Question

Explain the difference between the banking model of "originate and hold" and the model of "originate and distribute". What are the consequences of adopting the "originate to distribute" model? Elaborate with your answer.

Answer 1

The banking model of "originate and hold" involves a bank funding a loan and keeping it on its balance sheet, while the model of "originate and distribute" involves the bank selling the loan to investors. The consequences of adopting the latter model include risk diversification, better liquidity and capital management, and access to specialized investors.

Step-by-step explanation:

The banking model of "originate and hold" refers to when a bank originates a loan and holds it on its balance sheet until maturity. This means that the bank not only funds the loan but also bears the credit risk associated with it. On the other hand, the model of "originate and distribute" involves the bank originating a loan and then selling it to other investors in the secondary market, thus transferring the credit risk.

The consequences of adopting the "originate and distribute" model include:

1. Diversification of risk: By selling loans to investors, banks are able to diversify their risk and reduce their exposure to any individual borrower. This helps them manage their overall credit risk more effectively.
2. Liquidity and capital management: Selling loans in the secondary market allows banks to free up capital, which they can then use for new lending activities. It also helps improve their liquidity position, as they can convert illiquid loans into cash.
3. Access to specialized investors: By selling loans, banks can tap into a broader range of investors who have expertise in specific loan types or industries. This can lead to better pricing and terms for the loans.