The Indian financial services sector is witnessing a tremendous growth thanks to the economic liberalization measures adopted by the Government of India. The new developments taking place in the realm of finance services has led to the proliferation of innovative financial techniques and new financial instruments. One such important innovation is “Asset Securitization”. Banks and finance companies, with the backing of underlying assets such as hire purchase and property receivables, offer securitization packages.
Securitization, as a financing technique is concerned with trading in securities, backed by pools of mortgage loans. The securities so created are known as ‘Mortgages’. Mortgages facilitate investors to purchase a fractional undivided interest in a pool of mortgage loans. Securitization provides for a share in the income and principal payments generated by the underlying mortgages.
Banks and financial institutions make loans and advances for the purchase of assets such as cars, houses, trucks, machinery etc. Therefore they hold a pool of individual loans and receivables that generate cash flows. Securities are then created against them, which are rated and sold to investors.
1. Asset securitization is the process of separating certain assets from the balance sheet and using them as collateral for the issuance of securities. Securities may then be rated and sold based upon the economic quality of the assets. Raising funds through the sale of this commercial paper can provide substantial savings over the traditional terms loans.
2. A technique whereby assets are converted into securities, which are in turn converted into cash on an on going basis, with a view to allow for increasing turnover of business and profit, is known as asset securitization. The technique provides for flexibility in yield, pricing pattern issue risk and marketability of instruments, which is to the advantage of both borrowers and lenders.
3. The process of trading in the securities that are created on the backing of pools of mortgage loans from banks and financial institutions is called asset securitization. Mortgage loans include housing loans, car and truck loans, credit card receivables, trade receivables etc.
4. “Securitization”, in its widest sense, implies every such process which converts a financial relation into a transaction. Examples include securitization of relationships such as commercial paper which securitises a trade debt.
5. It is device of structured financing where an entity seeks to pool together its interest in identifiable cash flows over time, transfer the same to investors, either with or without the support of further collaterals, and thereby achieve the purposes of financing. Though the end result of securitization is financing, it is not “financing” as such, since the entity securitizing its assets is not borrowing money, but selling a stream of cash flows that was otherwise to accrue to it.
Securitization may be defined as a method of funding any kind of receivables (mortgage debts, leases, loans, credit card balances etc). It involves producing bearer asset backed securities, which can be freely traded (and which are normally rated) secured on a portfolio of receivables. The basic technique requires the rights to the receivables to be transferred to a special purpose company (referred to as the “issue”), which then purchases or arranges credit enhancement, and then issues rated debt (normally floating rate euro-bonds).
The securitization process is explained with an illustration as follows:
In a typical case of simple financing, a loan is obtained to buy a car. This creates a loan obligation and ownership of the car.
The car, financed by a financial institution, generates series of claims, in the form of interest and principal value over a period of time, to the lender. Securitization involves selling this series of cash flow that emanates from the above dealing by creating pools of securities and selling them for a certain maturity period.