Securitization originated in the US with the promotion of residential mortgage markets. The US Government provided active support to the development and growth of securitization through agencies such as Federal National Mortgage Association (FNMA), Government National Mortgage Association (GNMA), and the Federal Home Loan Mortgage Corporation.
These agencies bought residential mortgage loans which were crated and issued against guaranteed payment of principal and interest. Next to the US, the only place to have fairly developed market is the UK. In the UK, it is the bank of England that has issued various guidelines and helped in developing securitization as a financial service. Securitized debt instruments are now popular in Italy, Australia, Canada, France, Spain, Japan and many other countries and most of them have passed new legislations to assist the process.
The Indian scenario in securitization as a financial service is recent. A few players dominate the market. Public response to this service has been lukewarm. Citibank, HDFC and ICICI made the first securitization deal in India, in February 1991. The main motive of NBFCs to go for securitization has been to unlock investment in all liquid assets recycle cash and exploit new business opportunities. In India, securities are created against the backing of truck loans and LCVs receivables.
Against the backdrop of the poor popularity of the securitization as a financial service, a number of measures are being initiated by the government to make this service popular and as a low cost source of financing.
The use of securitization as a viable financial service has the following limitations:
Debility to Central bank:
Securitization process may lead to diminishing of the importance of banks in the financial intermediation process, by causing reduction in the proportion of financial assets and liabilities held by banks. This would in turn render more difficult, the execution of the monetary policy in countries where central banks operate through variable minimum reserve requirements. A decline in the importance of banks could also weaken the relationship between tenders and borrowers, particularly in countries where banks are predominant in the economy.
The transformation of non-liquid loans into liquid securities, facilitated by the process of securitization, may lead to an increase in the volatility of asset values, although credit enhancements could lessen this effect. Moreover, the volatility could be enhanced by events extraneous to variations in the credit standing of the borrower. A predominance of assets, with readily ascertainable market values, could, even in certain circumstances, promote liquidation as opposed to the going concern concept for valuing banks.
Pressure on Profitability:
Securitization process might lead to some pressure on the profitability of banks if non-banking financial institutions, exempt from capital requirements, were to gain a competitive advantage in investment in securitized assets.
Eroding Capital Base:
Securitization could lead to a decline in the total capital employed in the banking system, thereby increasing the financial fragility of the financial system as a whole, both nationally and internationally. With a substantial capital base, credit losses can be absorbed by the banking system. But a smaller capital base will entail larger losses to be shared by fewer. This concern applies, not necessarily in all countries, but especially in those countries where banks have traditionally been the dominant financial intermediaries.
Securitization and Financial Disintermediation:
Securitization is often to result in financial disintermediation. This concept is elaborated in the following manner:
In the absence of a financial intermediary, all financial transactions will be carried out only on a one-to-one basis. Accordingly, if a company needs a loan, it will have to seek it from the lenders, and the lenders will have to establish a one-to-one relation with the company. Similarly each lender has to understand the borrowing company, and look after the loan. This is often difficult, and hence, there appears a financial intermediary, such as a bank in this case, which pools funds from a lot of such investors, and uses these pooled funds to lend to the company.
When a company securitizes the loan, and issues debentures to the investors, the need or the functions of a financial intermediary undergoes a different role. The intermediary assumes the role of a mere distributor of financial products. This is because, the securitization process requires the following functions that are otherwise performed by the intermediaries.
Pooling of resources:
The intermediary bank pools the funds from small investors to meet the typical massive needs of the company. The intermediary may issue its own security of a smaller denomination.
A financial intermediary provides to investors, on a regular basis, the various types of information that are required by them in order to assess the risk return characteristics of the financial products.