Just how effective is securitization as a risk management tool?

This paper provides an examination of the efficacy of asset-backed securitization as a risk management tool. Interestingly the existing literature does not emphasize how a banks’ securitization activity affects their risk profile. In this study we attempt to fill this gap by analysing the impact of asset-backed securitization on banks’ credit risk exposures. Relying on an original dataset of 20 large US banks, we find that asset-backed securitization tends to increase credit risk of the issuing bank. We also perform cross-sectional analysis to examine the effect of securitization by asset type, and find that the positive effect of securitization on credit risk is primarily driven by the securitization of unsecured loans such as credit cards and other consumer loans. Finally, examining the possible impact of Basel II on banks’ securitization activities reveals a marked decrease in the positive effect of asset-backed securitization on banks’ credit risk subsequent to the announcement of the New Accord in 2004. Overall, this study provides findings which have practical application for bank risk management and also relevant for understanding the financial stability implications of banks’ securitization activities.