2013년 12월 4일 수요일

[Z. Pozsar's] The Rise and Fall of the Shadow Banking System (2008)


※ 발췌(reading note with excerpts): 

This article provides an overview of the constellation of forces that drove the emergence of the network of highly levered off-balance sheet vehiclesㅡthe shadow banking systemㅡthat is at the heart of the credit crisis.  Part one of this four-part article presents the evolution of collateralized debt obligations and how they changed from tools to manage credit risk to a source of credit risk in and of themsevles. Part two discusses the types of investors who ended up hold subprime exposure through CDOs, and why the promise of risk dispersion through originate-to-distribute model failed to live up to expectations.  Part three defines the shadow banking system, discusses the causes and repercussions of its collapse, and contrasts it with the traditional banking system. An accompanying chart provides an exhaustive view of the institutions, instruments and vehicles that make up the shadow banking system and depicts the asset and funding flows in it.  Finally, part four discusses why it might still be too early to call an end to the credit crisis.


Banking's changed nature.

The traditional model of bankingㅡborrow short, lend long, and hold on to loans as an investmentㅡhas been fundamentally reshaped by competition, regulation and innovation.  Everything from the types of assets bank hold to how they fund themselves to the sources of their income have changed dramatically.  Competition from finance companies and broker-dealers in lending to consumers, corporate and sovereigns; changes in rules governing capital requirements; and innovations in securitization and credit risk transfer have been key facilitators of this change, and have led to the gradual emergence of the originate-to-distribute model of banking.

   The originate-to-distribute model has deeply changed the way credit is intermediated and risk is absorbed in the financial system, as these functions now occur less on bank balance sheets and more in capital markets.  Banks no longer hold on to the loans they originate as investments, but instead sell them to broker-dealers, who in turn pool the undelying cash flows and credit risks and, using dedicated securities, distribute them in bespoke concentrations to a ranger of investors with unique risk appetites.  To properly function, the originate-to-distribute model needs liquid money and securities markets to intermediate credit through the daisy chain of asset originators, asset packagers and asset managers.

   The originate-to-distribute model and the securitization of creidt and its transfers to investors through traded capital market instruments has been part of the financial landscape since the 1970s, when the first mortgage-backed securities were issued.  But this model has grown increasingly more complex over the past decade, as securitization expanded to riskier loans and came in increasingly more opaque and less liquid forms such as structured finance collateralized debt obligations.  These developments were driven by loose monetary policy and depressed yields in recent years and became most apparent in subprime mortgage lending.  Low interest rates created an abundance of credit for borrowers and a scarcity of yield for investors.  With the housing boom as the backdrop, exotic mortgages to borrowers with spotty credit histories and investors stretched for yield made for a potent mix of inputs for trouble ahead.


Part I─CDO evolution

The 1988 Basel Accord was the main catalyst for the growth and development of credit risk transfer instruments.  Following the banking crises of the late 1980s, which were triggered by laon deaults by Latin American governments, the accord applied a minimum capital requirement to bank balance sheets and required more capital protection for riskier assets.  These rules prompted banks to reconfigure their assets using credit risk transfer instruments such as credit default swaps or CDOs.  This was done either by purchasing insurance against credit losses using CDSs (reducing the gross risk of a loan portfolio) or by removing the riskier (first loss) portions of a loan portfolio using CDOs.

   Initially, CDOs were applied to corporate loans. A bank would pool the corporate loans on its books (the assets of a CDO) and carve up the pool's underlying cash flows into tranches with varying risk profiles (the liabilities of a CDO).  Payouts from the pool were first paid to the least risky senior tranches, then the mezzianine tranches, and lastly to the most riskly equity tranches.  Conversely, losses were first allocated to equity tranches, then to the mezzanines, and only then to senior tranches. Correspondingly, equity tranches offered the highest yields and senior tranches the lowest in CDO's capital structures.

   Tranching did not reduce the overall amount of risk associated with the pool.  It merely skewed the distribution of risks such that equity tranches ended up with a concentrated dose and senior tranches ended up with diluted ones.  In this sense, equity tranches are overleveraged instruments, whereas senior tranches are underleverage of the entire CDO, and the leverage of the entire CDO, similar to whole loans and bonds, is one by construction.[n.1]  This pooling and tranching of loans allowed banks to sell credit risk in concentrated forms using equity tranches and to hold on to credit risk in diluted form through senior tranches, allowing them to set aside a much smaller amount of capital than for whole loans.[n.2]

   This initial raison d'etre of CDOs changed over time.  They were no longer used solely to fine-tune the risk profile of a bank's loan portfolios to manage capital requirements (so-called balance sheet CDOs), but also to pool traded whole loans and corporate bonds, earning a spread between the yield offered on these assets and the payment made to various tranches (arbitrage CDOs).

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Part II─ No risk dispersion  ( ... ... )


Part III─Shadow Banking System

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