Banking and Securitization

by Wenying Jiangli of the Federal Deposit Insurance Corporation,
Matthew Pritsker of the Federal Reserve Board, and
Peter Raupach of the Bundesbank

November 23, 2007

Abstract: We present a monitoring-based model of banking in which banks can fund their activities with debt, equity, loan sales, and asset securitization. Our results show that banks that have the opportunity to fund themselves via securitization, favor securitization over loan sales. When banks fund themselves with securitization, they have higher profitability, and, depending on the securitization method, higher leverage and lower risk of bank insolvency. We predict that banks with high franchise value will favor securitization methods that reduce bank insolvency, and empirically test this prediction of our theory. Our preliminary evidence is supportive of the theory that securitization reduces risk and increases leverage, but insignificantly improves bank profitability.

JEL Classification: G21, G32.

Keywords: Banking, Securitization, Loan Sales.

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