New Economics Papers
on Banking
Issue of 2007‒01‒14
24 papers chosen by
Roberto J. Santillán–Salgado, EGADE-ITESM

  1. Acquisition versus greenfield: The impact of the mode of foreign bank entry on information and bank lending rates By Sophie Claeys; Christa Hainz
  2. Bank Insolvencies, Regulatory Forbearance and Ambiguity By Dmitri V. Vinogradov
  3. Macroeconomic Evolution after a Production Shock: the Role for Financial Intermediation By Dmitri V. Vinogradov
  4. Should we Abandon the Intermediation Approach for Analyzing Banking Performance? By Mario Fortin; Andre Leclerc
  5. The role of banking portfolios in the transmission from currency crises to banking crises - potential effects of Basel II By Tobias Knedlik; Johannes Stöbel
  6. Does the Internet Kill the Distance? Evidence From Navigation, E-Commerce, and E-Banking. By Guido De Blasio
  7. Transition of the Serbian Banking Sector and European Integration By Miroljub Hadzic
  8. Activities of Greek Banks in Balkan Countries: A Comparative Balance Sheet and Income Analysis Between Affiliate Banks in Balkan Countries By Simeon Karafolas
  9. Is there a single frontier in a single European banking market? By Jaap W. B. Bos; Heiko Schmiedel
  10. Multiple-bank lending: diversification and free-riding in monitoring By Elena Carletti; Vittoria Cerasi; Sonja Daltung
  11. The World and the Indian Banking Industry By Mishra, Garima; Goyal, Rashi
  12. The cost efficiency of German banks : a comparison of SFA and DEA By Fiorentino, Elisabetta; Karmann, Alexander; Koetter, Michael
  13. Bank Intermediation and Small Business Lending By Susanne Prantl; Matthias Almus; Jürgen Egeln; Dirk Engel
  14. Moral Hazard in the Diamond-Dybvig Model of Banking By Andolfatto, David; Nosal, Ed
  15. Liquidity risk management in banks: international best practices and cases (In Spanish) By Delfiner, Miguel; Lippi, Claudia; Pailhé, Cristina
  16. Credit cooperatives: overview of international experiences (In Spanish) By Delfiner, Miguel; Perón, Silvana; Pailhé, Cristina
  17. Kerangka Kerja Ekonofisika dalam Basel II By Situngkir, Hokky; Surya, Yohanes
  18. Information systems for the management of credit risk: survey in the Argentine financial system (In Spanish) By Pailhé, Cristina
  19. Project Finance as a Risk-Management Tool in International Syndicated Lending By Christa Hainz; Stefanie Kleimeier
  20. Discriminant Analysys of Default Risk By Aragon, Aker
  22. Information systems for the management of operational risk: survey in the Argentine financial system (In Spanish) By Pailhé, Cristina
  23. Private vs. Official Creditors: The Record Speaks By Porzecanski, Arturo C.
  24. Mortgages market and securitization By Govori, Fadil

  1. By: Sophie Claeys (Research Division, Sveriges Riksbank, SE-103 37 Stockholm and Ghent University, W. Wilsonplein 5D, B-9000 Ghent.; Christa Hainz (Department of Economics, University of Munich, Akademiestr. 1/III, 80799 Munich.
    Abstract: Policy makers often decide to liberalize foreign bank entry but at the same time restrict the mode of entry. We study how different entry modes affect the interest rate for loans in a model in which domestic banks possess private information about their incumbent clients but foreign banks have better screening skills. Our model predicts that competition is stronger if market entry occurs through a greenfield investment and therefore domestic banks' interest rates are lower. We find empirical support for our results for a sample of banks from ten Eastern European countries for the period 1995-2003.
