Capital Requirement

The capital requirement is not related to moral hazards either. The capital requirement presents no statistical significance in relation to securitizations, which means that most banks do not use loan securitization to save on regulatory capital. This is because the Basel II framework under the 'standardized approach' no longer allows for regulatory capital arbitrage. Basel III, which could further enhance the capital regulation, was scheduled to be introduced from 2013 to 2019 (Financial Stability Board 2018). We consider regulatory capital arbitrage to be the main relation between regulatory authorities and banks. Those financial institutions seeking new opportunities of regulatory capital arbitrage might never come to an end, but it has become harder to continue with the maturity of regulations. Regulatory capital arbitrage is difficult to apply in loan securitization. Less regulatory capital could not result in moral hazard problems in securitization transactions before 2017Q4. However, banking regulators in China intensified capital rules in the three years prior to that; for example, banks that failed to comply with capital adequacy requirements by the end of 2010 in terms of the amount of capital they had to hold against their loans were punished, with limits on market access and so on (McMahon 2009). Chinese regulators also drafted tougher capital rules for China's too-big-to-fail banks, seeking to curb risks (Bloomberg 2021). Regulatory capital arbitrage might have been applied in securitization transactions under the pressure of stricter capital requirements after 2017Q4.

#### **6. Recommendations**

This paper aims to examine adverse selection and moral hazards by examining the determinants of securitization in China and then to answer the main research question: Does China need a higher standard of information transparency to protect against its risks? The findings show that securitization involved both adverse selection and moral hazard problems before 2017Q4, but the digital transformation of banking reduced those issues after 2017Q4. Generally, adverse selection, compared with moral hazards, is more serious. Even though digital transformation reduced information asymmetry significantly, adverse

selection and moral hazards still affected the loan securitization market and its stability. Thus, China still needs a higher standard of information transparency to protect against these risks. The recommendations according to this paper's findings are as follows:


#### **7. Conclusions**

In summary, by comparing two periods, FinTech applications in the banking industry could result in lower information asymmetry. However, moral hazard and adverse selection problems still affect the securitization market, which could affect financial stability. Thus, China needs a higher standard of information transparency.

The moral hazard and adverse selection problems were tested by studying the determinants of loan securitization in China's banking sector. Specifically, risk exposure was the main determinant of securitization issues over the whole period, which means that the adverse selection problem might affect the securitization market. This result is similar to that of studies by Minton et al. (2004) and Bannier and Hänsel (2008). Liquidity and performance were considered to test moral hazards, and they were less statistically significant with respect to securitization issuance after 2017Q4. However, the capital requirement could be a main determinant of securitization. This conclusion is similar to that of studies by Uzun and Webb (2007) and Ambrose et al. (2005).

In order to protect against adverse selection and moral hazards, China needs a higher standard of information transparency. First, since adverse selection in securitization mainly affects risk transfer, information disclosure should focus more on the underlying assets to ensure that investors know what they are investing in and that they are willing to pay corresponding prices and bear the corresponding risks. The second recommendation regards moral hazards, which are mainly reflected in the capital requirement. Information disclosure should correspond more to regulatory capital arbitrage. The third is that a regulatory scheme of information disclosure should be diversified according to the varying types of bank. The last recommendation is to apply blockchain in securitization to further enhance their information transparency.

**Author Contributions:** Conceptualization, C.W.; methodology, X.C.; software, X.C.; validation, C.W.; formal analysis, C.W. and X.C.; investigation, C.W. and X.C.; resources, X.C.; data curation, X.C.; writing—original draft preparation, C.W. and X.C.; writing—review and editing, C.W. and X.C.; visualization, C.W. and X.C.; supervision, C.W. and X.C.; project administration, C.W. and X.C. All authors have read and agreed to the published version of the manuscript.

**Funding:** This research received no external funding.

**Institutional Review Board Statement:** Not applicable.

**Informed Consent Statement:** Not applicable.

**Data Availability Statement:** Data was obtained from Bloomberg, banks' financial reports, Wind and China Securitization Analytics website.

**Conflicts of Interest:** The authors declare no conflict of interest.

#### **References**


Diggle, Peter, Patrick Heagerty, Kung-Yee Liang, and Scott Zeger. 2002. *Analysis of Longitudinal Data*. Oxford: Oxford University Press. Dowd, Kevin. 2009. Moral hazard and the financial crisis. *Cato Journal* 29: 141.

