Interest Rate Risk, Prepayment Risk and Banks’ Securitization of Mortgages

Abstract

I show that banks with interest-sensitive liabilities securitize more mortgages than banks with interest-insensitive liabilities do. This is because liabilities of interest-insensitive banks are similar to fixed-rate and long-term debt, thereby holding long-term and fixed-rate mortgages helps isolate their net interest income from interest rate risk. However, household mortgage refinancing in low-interest periods disrupts the isolation effect. Ex ante, anticipating the risk, interest-insensitive banks securitize more mortgages, resulting in a smaller securitization gap across banks. Ex post, interest-insensitive banks are less willing to meet household refinancing requests.