🔹 What is Securitization?
Securitization is the financial process of pooling various types of debt instruments (e.g., mortgages, auto loans, credit card debt) and transforming them into tradable securities sold to investors.
📌 It allows financial institutions to remove assets from their balance sheets, increase liquidity, and manage risk.
🔹 What is Structured Finance?
Structured finance refers to complex financial instruments that are created to transfer risk, raise capital, and customize cash flows.
Securitization is a major part of structured finance.
🧩 These structures often involve special purpose vehicles (SPVs) and tranching of risk.
🔧 Key Concepts in Securitization:
| Term | Meaning |
|---|---|
| Originator | The institution that owns the original assets (e.g., a bank) |
| Special Purpose Vehicle (SPV) | A separate legal entity that buys the assets and issues securities |
| Asset-Backed Securities (ABS) | Securities backed by loans (auto, credit card, student loans, etc.) |
| Mortgage-Backed Securities (MBS) | Securities backed by home or commercial mortgages |
| Tranches | Slices of risk (senior, mezzanine, junior) with different returns and default risks |
| Credit Enhancement | Techniques to make securities safer (e.g., overcollateralization, insurance) |
🔄 How Securitization Works (Simplified Steps):
-
A bank makes a set of loans (e.g., mortgages).
-
These loans are pooled together.
-
The pool is sold to an SPV.
-
The SPV issues securities to investors (ABS or MBS).
-
Investors receive cash flows (interest and principal) from the loan payments.
-
The bank receives immediate capital and offloads credit risk.
🔍 Types of Structured Finance Instruments:
| Instrument | Description |
|---|---|
| ABS (Asset-Backed Securities) | Based on non-mortgage assets like auto loans, student loans |
| MBS (Mortgage-Backed Securities) | Backed by mortgage loans (residential or commercial) |
| CMO (Collateralized Mortgage Obligation) | Structured MBS with tranches for risk/return management |
| CDO (Collateralized Debt Obligation) | Backed by corporate loans, bonds, or ABS |
| CLN (Credit-Linked Note) | Derivative-based instrument transferring credit risk |
| SIV (Structured Investment Vehicle) | Entity that profits from arbitrage between short-term funding and long-term investments |
🎯 Benefits of Securitization:
-
💰 Improved liquidity for banks and lenders
-
📉 Lower cost of capital
-
🧮 Risk diversification
-
🧾 Regulatory capital relief
-
💼 Access to broader investor base
⚠️ Risks and Criticisms:
-
Model complexity can obscure true risk (especially in CDOs)
-
Moral hazard: Lenders may loosen standards knowing risk will be offloaded
-
Market risk: Investors may face large losses in downturns
-
2008 Financial Crisis: Heavily tied to the misuse of securitized mortgage products
🏦 Regulatory Framework:
| Regulation | Key Focus |
|---|---|
| Basel III/IV | Capital requirements, risk weighting of securitized exposures |
| IFRS 9 | Expected credit loss recognition on securitized assets |
| US Dodd-Frank Act | Risk retention (“skin in the game”) and increased transparency |
| EU Securitization Regulation | Simpler, Transparent, and Standardized (STS) securitization framework |
🧠 Use Cases:
-
Banks offloading non-performing loans (NPLs)
-
Microfinance institutions raising additional capital
-
Governments securitizing infrastructure receivables
-
Startups securitizing subscription revenues
-
Insurance companies packaging premium receivables
🔚 Summary:
| Concept | Purpose |
|---|---|
| Securitization | Convert illiquid assets into liquid, tradable securities |
| Structured Finance | Customize financial products to match risk/return profiles and capital needs |