    Keywords: banking, foreign entry, mode of entry, interest rate, asymmetric information
    JEL: G21 D4 L31
    Date: 2006–11
  2. By: Dmitri V. Vinogradov (Universität Heidelberg, Alfred-Weber-Institut für Wirtschaftswissenschaften; Universität Heidelberg, Alfred-Weber-Institut für Wirtschaftswissenschaften)
    Abstract: Banking regulators often practice forbearance and ambiguity in insolvency resolutions. The paper examines the effects of regulatory forbearance and ambiguity in a context of allocational efficiency. Bailouts, liquidations and their stochastic policy mix lead to suboptimal allocations if banks do not internalize insolvency costs. The policy of forbearance may make banks internalizing such costs and improves the efficiency of intermediation.
    Keywords: Banks, insolvency resolution, forbearance, constructive ambiguity
    JEL: D50 E44 G21 G28
    Date: 2006–09
  3. By: Dmitri V. Vinogradov (Universität Heidelberg, Alfred-Weber-Institut für Wirtschaftswissenschaften; Universität Heidelberg, Alfred-Weber-Institut für Wirtschaftswissenschaften)
    Abstract: Financial intermediaries may increase economic efficiency through intertemporal risk smoothing. However without an adequate regulation, intermediation may fail to do this. This paper studies the effects of a production shock in a closed economy and compares abilities of market-based and bank-based financial systems in processing the shock. Unregulated banking system may collapse in absence of a proper regulation. The paper studies several types of regulatory interventions, which may improve the performance of the banking system.
    Keywords: Financial intermediation, overlapping generations, general equilibrium, intertemporal smoothing
    JEL: D50 G21 G28 E44 E53 O16
    Date: 2006–08
  4. By: Mario Fortin (GREDI, Département d'économique, Université de Sherbrooke); Andre Leclerc (Secteur sciences humaines, Université de Moncton, campus d’Edmundston)
    Abstract: The intermediation approach considers banks’ liabilities as inputs to produce loans and other banking assets. We show that measures of banking efficiency and productivity are biased when there is an incomplete coverage of assets and liabilities. The bias can be eliminated with a complete coverage, but in this situation we show that banks are necessarily technically efficient. Moreover, the Malmquist decomposition of productivity growth becomes useless. The difficulties identified in this paper question the usefulness of the intermediation approach in assessing banks’ performance.
    Keywords: Intermediation approach, efficiency, Malmquist index
    JEL: G21 D24
    Date: 2006
  5. By: Tobias Knedlik; Johannes Stöbel
    Abstract: This paper evaluates the potential effects of the Basel II accord on preventing the transmission from currency crises to financial crises. By analyzing the case study of South Korea, it shows how mismatches on banks’ balance sheets were the primary cause for such a transmission, and models how Basel II would have affected those balance sheets. The paper shows that due to South Korea’s positive credit rating in the months leading up to the crisis, the regulatory capital reserves under Basel II would have been even lower than those under Basel I, and that therefore Basel II would have had adverse effects on the development of the crisis. In the second part, the article analyses whether the behavior of rating agencies has changed since their failure to predict the Asian crisis. The paper finds no robust econometric evidence that rating agencies have started to take micromismatches into account when assigning sovereign ratings. Thus, given the current approach of credit rating agencies, we have reservations concerning the effectiveness of Basel II to prevent the transmission from currency crises to banking crises, both for the case of South Korea and for potential future crises.
    Keywords: Asian Financial Crisis, Bank Portfolios, Currency Mismatch, Maturity Mismatch, Basel II, Credit Ratings
    JEL: F3 F40 G15 G28
    Date: 2006–12
  6. By: Guido De Blasio
    Abstract: By diminishing the cost of performing isolated economic activities in isolated areas, information technology might serve as a substitute for urban agglomeration. This paper assesses this hypothesis by using Italian household level data on internet navigation, e-commerce, and e-banking. Empirically, I find no support for the argument that the internet reduces the role of distance. My results suggest that: (1) Internet navigation is more frequent for urban consumers than their non-urban counterparts. (2) The use of e-commerce is basically not affected by the size of the city where the household lives. Remote consumers are discouraged by the fact that they cannot see the goods before buying them. Leisure activities and cultural items are the only goods and services for which e-commerce is used more intensively in isolated areas. (3) E-banking bears no relationship with city size. In choosing a bank, non-urban customers evaluate personal acquaintances as an important factor more intensively than urban clients. This also depends on the fact that banking account holders in remote areas are more frequently supplied with a loan by their bank.
