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.

Originally Published: 
18/01/2011