Enhancing Loan Quality Through Transparency: Evidence from the European Central Bank Loan Level Reporting Initiative

• Published date: 01 September 2017
• Author: AYTEKIN ERTAN,MARIA LOUMIOTI,REGINA WITTENBERG‐MOERMAN
• Date: 01 September 2017
• DOI: http://doi.org/10.1111/1475-679X.12162

DOI: 10.1111/1475-679X.12162

Journal of Accounting Research

Vol. 55 No. 4 September 2017

Printed in U.S.A.

Enhancing Loan Quality

Through Transparency: Evidence

from the European Central Bank

Loan Level Reporting Initiative

AYTEKIN ERTAN,

∗MARIA LOUMIOTI,

†

AND REGINA WITTENBERG-MOERMAN

‡

Received 1 September 2015; accepted 25 November 2016

ABSTRACT

We explore whether transparency in banks’ securitization activities enhances

loan quality. We take advantage of a novel disclosure initiative introduced

∗London Business School; †University of Texas at Dallas; ‡Marshall School of Business,

The University of Southern California.

Accepted by Philip Berger. This paper greatly benefited from discussions with Euro-

pean DataWarehouse (ED) personnel, securitized credit specialists from two large Euro-

pean banks and credit analysts in Moody’s local offices in Italy, Spain, and Germany re-

garding the first loan level ABS reporting initiative. We are also thankful to ED staff

for their guidance and support in understanding the data structure. We are grateful to

Jan Bouwens, Jean-Edouard Colliard (discussant), Mark DeFond, Cem Demiroglu, Douglas

Diamond, David Erkens, Michelle Hanlon, Chris Higson, Anya Kleymenova, Christian

Leuz, Robin Litjens, Mike Minnis, Maria Ogneva, Tjomme Rusticus, Haresh Sapra, Andrew

Sutherland, Ahmed Tahoun, Irem Tuna, Florin Vasvari, Chris Williams (discussant), and the

conference participants at the Banque de France — Toulouse School of Economics confer-

ence, the Tilburg University Spring Camp, the HKUST Accounting Research Symposium, the

FARS Annual Meeting, 10th Annual Tel-AvivUniversity Conference, the UCLA-USC-UCI Sym-

posium and workshop participants at the London Business School, Massachusetts Institute

of Technology, the Ohio State University, the University of Chicago Booth School of Busi-

ness, the University of Southern California, and the University of Texas at Dallas for help-

ful comments. We thank Blake Sainz and Yina Yang for their excellent research assistance.

Aytekin Ertan, Maria Loumioti, and Regina Wittenberg-Moerman acknowledge research sup-

port from London Business School, MIT Sloan School of Management, and the University

of Southern California, respectively. An online appendix to this paper can be downloaded at

http://research.chicagobooth.edu/arc/journal-of-accounting-research/online-supplements.

877

Copyright C, University of Chicago on behalf of the Accounting Research Center,2016

878 A.ERTAN,M.LOUMIOTI,AND R.WITTENBERG-MOERMAN

by the European Central Bank, which requires, as of January 2013, banks

that use their asset-backed securities as collateral for repo financing to report

securitized loan characteristics and performance in a standardized format.

We find that securitized loans originated under the transparency regime are

of better quality with a lower default probability, a lower delinquent amount,

fewer days in delinquency, and lower losses upon default. Additionally, banks

with more intensive loan level information collection and those operating

under stronger market discipline experience greater improvement in their

loan quality under the new reporting standards. Overall, we demonstrate that

greater transparency has real effects by incentivizing banks to improve their

credit practices.

JEL codes: G14; G21; G23; M41

Keywords: securitization; asset-backed securities; transparency; credit risk;

credit standards; loan quality

1. Introduction

Loan securitization is an important credit market practice that allows banks

to diversify credit risk and gain liquidity and offers borrowers easier access

to credit (e.g., Shin [2009]). However, securitization was blamed for play-

ing a detrimental role in the 2008 global financial crisis by giving rise to

severe agency problems in loan underwriting, screening, and monitoring

(e.g., Keys et al. [2010], Garmaise [2015]). These agency problems were

primarily attributed to structural inefficiencies inherent in securitization,

such as the complexity and opacity of securitized loan portfolios. In the

aftermath of the crisis, regulators and investors called for greater trans-

parency in banks’ securitization activities, which would facilitate better as-

sessment and pricing of banks’ risk-taking by credit market participants.

