Background

Asset securitization is one of the ways in which assets can be hedged in a derivative market. It is designed to give traditional commercial banking, a new direction. Asset securitization is used by banks that actually look to transform their non-liquid assets into liquid assets, thereby allowing them to allocate their capital more efficiently. In addition to this, asset securitization also helps banks access diverse and cost-effective funding sources, and help in the better management of business risks.

The securitization markets, come with inherent challenges as well as opportunities.

In the scenario, where the non-banking securities have given tough competition to the banks, these banks have now got chances to adopt some of their practices. Earlier, different underwriting and Captive Finance companies have been main threat to bank's market share and profitability in the prime credit and consumer loan businesses. And the growing competition within the banking industry from specialized firms that rely on securitization puts pressure on more traditional banks to use securitization to streamline as much of their credit and originations business as possible. Because securitization may have such a fundamental impact on banks and the financial services industry, bankers and examiners should have a clear understanding of its benefits and inherent risks.

Traditionally non-banking securities have been tough competition to banks. Through asset securitization, banks now have the opportunity to adopt some of the practices of non-banking securities.

There are limitations too. In the prime credit and consumer loan businesses different underwriting and Captive Finance companies have been a threat to a bank's market share and profitability. The increased use of asset securitization within the banking industry has put undue pressure on traditional banks to adopt similar methods. This in turn has had a fundamental impact on banks and the financial service industry. Bankers therefore need to be advised about the benefits and inherent risks of asset securitization.

Definition

Asset securitization is a financial instrument of structured finance in which loan interest and receivables are packed and sold in the form of ABS securities. Asset securitization maximizes capital & minimizes risk due to its diversification nature.

In other words, this is the process which helps create a financial instrument by combining other financial assets and then marketing them to investors. Again, in this process certain assets from the balance sheet of a company get separated and are used as collateral for the issuance of securities. The securitized assets like commercial papers, notes or bonds are typically sold through special purpose vehicle (SPV) in order to provide funding.

Asset securitization differs from collateralized debt or traditional asset backed lending. Loans are sold to a third party through a special purpose vehicle (SPV) or trust. This SPV issues one or more debt instruments - asset backed securities whose interest and principal payments are dependent on the cash flows coming from the underlying assets. It can be figured like:

Bank or Company Special Purpose Vehicle Or Trust Investors
(Pool of Loans or receivables) (Asset Backed Securities)