19
Securitisation described by Fig-4 is also applicable to securitisation by the venture business. First we shouldnote that this never means the venture issues the security by itself. If so, the venture can raise the fund directly
form the capital market. See below, where A denotes the venture's asset for the production.
householdventureEQ 90  P 90
A 90  EQ 90
Initially the venture must borrow the fund from the intermediary, at the same time the intermediary issues the
security backed by the cash flow from the venture's expected profit. The intermediary loan on the condition
that it can be securitised immediately.
18

11

balance securitisation under some condition. Accordingly, our final task is to consider the advantage
of off-balance securitisation over the traditional intermediation. Needless to say , the income positionof traditional banking was already given by (12). Compare (12) with (21), with noting the balance
sheet condition.
Π S - Π B = exp(β)(rG -rK )(δS-δ' ) + C(α‑1 + rC*– r)(24)

The first term is negative because of rG -rK < 0 and δS > δ'( in our concrete balance sheet, δS =1/7,
δ'=1/9), this reflects the capital/asset ratio effect. Because by proposition 6 we know rC*>rS* andfrom Proposition 1 we have r = rS* + φ-1 , then rC*– r = (rC*– rS*)+ φ-1 > 0. Hence the second term is
positive. Accordingly, the sign of (24) is unknown.
However, we can say if Π S > Π B then rC*>rS*. This means rC*>rS* is the necessary
condition for on-balance securitisation, but it is more restrictive than proposition 6 says.
Accordingly, we can relate rC and rS* to banks’profit in different securitisation schemes. See
Fig-5 where rC* is rate at where Π S = Π B. Proposition 2 ensures the axis is positive and proposition
4 ensures Π locates between Π P and Π B.
(capital/asset ratio effect)Π P =0

Π

←

ΠB

S

( Π < Π)B

( Π< Π < Π )(Π < Π )(rC<rS*)(rS*<rC<rC*)(rS*<rC)

S

B

ΠS

S

rC
rS*

rC*

From the view of banks’profit in the imperfect financial markets, three cases are classified
according to the level of rC .
1. If rC<rS *(= banks cannot get sufficiently high return from C) on balance
securitisation is desirable.
2. If rS*<rC<rC*, on-balance securitisation is preferable to off.
3. If rC*<rC , off-balance securitisation is desirable.
However, further consideration leads us to a more interesting finding.
PROPOSITION 7:
If rC < rC*, the traditional intermediary is dominant.
If rC > rC*, off-balance securitisation is dominant.
On-balance securitisation is not conducted.
PROOF:
The case 3 descried above gives the proof for rC>rC*.
When rC < rC*, on/off-balance securitisation is desirable (case 1 and 2 ). However, banks canrealize Π B in traditional intermediation. So they have no incentive to securitise their assets, i.e., bothsecuritisations are always dominated by intermediation in this area(dashed line).
Q.E.D
This proposition is again emphasizing the importance of banks’asset management ability insecuritisation process. Inversely, the traditional intermediation is not always inferior business, evenin the liberalized financial markets.
V

Concluding Remarks

In preceding sections we have been exploring the theoretical foundations for on /off balance
securitisation. We found that the net benefit of on-balance securitisation depends on (1) the effectbased on the improved capital/asset ratio and (2) the effect based on the imperfect information.

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Although the former decreases the profit, the latter wholly cancels it out. This suggests that weshould not regard securitisation as financial innovation to improve the capital/asset ratio.
Another finding is that there is a substantial difference between on-balance and off-balance
securitisation, in the sense of whether or not banks can convert loans into cash without any changes
in the liability side, for example, banks can liquidate the asset and get a perfect disposal fund.
Further, we succeeded to show off-balance securitisation is valid only for banks with excellent
asset management ability.
Our findings have some policy implications. Suppose the rating is enhanced by securitisation,
which is often referred as an important benefit of securitisation. Our model ensures this. Because
banks’capital costs (=rK) are decreased, stock prices buoy up. This brings smaller r (=rG (1-δ)+δrK)
and makes Π < Π S more attainable.
The introduction of the off-balance sheet securitisation into their mortgage program by somegovernments, for example Irish, Argentina government, is one vital example, which shows thebenefits of it. The expanding the policy to promote the house ownership may worsen the financial
deficit. If the government could securitise the cash flow from the mortgage payments, it can setup the
program without further deterioration.
When no alternative market in which invests the additional fund is available, banks must holdcash or find a new lending. This leads to Π > Π S. Before 1970’s, on-balance securitisation was not
popular in Japan. According to our discussions, it is because there was little market where banks
could earn a preferable rate. This explanation enables us to focus on an another aspect of theJapanese financial system characterized mainly by the main-bank relationship between banks andfirms. Japanese monetary authority enacted a special law for securitisation in 1992, however, it has
too many restrictions to encourage securitisation. In US, these restrictions requiring banks to backtheir loans with capital even after securitisation or limiting the type of investor that could buy the
resultant securities were all eliminated in 1994. These deregulation resulted in the growing concern
about securitisation in US. It was not a happening but a natural process.
After the middle of 70’s, markets for CD, repo, swap and option, foreign exchange and so on,
have dramatically been extending . These markets give banks a large opportunity to realize higher rC.
This makes Π < Π S more attainable. At the same time, however, we must remember that if banks
cannot raise sufficiently high return, securitisation deteriorates the profitability of banks.
REFERENCES
J. Bessis, 1998, Risk Management in Banking, Wiley
R.Cantor,R.Demsetz, 1993, Securitisation, Loan Sales, and the Credit Slowdown, Federal Reserve
Bank of New York Quarterly Review.
F.R.Edwards, F.S.Mishkin, 1995, The Decline of Traditional Banking: Implications for Financial
Stability and Regulatory Policy, Economic Policy Review, Federal Reserve Bank, New York
A.Fukaura, 1997, Economics of Securitisation( in Japanese), Nihon-Hyoronsya
S.I.Greenbaum, A.V.Thakor, 1987, Bank funding modes:securitisation versus deposit. Journalof Banking and Finance Vol.11
F.S.Mishkin, 1997,The Economics of Money, Banking, and Financial Markets, Addition Wesly
O.E.C.D.,1995, Securitisation : An international Perspective, Financial Market Trends.
C.I.Twinn, 1995, Asset-backed securitisation in the United Kingdom, Bank of England Quarterly
Bulletin.

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