The main purpose of securitization is to create the maximum cash flow that allows banks to reinvest and increase its income. Therefore, if the cost of securitizing low quality assets is greater than securitizing higher quality assets, banks will have the incentive to securitize their better quality assets, which may cause asset quality deterioration. Firstly, we will analyze whether the cost of securitization will be affected by the asset quality in securitization. This study is based on a cross-sectional data set that contains information of around 500 real securitization deals in US and European markets. The cost of securitization is proxied by the reserve fund that is required to support the securitized assets in case they are default or fail to pay off the coupon. Our empirical model proves that the cost of securitization is positively related to the quality of assets. It justifies s the incentive for issuers to securitize their better quality assets. Hence, riskier assets have been left on the balance sheet, which may result the asset quality deterioration. Based on the cost analysis, we carry on our important study on the asset quality deterioration phenomenon in banks caused by securitization activity. Since securitizing lower quality assets can increase the profit without significantly increasing the capital adequacy requirement, banks have the incentive to take the regulatory arbitrage and asset quality deterioration may happen. The empirical result shows that securitization activity causes the risk-weighted asset ratio to increase, the asset quality in the bank is worsening off and deterioration does exist. This empirical model is tested based on the full sample of 30 banks that have securitized assets among top 100 FDIC banks and also on the bank grouping in terms of the large, medium and small size banks. Different panel data analysis techniques, such as Fix/random effect test, GMM etc, have been applied to ensure the reliability of the result.
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