    Date: 2006–08
  7. By: Miroljub Hadzic
    Abstract: The Serbian banking sector after four years of transition is almost completely different from the situation before. Last year the growth rate of GDP in the sector was among the highest in neighborhood and even among all transition countries. Ten big acquisitions of domestic banks, with majority stake possessed by the state or private persons or legal entities, were realized with results that 2/3 of the sector now belong to foreign investors. Necessary prerequisite for transition was really independent role of National bank in definition and realization of monetary policy and supervision of banking sector. Transition of the banking sector was realized step by step threw three lines of activities.Firstly, restructuring and rehabilitation of existed banks. This painful step included closing of 18 banks and merging of small, week banks. National bank introduced tight financial discipline and international banking standard. Secondly, financial market was opened for foreign investors. At the beginning monetary authorities gave several license for green field investments, but later on foreign banks could penetrate the market threw acquisition of domestic banks, only. Thirdly, recently the state started privatization of majority stake in domestic banks owned by the state. This process will be finished by the end of 2006. At the same time domestic private shareholders recognized their interest to sell majority stake in several others banks. Although Serbian banks improved their efficiency and increased total amount of credit lines and assets for several times, there is still room for further transition steps. Among others, the law on banks and other financial institutions has to be amended, especially regarding stronger supervisory role of National bank, higher responsibility for bank management and auditors, as well. Important role for National bank would be also transition of insurance market, which is now at the very beginning phases of overall reform. Serbian banking sector with linkages to banks from EU countries and full introduction of international banking standards can be solid basis for European integration of Serbian economy.
    Date: 2006–08
  8. By: Simeon Karafolas
    Abstract: The paper proposes a comparative analysis of the activities and income of Greek banks in the Balkan countries (Albania, Bulgaria, FYROM, Romania and Serbia) by examining the balance sheet and the statement of income within the period of 2000-2004. Greek bank have a strong presence in the Balkan countries that begun the decade of ’90. Their presence took the form of affiliate bank and branches. The paper examines activities through affiliate banks and parent banks for which balance sheet and income data are available. Results show differentiations of Greek banks especially with regard activities with non bank-clients and interbank activities in assets and liabilities as well. Non-bank activities arise to 80% in some cases, which represents a strong confidence to these banks. Differentiations between affiliates and with regard parent bank are presented to income and profitability results as well.
    Date: 2006–08
  9. By: Jaap W. B. Bos (Corresponding author: Utrecht School of Economics, Utrecht University, Vredenburg 138, 3511 BG, Utrecht, The Netherlands.); Heiko Schmiedel (European Central Bank, Kaiserstrasse 29, 60311 Frankfurt am Main, Germany.)
    Abstract: This paper attempts to estimate comparable efficiency scores for European banks operating in the Single Market in the EU. Using a data set of more than 5000 large commercial banks from all major European banking markets over the period 1993-2004, the application of meta-frontiers enables us to assess the existence of a single and integrated European banking market. We find evidence in favor of a single European banking market characterized by cost and profit meta-frontiers. However, compared to the meta-frontier estimations, pooled frontier estimations tend to underestimate efficiency levels and correlate poorly with country-specific frontier efficiency ranks. JEL Classification: G21, L11, L22, L23.
    Keywords: X-efficiency, stochastic frontiers, banking, meta-frontiers, technology gap ratios.
