The real and financial implications of complex financial innovations is a topical issue. Exotic instruments and financing methodologies, combined with poor regulatory supervision have had extremely adverse effects on the global economy. But does this mean financial innovation was directly harmful to the real economy? In a recent IMF working paper, Mangal Goswami, Andreas Jobst, and Xin Long explore this question in the context of a specific form of financial innovation that was most relevant to the sub-prime crisis?asset securitisation.
Asset securitisation is the process of using cash flows from a set of financial assets to convert them into tradable obligations. It has many benefits?removing balance sheet mismatches, removing financial constraints, optimising funding costs, risk diversification, local capital market development, financing housing and consumer deficits and so on. However, it also carries some risks. Most of these are financial?pricing distortions due to badly designed transactions, opacity of underlying asset configurations, asymmetrical information, balance-sheet evasion. There is also an important real effect?the impact on the monetary policy transmission mechanism. This impact has been widely discussed as one of the potential driving factors behind the exacerbation of the current financial crisis.
There are two possible impacts of asset securitisation on the monetary policy transmission mechanism. The first is positive?since the financing costs of securitised assets are likely to be aligned with market interest rates, it could increase the linkages between the market interest rate and the policy rate. This implies that when the central bank changes rates, the new rate is reflected faster in financial markets. The second impact is negative?securitisation provides an alternate to financing via traditional bank lending. This lowers the impact of a change in interest rates on the demand for credit. It increases the resilience of banks to interest rate shocks, since it effectively breaks the balance sheet link between the banks? deposit base and lending activities.
So which one of these effects dominate? This is a function of the width and depth of the securitisation of markets. Mangal Goswami et al explore this issue in their paper. They first study the US, over the period 1970-2007. They find that securitisation increases ?interest rate pass-through?, or the transmission of the policy rate into the market rate. This is the first effect, and helps to strengthen the transmission mechanism. However, they also find that securitisation does lower the interest rate elasticity of output, or sensitivity of output to a change in interest rates. This is the second effect, which suggests that securitisation hampers the transmission mechanism, as a lowering of rates is less likely to translate into increased output when securitisation exists. The second effect is found to be larger in magnitude than the first, indicating that overall, securitisation actually enhanced the monetary policy transmission mechanism in the US.
The US is an example of a mature and well-developed financial system. What are the impacts of securitisation on emerging market monetary policy, where financial institutions are not well-developed and markets are not wide or deep? To answer this, the second part of the paper takes the case study of South Africa, an emerging market with relatively well-developed mortgage backed securities markets. The authors conduct a similar analysis of South African output and interest rates. Again, they find that the interest rate-output relationship is muted by securitisation, and that securitisation increases interest-rate pass through. However, in an emerging market situation, there is an added effect. There is no clear evidence that securitisation increases credit supply. Investors in securitised assets could have invested elsewhere, such as bank deposits or capital. This would have resulted in banks originating the same volume of loans in the traditional manner
Therefore, the paper finds that while securitisation provides an alternative to traditional sources of financing, it does not significantly enhance availability of credit in emerging markets
?The author is consultant, NIPFP. These are her personal views