The European Central Bank published a research article examining how banks create privately supplied safe assets through securitisation and the implications for financial stability. It finds that as safe assets become scarcer, stronger demand for safety can push banks to securitise more and relax borrower screening, lowering loan quality and potentially undermining both financial stability and real economic activity, creating a case for policy intervention. The article describes how securitisation and loan trading can diversify banks’ portfolios and support the issuance of safe debt, but can also dilute incentives to screen when banks expect to transfer credit risk. In the framework discussed, loan quality and diversification jointly determine the economy’s “safe payoffs”, and at high levels of demand for safety the erosion in screening can dominate, yielding a backward-bending supply of private safe assets where greater demand ultimately reduces safe payoffs and safe debt issuance. The resulting inefficiency reflects a free-rider problem in which banks do not internalise how their own screening affects aggregate loan quality and, in turn, the system’s capacity to generate safe assets. On policy tools, the article argues that loan risk retention requirements are well-suited to address the incentive problem and should be calibrated to safe asset scarcity, including the convenience yield investors pay for safety, rather than set as a fixed threshold. It contrasts this with capital requirements, which it suggests do not directly tackle the securitisation-and-screening distortion, and notes that greater public supply of safe assets can partially alleviate scarcity but with offsetting effects on securitisation, diversification and screening; it also highlights that central bank balance sheet composition and collateral policies can materially influence private incentives to produce safe assets.
European Central Bank 2025-05-27
European Central Bank research warns securitisation-driven safe asset supply can weaken loan screening and calls for flexible risk retention
The European Central Bank's research article examines how banks create privately supplied safe assets through securitisation and its implications for financial stability. It notes that increased demand for safety can lead banks to securitise more and relax borrower screening, potentially undermining financial stability and economic activity. The article suggests loan risk retention requirements, calibrated to safe asset scarcity, as a policy tool to address these issues, contrasting them with less effective capital requirements.