Innovation was the key word in financial markets during the 1980s. Liberalisation of financial markets – often accompanied by a restructuring of the regulatory system – led to a wave of financial innovation. This covered both new instruments and new markets for both financial intermediaries and ultimate borrowers and savers.

Fulghieri's Chapter 11 is a theoretical study of the motives for securitisation of part of the assets of a financial intermediary. It is clear that one of the major developments in the 1980s has been the growth of off-balance sheet activities of which ‘securitisation’ has been perhaps the main example. This has affected both firms themselves and the regulators of financial institutions. Securitisation can mean the substitution of finance from bank intermediaries by the issue of marketable securities directly to investors, as well as the packaging and selling of parts of the total loan book to outside investors. This chapter is concerned with the latter aspect of securitisation. Fulghieri sets up a sophisticated optimisation model to examine the impact of changes in the ratio of securitised loans to the size of the total loan book on the optimal degree of monitoring by banks of agents to whom they have lent funds. The basic idea is that by securitising one part of the loan book they have more incentive to monitor carefully the remaining part of the loan book that has not been sold. It is assumed that the return to the bank on the loans made depends on the level of monitoring.