Low interest income and securitization of banks as key drivers of global financial crisis 2007-2009

The role of low interest income as well as securitization in amplifying the global crises was significant. Prolonged low interest rate environment led to decline in banks’ earnings. The banks reacted by increasing their leverage as cost of equity was higher than cost of credit. Besides, banks were searching for high yields by increasing non-lending investment activity, such as derivatives. As the result the use of financially innovative instruments such as securitization increased. In the article 4 aspects of securitization’s role in the amplification of the crisis are distinguished: contributing to lengthening of the intermediation chain; creating conditions for incentives and interests between participants in the securitization chain to be misaligned; increasing the reliance on mathematical models and on external risk assessments; increasing both individual and systemic bank risks. However, it exposed a number of misaligned incentives. The financial institutions were not interested to support quality of loans. On the other side investors searching for yields were not incentivized to evaluate the risk of securities issued by the SPVs and check the quality of collateral. Credit rating agencies failed to assess total and systemic risk. Regulators were not incentivized to regulate shadow banking sector. However, lessons were drawn from the crises and regulators responded with establishment of macroprudential regulation, as well as additional requirements towards bank management compensation and credit rating agencies. As the result risks associated with securitization are now better managed and securitization activity is rising.

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