abhishreshthaa
Abhijeet S
WHEN CAN SECURITIZATION OCCUR?
When the originator expects to benefit by way of cost reduction or higher returns, by securitizing, they initiate the process. If the value of the new securities exceeds the value of the underlying assets, securitization would be beneficial.
The Cost Factors
The cost of carrying a bank loan in its balance sheet consists of four distinct components follows:
r1 = r2c + [(1-c) r3/ (1-k)] + a + n
Where,
r1= lending rate (PLR plus)
r2= required return on equity capital
c = equity capital to asset ratio
r3 = interest rate paid on deposits including servicing costs and deposit insurance
k = effective CRR
a = servicing costs of loans per rupee of loan
n = expected loan loss per rupee net of recoveries
Let, S = (r1-r3) as the spread. Suppose the costs of commercial paper
borrowing can be split into:
CP = r4 + CU
Where,
CP = cost of commercial paper borrowing
r4 = return to the investor in commercial paper
CU = underwriting cost of commercial paper
The borrower would prefer to use the commercial paper if r1>CP.
But securitization can occur once s> (r4-r3) +CU. Thus, securitization becomes profitable so long as the lending rate exceeds the rate on commercial paper plus costs of underwriting the commercial paper.
When the originator expects to benefit by way of cost reduction or higher returns, by securitizing, they initiate the process. If the value of the new securities exceeds the value of the underlying assets, securitization would be beneficial.
The Cost Factors
The cost of carrying a bank loan in its balance sheet consists of four distinct components follows:
r1 = r2c + [(1-c) r3/ (1-k)] + a + n
Where,
r1= lending rate (PLR plus)
r2= required return on equity capital
c = equity capital to asset ratio
r3 = interest rate paid on deposits including servicing costs and deposit insurance
k = effective CRR
a = servicing costs of loans per rupee of loan
n = expected loan loss per rupee net of recoveries
Let, S = (r1-r3) as the spread. Suppose the costs of commercial paper
borrowing can be split into:
CP = r4 + CU
Where,
CP = cost of commercial paper borrowing
r4 = return to the investor in commercial paper
CU = underwriting cost of commercial paper
The borrower would prefer to use the commercial paper if r1>CP.
But securitization can occur once s> (r4-r3) +CU. Thus, securitization becomes profitable so long as the lending rate exceeds the rate on commercial paper plus costs of underwriting the commercial paper.