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Securitisation of debt or asset refers to the process of liquidating the illiquid and-ibng term
assets like loans and receivables of financial institutions like banks by issuing
marketable securities againot them, in other words, it is a technique by which a long term,
non-negotiable and high valued financial asset like hire purchase is converted into
securities of small values which can be tradable in the market just like shares?)
Thus, it is nothing but a process of removing long term assets from the balance sheet of a
lending financial institution and replacing them with I 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 cost of traditional term loans.
A technique whereby assets are converted into securities, which are in turn converted into
cash on m ongoing 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. The process of trading in the securities that are created on the
backing of pools of mortgage Voans from banks and financial institutions is called asset
securitization. Mortgage loans include housing Joans, car and truck loans, credit card
receivables, trade receivables, etc. "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, whkh securitizes a trade debt.
It is a 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 purpose of financing. Though the
end-result of securifatfion is fin&icing, it is not "financing" as such, since the entity
securitizing its assets is not borrowing but selling a stream of cash flows that was otherwise
to accrue to it.
the capital adequacy ratio. Capital adequacy ratio can also be improved by replacing
the loan assets with the lesser risk weighted assets. Thus, the removal of assets from
the Balance Sheet under a true sale improves the capital adequacy norms.
Generally,extensionofcreditbybanksandotherfinancialinstitutionsintheformofbillspurchaseordiscountingorhirepurchasefinancingappearsasanassetontheirbalancesheets.Someoftheseassets
arelongterminnatureanditimpliesthatfundsarelockedupunnecessarilyforanunduelongperiod.So,tocarryontheirlendingoperationswithoutmuchinterruptions,theyhavetorelyuponvarious
othersourcesoffinancewhicharenotonlycostlybutalsonotavailableeasily.Again,theyhavetobeartherisk of the credit outstandings. Now, securitisation is a
readymadesolutionforthem.Securitisationhelpsthemtorecyclefundsatareasonablecostandwithlesscreditrisk.Inotherwords,securitisationhelpstoremovetheseassetsfromthebalancesheetsof
financialinstitutionsbyprovidingliquiditythroughtradablefinancialinstruments.
Againfromanotheranglealso,securitisationisaboontofinancialinstitutions.Fromtheriskmanagementpointofview,thelendingfinancialinstitutionshavetoabsorbtheentirecreditriskbyholdingthe
creditoutstandingsintheirownportfolio.Securitisationoffersagoodscopeforriskdiversification.
ItisworthwhiletonotethattheentiretransactionrelatingtosecuritisationiscarriedoutontheassetsideoftheBalanceSheet.That»«oneasset(ill-liquid)isconvertedintoanotherasset(cash).
Definition
"Acarefullystructuredprocesswherebyloansandotherreceivablesarepackaged,underwrittenandsoldintheformofassetbackedsecurities".
Yetanothersimpledefinitionisasfollows:
"Securitisationisnothingbutliquifyingassetscomprisingloansandreceivablesofaninstitutionthroughsystematicissuanceoffinancial
instruments". /
AccordingtoHendersen,J.andScott,J.P. "Securitisationis the process which takeswhenalendinginstitution'sassetsareremovedin one way or anotherfrom the balancesheetofthat
lendinginstitutionandarefunded
Instead, by investorswhopurchaseanegotiablefinancial instrument evidencing this indebtedness without recourse, or in some cases wttti
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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 lenders and borrowers, particularly in countries where banks are predominant
in the
economy.
Heightened Volatility
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 certai
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 Sectaitized assets.