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

Abstract

We explore whether transparency in banks’ securitization activities enhances loan quality. We take advantage of a novel disclosure initiative introduced by the European Central Bank (ECB), which requires, as of January 2013, banks that use their asset-backed securities (ABS) as collateral for repurchase (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. We show that our results cannot be attributed to concurrent changes in the securitized loan market dynamics, banks’ strategic reporting incentives, regulatory initiatives or higher monitoring pressures in different European countries. Overall, we demonstrate that greater transparency has real effects by incentivizing banks to improve their credit practices.