    Date: 2006–12
  10. By: Elena Carletti; Vittoria Cerasi; Sonja Daltung
    Abstract: This paper analyzes the optimality of multiple-bank lending, when firms and banks are subject to moral hazard and monitoring is essential. Multiple-bank lending leads to higher per-project monitoring whenever the benefit of greater diversification dominates the costs of free-riding and duplication of effort. The model predicts a greater use of multiple-bank lending when banks are highly leveraged, firms are less profitable and monitoring costs are high. These results are consistent with some empirical observations concerning the use of multiple-bank lending in small and medium business lending.
    Keywords: multiple monitors, diversification, free-riding problem, multiple-bank lending.
    JEL: D82 G21 G32
    Date: 2006–07
  11. By: Mishra, Garima; Goyal, Rashi
    Abstract: The Indian banking industry is presently in a situation of great flux. There are various developments, changes within the Indian economy and deregulations occurring that have the potential to drastically change the way this industry functions in the future. As per the changes envisaged by the Reserve Bank of India (RBI), a roadmap has been laid down to gradually deregulate this sector to the foreign banks. This paper discusses related issues that Indian banks might face in the future and tries to draw uopn the experiences of other developing countries.
    Keywords: Indian; Banking; RBI; risk; savings; deregulation
    JEL: F01
    Date: 2006–08–26
  12. By: Fiorentino, Elisabetta; Karmann, Alexander; Koetter, Michael
    Abstract: We investigate the consistency of efficiency scores derived with two competing frontier methods in the financial economics literature: Stochastic Frontier and Data Envelopment Analysis. We sample 34,192 observations for all German universal banks and analyze whether efficiency measures yield consistent results according to five criteria between 1993 and 2004: levels, rankings, identification of extreme performers, stability over time and correlation to standard accounting-based measures of performance. We find that non-parametric methods are particularly sensitive to measurement error and outliers. Furthermore, our results show that accounting for systematic differences among commercial, cooperative and savings banks is important to avoid misinterpretation about the status of efficiency of the total banking sector. Finally, despite ongoing fundamental changes in Europe’s largest banking system, efficiency rank stability is very high in the short run. However, we also find that annually estimated efficiency scores are markedly less stable over a period of twelve years, in particular for parametric methods. Thus, the implicit assumption of serial independence of bank production in most methods has an important influence on obtained efficiency rankings.
    Keywords: Cost Efficiency, Banks, Stochastic Frontier Approach, Data Envelopment Analysis
    JEL: D24 G21 L25
    Date: 2006
  13. By: Susanne Prantl; Matthias Almus; Jürgen Egeln; Dirk Engel
    Abstract: Loan financing, especially long term bank loan financing, is important for young or small firms in Germany. A large share of all small business lending in Germany originates in public financing programs and cooperative banks, (non-cooperative) private sector credit banks as well as savings banks mediate in the assignment of loans from these programs. Our empirical analyses of this loan type provide insights into the small business loan assignment behavior of the three different bank groups in general. Using various econometric techniques, observation periods and data sources -including detailed data on 6.880 firms- we find three robust, originate results: Not only recently, but already at the beginning of the 1990s credit banks played no substantial, statistically significant role in small business lending. Cooperative and savings banks have, in contrast, a strong, significant positive influence on young, small firms’ loan access. In addition, the loan assignment behavior of the two latter groups is found to be very similar. This is an important result given the ongoing controversial discussion on reforming the German savings bank