Question

What is Originate-To-Distribute approach? Discuss.

Answer 1

Originate to distribute (OTD) is the term most popularly used by financial institutions and banks.under this OTD approach the originator invents or creates loans and sells it to various third parties through securitisation process,instead of holding it till maturity was one of the very popular way of mortgage lending adopted by banks, there are six major players involved in OTD approach and each one of them posses different key roles they are investors,borrowers, originators,arrangers,distributors and credit rating agencies.where each party is interested in next party which created potential incentive problems which prohibited each party in performing its origin screening and due diligence functions because there was lot of difference of opinion between each of them one of the biggest advantages of OTD approach was it enabled banks to quickly change its level of mortgages without having to make any adjustments to their equity capital or assets portfolio a kind of flexibility was granted to the banks. Disadvantages of OTD approach are no proper screening of borrowers was done like location details of property was not checked,credibility of the borrower was not considered, cost of capital was in some banks very high while it was low in some others no uniformity was there,which resulted in increasing the risk factor significantly high for banks or originator thus making the originate to distribute approach OTD a failure which led to recent sub prime mortgage crisis.many banks and big financial institutions gone bankrupted for instance Lehman brothers, northern rock etc.because of majority of UK banks was playing in position of investors in OTD model they brought significant financial products originated from UK mortgage market they were moved by low interest rate from 2001 to 2004 and booming property market so they adopted this kind of negligence in behavior towards risk taking,and investment decisions. Recommendations it is important to introduce appropriate screening system within the OTD model rather than completely give up this financial innovation as the OTD helps financial institutions to achieve better risk sharing and managing banks portfolio.