What is Securitization? Definition of Securitization, Securitization Meaning - The Economic Times (2024)

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What is Securitization? Definition of Securitization, Securitization Meaning - The Economic Times? ›

Definition: Securitization is a process by which a company clubs its different financial assets/debts to form a consolidated financial instrument which is issued to investors. In return, the investors in such securities get interest.

Securitization is the process in which certain types of assets are pooled so that they can be repackaged into interest-bearing securities. The interest and principal payments from the assets are passed through to the purchasers of the securities.

Whole-business securitization enables a business to set up a structure in which business and financial risks can be managed and in which the level of credit risk for the investor can be substan- tially reduced.

Securitizing is not an inherently good or bad thing. It is simply a process that helps banks turn illiquid assets into liquid ones and frees up credit.

There are three most common types of securitisations from the perspective of cash flow: Collateralized Debt, Pass-Through and Pay-Trough structures. Collateralized debt is the form most similar to traditional asset-based borrowing.

Indeed, thanks to years of experience and market reforms, securitization benefits lenders and borrowers alike and helps global capital flow in the U.S.

A mortgage-backed security (MBS) is a classic example of securitization. A group of home loans are sold by the original lender to another financial institution, which turns the package of mortgages into one distinct unit that the public can invest in.

Risks: Since securitization is a structured transaction, it may include par structures as well as credit enhancements that are subject to risks of impairment, such as prepayment, as well as credit loss, especially for structures where there are some retained strips.

Securitization allows the original lender or creditor to remove assets from its balance sheets to underwrite additional loans. Investors profit as they earn a rate of return based on the associated principal and interest payments made on the underlying loans and obligations by the debtors or borrowers.

Scrutinization helps companies in raising funds and generating additional income using the financial debts or assets which helps banks in lending out more money while the investors diversify their portfolio and get higher returns.

What are the disadvantages of securitization? ›

Disadvantages of securitisation

it may restrict the ability of your business to raise money in the future. you could lose direct control of some of your business assets - this may reduce your business' value in the event of flotation. it may cost you substantially if you want to take back your assets and close the SPV.

Securitization lowers the risks on banks' balance sheets and allows them to release economic and/or regulatory capital. 5 This should encourage banks to increase their lending activities and charge lower rates to borrowers.

In a pool securitization, all investors are equal, sharing all of the risks. If there is bad debt on the pooled security, all investors suffer the financial loss. In a tranche securitization, the security is split into different levels (tranches) that are made up of assets with different risk profiles.

Securitized issues are split into tranches, which are categorized into varying degrees of subordination. Each tranche is separate and distinct from the other tranches, and each has a different level of credit protection or risk exposure. The primary benefit of securitization is to reduce funding costs.

Collaterals ensure the pecuniary claims from these assets. The largest investors in securitised assets are typically pension funds, insurance companies, investment fund managers, and to a lesser degree, commercial banks.

Originators include captive finance companies of the major auto makers, other finance companies, commercial banks, thrift institutions, computer companies, airlines, manufacturers, insurance companies, and securities firms. The auto finance companies dominate the securitization market for automobile loans.

Example of securitization

A company is in the business of leasing equipment to mining companies. These huge pieces of expensive machinery can cost more than $3 million apiece. Rather than owning the equipment, the mining company enters into a lease agreement. The mining and leasing companies agree to payment terms.

Securitisation is part of structured finance. It is a financing technique by which hom*ogeneous income-generating assets − which on their own may be difficult to trade − are pooled and sold to a specially created third party, which uses them as collateral to issue securities and sell them in financial markets.

According to securitisation theory, political issues are constituted as extreme security issues to be dealt with urgently when they have been labelled as 'dangerous', 'menacing', 'threatening', 'alarming' and so on by a 'securitising actor' who has the social and institutional power to move the issue 'beyond politics'.