[rndmwlk]

Been awhile since I've worked in the industry, but the commoditization of loans has increased the risk threshold banks are willing to take on. Can tranche up loans to cater to specific buyers and decrease the overall risk in certain measures.

I'd wager smaller banks would, in general, be more conservative with their loans if not for commoditization.

[taeric]

I think they would be more conservative, to an extent. My question is if they work out long term? If you are able to take riskier loans and sell them off from an area, how long until you have nothing but high risk left that nobody will touch? And does that leave places depleted?

[rndmwlk]

>Do they work out long term?

Assuming we are talking about loans as a commodity, yes & no. They work out in the same manner as any other economic commodity which is some will outperform, some will perform, and others will under perform. Will gold work out long term, or TSLA? If I could definitively answer these questions I'd be very wealthy. The logic behind tranching makes sense and allows some shifting around of risk and some diversification.

>If you are able to take riskier loans and sell them off from an area, how long until you have nothing but high risk left that nobody will touch? And does that leave places depleted?

This scenario of "nothing but high risk left that nobody will touch," can happen both in a non-commoditized world and in a commoditized world. There will always be loans which are too risky for a bank to take. Commoditization has increased the risk ceiling so to speak. If commoditization wasn't happening wouldn't these places still be depleted, what is shifting is that ceiling of letting people in or not.

[taeric]

I meant "does it work out for the small towns, long term?"

The current scenario seems to be:

  * regional bank gets local depositors to get cash for lending
  * regional bank can originate loans that they sell off to larger bank
  * larger bank makes long term money off the intrinsics of the loan
  * regional bank made short term money on sale and now has to invest in other long term assets
  * regional bank loses all lending opportunities they have locally, so now survive only on long term assets and depositors

The hope is that any profit that the local bank is making is invested back into the community. But profits being what they are, this dries up quickly and now the bank is firmly at the mercy of depositors and long term investments?

My gut is that there is no way you can spin a risk free story here. Big banks don't really solve it, either. We ultimately push that risk back to the government and some of our backstop regulations?

Edit: At least, on paper, if the depositors are local to the bank, that aligns them to the same incentives as the bank. Something SVB definitely did not have.

[rndmwlk]

Ahh, I see what you're saying now.

First, there's a bit of an assumption of local lending opportunities drying up. This isn't necessarily going to happen, local banks don't have infinite capital, but lets assume that it does happen and consider the scenario you outlined.

I think you are right in that there will be a misalignment of incentives. From the standpoint of long term assets the bank will be holding it will likely be diversified away from exposure to the town. I imagine banks wouldn't be selling off their entire portfolios, and would still have a solid amount of local exposure - but maybe not.

Banking is definitely not risk free! It is multiplying your money supply but doing so through leverage. Back to our scenario to see this effect, what "big bank world" allows there is a step that you missed:

  * regional bank gets local depositors to get cash for lending
  * regional bank can originate loans that they sell off to larger bank
  * larger bank makes long term money off the intrinsics of the loan
  * regional bank made short term money on sale and now has to invest in other long term assets
  * regional bank can originate more loans with short term money on sale
  * regional bank loses all lending opportunities they have locally, so now survive only on long term assets and depositors

So, the tradeoff is really: The town is able to get more local loans, but the bank is able to commoditize away (some) of their risk associated with this town. Is it better for the town to have less capital and a more aligned town bank? It's hard to say.

[taeric]

Thanks for sticking with me on the conversation! Love to see more exploration of this idea. And I would not be shocked/upset to find that I'm asking overly silly questions, or contriving too simple scenarios.