Mark-to-Market, Loan Retention, and Loan Origination

Abstract

ABSTRACT We study the effects of mark-to-market accounting (MTM) for banks following the originate-to-distribute lending model. Banks have expertise in originating loans, but it is costly for them to retain the loans on their books. We study how the accounting measurement of the retained loans affects the banks’ origination and retention decisions. We show that, relative to historic cost accounting (HC), MTM has three consequences. First, it improves the accuracy of loan measurement ex post. Second, it forces banks to retain more risk exposure on their own books. Finally, it can reduce ex ante origination efforts and lower the average quality of loans in the economy. JEL Classifications: G01; G21; G30; M41.