sector. <br> <br> <i>ZUSAMMENFASSUNG - (Bankintermediation bei der Kreditvergabe an junge oder kleine Unternehmen) <br>In diesem Beitrag wird das Verhalten von Genossenschaftsbanken, Kreditbanken und Sparkassen bei der Vergabe langfristiger Kredite an junge, kleine Unternehmen untersucht. Dies geschieht am Beispiel von Krediten aus öffentlichen Förderprogrammen, die in Deutschland einen substantiellen Anteil aller langfristigen KMU-Kredite ausmachen und deren Allokation die drei Bankengruppen direkt involviert. Entsprechend erlauben die empirischen Analysen Rückschlüsse auf die allgemeinen Vergabestrategien der Bankengruppen bei KMU-Krediten. Unter Verwendung verschiedener Schätzverfahren, Analysezeiträume und Datenquellen, darunter detaillierte Unternehmensdaten für 6.880 Unternehmen, können wir drei robuste, in dieser Form einmalige Hauptresultate aufzeigen: Kreditbanken spielen nicht erst in jüngerer Vergangenheit, sondern auch schon zu Beginn der 90er Jahre keine starke, statistisch signifikante Rolle bei der Kreditversorgung der Mehrheit junger, kleiner Unternehmen. Genossenschaftsbanken und Sparkassen haben nicht nur im Gegensatz zu Kreditbanken substantielle, signifikant positive Einflüsse, sondern die Effekte dieser beiden Bankgruppen sind zudem sehr ähnlich. Dieses letzte Ergebnis ist von besonderem Interesse im Rahmen der aktuellen Kontroverse um Reformen für den deutschen Sparkassensektor.</i>
    Keywords: Kreditvergabeverhalten von Genossenschaftsbanken, Kreditbanken und Sparkassen, Finanzierung junger, kleiner Unternehmen, langfristige Kredite und öffentliche Förderprogramme, Reformierung des deutschen Sparkassensektors
    JEL: M13 G21 G28 L26 C24 C25
    Date: 2006–12
  14. By: Andolfatto, David; Nosal, Ed
    Abstract: We modify the Diamond-Dybvig [3] model studied in Green and Lin [5] to incorporate a self-interested banker who has a private record-keeping technology. A public record-keeping device does not exist. We find that there is a trade-off between sophisticated contracts that possess relatively good risk-sharing properties but allocate resources inefficiently for incentive reasons, and simple contracts that possess relatively poor risk-sharing properties but economize on the inefficient use of resources. While this trade-off depends on model parameters, we find that simple contracts prevail under a wide range of empirically plausible parameter values. Although moral hazard in banking may simplify the optimal structure of deposit liabilities, this simple structure does not enhance the prospect of bank runs.
    Keywords: Banking; Private record-keeping; Moral hazard; Mechanisms; Bank runs.
    JEL: G21
    Date: 2006–12–31
  15. By: Delfiner, Miguel; Lippi, Claudia; Pailhé, Cristina
    Abstract: This paper studies the best practices related to the management of liquidity risk in financial institutions from the viewpoint of the standards, as well as its treatment in a series of countries. Firstly it reviews the best practices suggested by the Basel Committee on Banking Supervision, the developments in European countries observed by the European Central Bank, and sound practices for liquidity risk management proposed in the supervision manuals of the US regulatory agencies. Secondly, it examines particular experiences of countries that apply policies for the management of liquidity risk, through their supervision manuals or their regulation. The paper also includes the experiences of some Latin-American countries that rely on a specific regulation of liquidity, together with the Argentine case. Although the importance of liquidity risk is well known, given the idiosyncratic characteristics shown in different banks, the organisms in charge of establishing the best practices regarding the subject prefer to give general principles that can be used as a guide in the management of the risk rather than to specify a quantitative regulation. Most of the analysed countries have adopted these recommendations, in some cases giving some freedom for the banks to apply internal methods, in others providing guidance for banks that don’t have advanced developments in the subject yet. In other countries, instead, quantitative regulations have been implemented.
