Securitisation

Let us commence by assuming that Bank B has extended a loan of Rs. 100 crore to Party P and this loan is standing in its balance sheet as an asset. This Bank has another customer C, who is seeking to raise debt from the bank and although bank intends to finance this customer, it is limited by the size of its own balance sheet. The bank believes that if somehow it can get the earlier loan of Rs. 100 crore re-financed, it can serve customer C.

The bank therefore, approaches other banks and financial institution (FI’s) for refinancing of is loan standing in its balance sheet and does get finance fron other banks/FIs against its original loan of Rs. 100 crore. From the account opening perspective, original loan or Rs. 100 crore will continue to show on the asset side of the bank’s balance sheet and the refinancing transaction will will appear as obligation (Liability).

An alternative way the bank can structure the financing is to sell the loan of Rs. 100 crore to the other interested parties. In this case, only the right hand side of the balance sheet (asset side) will be affected because the loan will get converted into cash. In order to keep the concept simple, accounting for the difference between the book value of the loan and the money realized from the sale of loan is not considered here.

A third way for the bank to structure the financing is to sell this asset (loan of Rs. 100 crore) to several investors in form of a tradable paper (security). In this case, like the second alternative, bank is selling its loan but to many investors in the form of tradable instrument with smaller denomination. This process of creating securities out of an existing asset is called securitization.

In reality, there have been only few issuances of whole loan securitization (sale of loan through securitization route) and generally institutions pool similar assets lile auto loan, mortgages etc. on their balance sheet and sell out through securitization route.

It is evident that securitization is all about packaging a designated pool of assets and marketing that to a large set of investors in the form of a tradable instrument. In other words, securitization is the process of transforming an asset into marketable securities. It should be noted that securitized instruments are backed by assets and they are not the securities of an issuer.

 

[Dhruv Bindhani]

Let us commence by assuming that Bank B has extended a loan of Rs. 100 crore to Party P and this loan is standing in its balance sheet as an asset. This Bank has another customer C, who is seeking to raise debt from the bank and although bank intends to finance this customer, it is limited by the size of its own balance sheet. The bank believes that if somehow it can get the earlier loan of Rs. 100 crore re-financed, it can serve customer C.

The bank therefore, approaches other banks and financial institution (FI’s) for refinancing of is loan standing in its balance sheet and does get finance fron other banks/FIs against its original loan of Rs. 100 crore. From the account opening perspective, original loan or Rs. 100 crore will continue to show on the asset side of the bank’s balance sheet and the refinancing transaction will will appear as obligation (Liability).

An alternative way the bank can structure the financing is to sell the loan of Rs. 100 crore to the other interested parties. In this case, only the right hand side of the balance sheet (asset side) will be affected because the loan will get converted into cash. In order to keep the concept simple, accounting for the difference between the book value of the loan and the money realized from the sale of loan is not considered here.

A third way for the bank to structure the financing is to sell this asset (loan of Rs. 100 crore) to several investors in form of a tradable paper (security). In this case, like the second alternative, bank is selling its loan but to many investors in the form of tradable instrument with smaller denomination. This process of creating securities out of an existing asset is called securitization.

In reality, there have been only few issuances of whole loan securitization (sale of loan through securitization route) and generally institutions pool similar assets lile auto loan, mortgages etc. on their balance sheet and sell out through securitization route.

It is evident that securitization is all about packaging a designated pool of assets and marketing that to a large set of investors in the form of a tradable instrument. In other words, securitization is the process of transforming an asset into marketable securities. It should be noted that securitized instruments are backed by assets and they are not the securities of an issuer.

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