Securitization
What is Securitization?
Securitization is a process that converts various forms of loans, such as mortgage, car loans, credit card debt, and several others, into investment forms. This process allows converting loans, which are in themselves hard to sell by financial institutions, into financial instruments that can be traded actively in the market.
How Securitization Works?
Pooling:
Banks or other financial institutions lump loans that bring in income, whether home loans or car loans, into a large group or a "pool."
Securitization:
The pooled loans are then sold to another entity, an SPV (Special Purpose Vehicle), which converts them into securities (such as mortgage-backed securities or asset-backed securities). These are essentially investment products that can be traded.
Selling to Investors:
Investors buy these securities in return for a yield that comes from the payment of the borrowers, whether monthly mortgage payments or repayments from car loans.
Risk Management:
Securitization is a process through which risk is managed by banks by dispersing it. In this regard, the ultimate risk of individual loans would not be borne by the economy alone but shared among many investors.
Advantages of Securitization
Liquidity: It means the ability of financial institutions to quickly transform loans into cash. This helps improve their capabilities of raising money.
Risk Reduction: Because the risk is diffused among thousands of investors, no single entity is exposed to the full risk of a loan in case of default.
Access to Capital: Securitization helps raise funds for institutions at better rates compared to conventional loans offered by banks.
Securitized Asset Types
Securitization may take other forms, such as different types of loans.
Examples include:
Residential Mortgages: Home loans turned into mortgage-backed securities.
Commercial Mortgages: Loans granted to businesses with commercial properties used as securities.
Auto Loans: Loans given to buy automobiles.
Credit Card Debt: Owed from consumer credit cards.