    Keywords: Liquidity Risk; Liquidity Mismatches; Regulation
    JEL: G21
    Date: 2006–10
  16. By: Delfiner, Miguel; Perón, Silvana; Pailhé, Cristina
    Abstract: This paper presents a comprehensive review on the activity of credit cooperatives in those countries where this sector has a long tradition and reached an important development. It describes the historical evolution in each country with special focus on the regulatory issues. The main differences between the cooperative financial sector and the traditional banking system are their corporative structure and the geographical area where these entities operate, which are a result of the market where they operate. We found an important development of a banking cooperative structure in those countries where the activity is significant, which is usually organized in federations and central entities operating with different products and services. This pyramidal structure is mainly related with the need of reaching economies of scale and synergies that local entities could not obtain. The federations provide services to local entities and represent them before the authorities. Central units work close to federations, providing a broad range of services too. This kind of structure, called cooperative net, allows local entities to exploit their relative advantages in contrast to big banks, related to the knowledge and geographical proximity to clients, but without having to suffer disadvantages in the variety of services they can provide.
    Keywords: Credit Unions; Cooperative Nets; Regulatory Issues
    JEL: G21
    Date: 2006–09
  17. By: Situngkir, Hokky; Surya, Yohanes
    Abstract: The paper elaborates some analytical opportunities for econophysics in the implementation of Basel II documents for banking. We see this chances by reviewing some methodologies proposed by the econophysicists in the three important aspects of risk management: the market risk, credit risk, and operational risk.
    Keywords: risk management; econophysics; Basel II.
    JEL: G23 E51 H55 D81 C52 G32
    Date: 2006–06–07
  18. By: Pailhé, Cristina
    Abstract: In order to analyse the current state of development and use of the information systems for credit risk in the local financial system, a survey was carried out with a sample of banks that voluntarily decided to take part in the exercise. In relation to the degree of advance of their information systems, the results show that 50% of the banks in the sample are highly developed in that regard (their systems are more than 85% complete), although they are less significant when measured by their assets in terms of the assets of financial system, since the largest banks are not so developed. The most frequently used tools are credit scorings (in particular those used in loan applications) for consumption credits (95% of consumption credit in the sample is originated, or will be in the near future, with application scorings) and ratings for corporate clients (83% of this credit is managed with these ratings). Also, it has been observed a significant coincidence in the variables used for granting credits and during their follow up. Nevertheless, major differences exist in the variables used regarding colaterals and recoveries.
    Keywords: Credit Risk; Credit Scoring; Rating Systems; Information Systems
    JEL: G28
    Date: 2006–10
  19. By: Christa Hainz (Department of Economics, University of Munich, Akademiestr. 1/III, 80799 Munich.; Stefanie Kleimeier (Limburg Institute of Financial Economics, FdEWB, Maastricht University, P.O. Box 616, 6200 MD Maastricht, Netherlands.
    Abstract: We develop a double moral hazard model that predicts that the use of project finance increases with both the political risk of the country in which the project is located and the influence of the lender over this political risk exposure. In contrast, the use of project finance should decrease as the economic health and corporate governance provisions of the borrower’s home country improve. When we test these predictions with a global sample of syndicated loans to borrowers in 139 countries, we find overall support for our model and provide evidence that multilateral development banks act as “political umbrellas”.
    Keywords: project finance, syndicated loans, political risk, double moral hazard
    JEL: D82 F34 G21 G32
    Date: 2006–12
  20. By: Aragon, Aker
    Abstract: In this work discriminant analysis was applied, but firstly the variables were transformed in order to get normal distribution; and Component Analysis was applied in order to get uncorrelated factors.
    Keywords: discriminant; default risk; box cox
    JEL: G21 C13
    Date: 2004–10–21
  21. By: Govori, Fadil
    Abstract: Financial intermediaries expedite the flow of savings from savers to ultimate investors in real assets. Compared to direct investment, financial intermediaries offer some advantages, including pooling of savings, diversification of investment risks, economies of scale in monitoring information and evaluating investment risks, and lower transactions costs. In addition, individual types of intermediaries provide specialized services.