However, whether transparency can have real effects on a bank’s credit prac-

tices and risk-taking behavior by improving the quality of securitized loans

has yet to be empirically explored.

We attempt to address this question by taking advantage of the novel se-

curitized loan level reporting requirements introduced by the European

Central Bank (ECB) for banks that borrow from the ECB’s repurchase

(repo) financing operations by pledging as collateral their asset-backed se-

curities (ABS). From January 2013 onwards, banks that use their ABS for

repo borrowing are required to quarterly report loan level data on the struc-

ture and performance of their securitized loan portfolios in a detailed and

standardized format set by the ECB. A bank that fails to adhere to these new

reporting requirements cannot borrow from the ECB’s repo operations,

which can be costly given the very low interest rates the ECB offers (ECB

Euro Money Survey [2012]). A third party agency, the European DataWare-

house (ED), administers the data collection, monitoring, and control pro-

cess under the new reporting regime. Access to ED data is open to banks,

nonbank institutional investors, regulators, and credit rating agencies. This

ENHANCING LOAN QUALITY THROUGH TRANSPARENCY 879

reporting initiative represents the first loan level disclosure for the portfo-

lios of ABS globally. The ECB’sprimar y objective for mandating this report-

ing system is to facilitate better risk assessment in securitized transactions

and to restore investor confidence in the securitized loan market.

We expect that greater transparency in banks’ securitization activities will

incentivize them to issue and securitize better quality loans. Under the new

reporting regime, banks are required to quarterly report very detailed loan-

and borrower-specific information. We presume that the comprehensive

and recurring information collection and reporting required by the new

standards will result in a greater information set being available to banks

for making credit decisions. In turn, this will enhance banks’ screening ef-

forts and underwriting standards, leading to higher quality loans relative to

those issued under the pretransparency regime. Further, we expect the new

reporting requirements to result in stronger market discipline. Detailed

loan level disclosure should assist investors and regulators in more accu-

rately assessing the riskiness of securitized loan portfolios. Moreover, these

disclosures are standardized and will therefore allow these institutions to

compare credit standards and securitized loan performance across banks.

This greater oversight should further incentivize banks to issue better qual-

ity loans.

However,greater transparency may not result in higher loan quality. Over

the past few years, the ECB has relaxed its lending standards for banks par-

ticipating in repo financing. Thus, these banks may not feel pressured to

improve their underwriting standards and decrease risk-taking. Relatedly,

since the participating banks are highly leveraged, they may not have suf-

ficient resources to be able to invest in training personnel and improving

their monitoring and control systems to utilize the large amount of infor-

mation collected. Further, the inherent complexity of a securitized credit

structure may prevent investors from accurately assessing loan portfolio

riskiness even when loan performance measures are reported, which may

discourage banks from improving their securitized loan quality.

To test our research question, we employ data on the SME (small and

medium-sized enterprise) loan-backed securities reported to the ED from

the first quarter of 2013 to the second quarter of 2014.1The sample covers

974,717 unique SME loans issued to 606,396 borrowers by 37 banks located

in Italy, Spain, Portugal, France, the Netherlands, Germany, and Belgium.

These loans were originated over the period from 2009 through 2014 and

securitized in 73 unique SME loan-backed ABS deals. We focus on four pri-

mary loan performance metrics reported by participating banks—whether

a loan is in default, the amount of late loan principal and interest payments

(delinquent amount), the number of days that loan payments are delayed

1SMEs are considered one of the most important drivers of GDP growth in Europe (the

European Commission’s 2013/2014 SME Performance Review). In particular,SMEs constitute

over 99% of European companies and contribute 58 cents of every euro value added in the

EU business sector, employing about 70% of the European workforce.