REDUCES THE EFFECTIVES OF MONETARY POLICY
In 1992, the Bank for International Settlements (1992) while recognizing the potential advantages of securitization also expressed concerns that could potentially offset those benefits. These concerns are beyond those the Bank for International Settlements identified as regulatory concerns. A major concern was that making credit available by allowing borrowers direct access to end lenders of funds could lead to the reduced role of banks in the financial intermediation process and less financial assets and liabilities held at banks. This could make it more difficult for monetary authorities to implement monetary policy. Thus, during periods of tight monetary policy, for example, banks can originate loans and then securitize the loans rather than holding them in their portfolio. This avoids the need for banks to fund the loans originated.
At a theoretical level, there are various theories that economists have proffered to explain securitization’s influence on monetary policy. Bernanke and Gertler (1995) identify two channels through which securitization can influence monetary policy: the bank lending channel and the balance sheet channel. Both theories are based on the effect of cyclical changes on the suppliers and demanders of credit. The bank lending channel theory is based on cyclical changes in the ability of banks to intermediate credit while the balance sheet channel theory is based on cyclical changes in the financial condition of borrowers. The more obvious and direct link to securitization is the bank lending channel theory which is the one noted already.
Several empirical studies provide support for the thesis that securitization has weakened monetary policy. Loutskina and Strahan (2006) show how securitization has weakened the link from bank funding conditions to credit supply in the aggregate and as a result has mitigated the real effects of monetary policy. Frame and White (2004) and the Bank for International Settlements (2003) have shown that the mortgage hedging activities of the two government-sponsored entities, Fannie Mae and Freddie Mac, have at times moved Treasury rates. Two empirical studies by Federal Reserve economists support the view that based on mortgage loans, securitization has had a significant impact on monetary policy (see Estrella, 2002 and Kuttner, 2000).
If the regulatory control of the financial supervisor is based on assets that are held on the balance sheet of regulated institutions, such control has been rendered highly ineffective as banks and financial intermediaries throughout the world today operate on an originate-and-distribute model. They originate assets that do not necessarily rest on the balance sheet of the originator: they are distributed in various ways, of which securitization is only one. Several controls of traditional monetary theory are based on assets held on the balance sheet—for example, liquidity ratios imposed on banks.
In the present day model of financial intermediaries, financial supervisors have to learn to impose regulations that do not differentiate assets based on where they ultimately stay—the balance sheet of the bank or that of some conduit or off-balance-sheet entity.
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