    Keywords: Financial Intermediation; Financial Intermediaries; Financial Institutions
    JEL: G23 G22 G21 G24 G20
    Date: 2006–07–01
  22. By: Pailhé, Cristina
    Abstract: A survey of the information systems for the control, measurement and mitigation of operational risk (OR) was carried out, with a representative sample of banks of the argentine financial system. The survey was structured in three sections: i. organizacional structure and resources for the management of OR; ii. data monitoring and back up and; iii. other aspects. With the results of the survey, four groups of financial institutions were distinguished with regard to OR information systems: i. those that have assigned the function to a specific sector and have advanced in the registration of OR events and in the measurement of their impact, with the object estimating and mitigating the OR; ii. those in which the function is in charge of other areas related to the management of risks and/or audit, but that register important developments in their OR information systems; iii. those with a specific management unit responsible for the function, but that are in a preliminary stage as far as the measurement of OR and; iv. organizations that lack an area responsible for the administration and measurement of OR, but nevertheless register OR event data. A conclusion of the paper is that while most local banks are still in an initial stage regarding information systems for OR and in general lack an integral approach to OR management, their registries usualy contain data regarding OR events useful to perform estimations. The financial institutions also consider the measurement and control of OR as an important factor, since they consider that its consequences have huge cost although they can be mitigated.
    Keywords: Operational Risk; Information Systems; Survey
    JEL: G28
    Date: 2006–10
  23. By: Porzecanski, Arturo C.
    Abstract: Here we highlight the contribution that private creditors have made to resolve expeditiously and even generously the many sovereign debt crises in which they have been involved. The road from debt restructuring to debt forgiveness – from reprofiling to cancellation, in the jargon of the official community – has been a fairly short one for commercial banks and bondholders, but a very long one for the official export-credit and foreign-aid agencies represented by the Paris Club, as well as for the multilateral agencies such as the World Bank and the IMF. They have yet to grant any debt reduction to the middle-income countries that were the object of bailouts during the 1990s and the recipients of subsequent debt relief from the private sector, and they have moved far too slowly to address the needs of the poorest countries, many of which have received substantial, upfront and unconditional debt forgiveness from private creditors.
    Keywords: international finance; sovereign debt
    JEL: F35 F34
    Date: 2006–11
  24. By: Govori, Fadil
    Abstract: Mortgages are an extremely important component of the debt markets. A mortgage is a loan with real estate as collateral. In the event of default by the borrower, the property is sold to satisfy the obligations to the lender. For residential mortgages, banks, thrifts, and mortgage companies are originators of loans. For income properties, such as office buildings and equipment complexes, commercial banks, thrifts, and insurance companies are large originators and holders of mortgages. Before 1970, banks and thrifts held residential mortgages until maturity. Since 1970, groups of residential mortgages have been increasingly insured by government or private insurers against default, packaged together and sold to investors in the form of pass-through securities or collateralized mortgage obligations (CMOs). The majority of mortgages tend to be prepaid before final maturity. There are two major reasons for prepayment: the sale of the property or a decline in interest rates, which allows the borrower to refinance at a lower interest rate. The buyer of a pass-through security has a proportional claim on the pool of mortgages. When some of the mortgages in the pool are prepaid, all holders of pass-throughs share in the prepayments. Collateralized mortgage obligations (CMOs) break the prepayments into tranches. The initial prepayments go to the holders of the first tranche, until that tranche is completely prepaid and ceases to exist. Then prepayments are made to the next tranche until that is completely paid. And so on. Government agencies have played an important role in the process of securitization of mortgage debt. First, government agencies have acted as insurers against default by the borrowers. Second, government agencies have pooled together individual mortgages and sold claims, that is, pass-throughs on the pool. Securitization of mortgage loans has provided desirable investment vehicles for some investors. In fact, securitization has changed the operations of commercial banks and thrifts in the residential mortgage market. Thus, banks and thrifts have acted as originators and processors of mortgages and have held fewer mortgages in their portfolios. This process has tended to reduce risk and expected returns for banks and thrifts.
    Keywords: Mortgages; Mortgage Loans; Mortgages Market; Securitization of Mortgages
    JEL: G12 G22 G21 G11 G0
    Date: 2005–09–21

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