Financial Stability Oversight Council Reports on Macroeconomic Effects on Risk Retention Requirements
Section 941 of the Dodd-Frank Wall Street Reform and Consumer Protection Act 2010 imposes credit risk retention (“risk retention”) requirements, under which securitizers, and, in certain circumstances, originators of asset-backed securities (“ABS”) must retain not less than 5 percent of the credit risk for any asset unless the asset is a Qualified Residential Mortgage or the originator of the asset meets underwriting standards that the regulatory agencies will jointly prescribe. The study makes the following conclusions: (i) securitization is an important source of credit formation to the economy, but certain risks of securitization contributed to the financial crisis and macroeconomic instability; (ii) risk retention, if properly structured, can address some of these inherent risks by requiring an originator or securitizer to have ongoing exposure to the credit risk of the underlying assets; and (iii) there are macroeconomic implications of securitization and risk retention; to the extent that risk retention can incent better lending decisions, it may help to mitigate some of the pro-cyclical effects securitization may have on the economy. This study also offers several principles and recommendations that should inform the design of a risk retention framework so as to strengthen the securitization process and facilitate economic growth by allowing market participants to price credit risk more accurately and allocate capital more efficiently.