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| Malcolm Knight |
The originate-to-distribute model has come under fire from all sides and is held by many to be the main cause of the sub-prime crisis in financial markets. However, the Bank of International Settlement (BIS), the guardian of Basel II, believes that there are no inherent flaws and that it is the controls that need strengthening.
Last Monday, Malcolm Knight, General Manager of the BIS, in a speech to a London audience at the Euro 50 Group roundtable, said that originate-to-distribute - the creation of financial products, their sale to customers, the packaging of those sales into consolidated products, and the onward sale of these, often complex, products to investors – should not be condemned out of hand. He said that it was the controls that needed strengthening, in particular by enhancing the information available to investors, by reviewing the sales incentives structures at origination, improving the risk management practices and by greater transparency in the reviews of the credit ratings agencies.
Knight said that when searching for explanations for the current sub-prime crisis, “The explanation I find most persuasive focuses on where the troubles began: the US subprime mortgage market and the associated markets for structured products. It highlights the key features of the recent turmoil: the lack of transparency in the originate-to-distribute model; the role played by credit rating agencies in the evaluation of structured products; and the covert reliance on special purpose vehicles to conduct off-balance sheet financial transactions on a large scale.”
He went on to say, “I personally believe that the originate-to-distribute model basically remains a good one. When it functions correctly, it has the capacity to distribute risk widely and efficiently, while at the same time diversifying the revenue streams of the banks that still form the core of the global financial system.” He blamed poor credit lending due diligence by the originators and poor judgement of the credit rating agencies – all exacerbated by the ability of the modern financial markets to spread these complex instruments far and wide.
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