The basic definition of securitization is to pool certain form of assets so that they can be clubbed together into interest-bearing securities. This decade old concept is given a bad name since the devastating mortgage crisis of 2007 began. In securitization the payment of principle and interest of the assets are passed on to the buyer of the securities.
The process of securitization dates back to 1970’s when government backed agencies pooled the home mortgages. Beginning from 1980s, the market has grown leaps and bounds in the recent years as other income producing assets were also securitized. In certain markets, for example in case of risky subprime mortgages backed securities, the investors lose confidence as the quality of the assets deteriorated.
Poor origination of credit, inefficient methods of evaluation, and loop holes in regulatory oversight has caused considerable harm to financial stability; this is evident both through the persistence in audit crisis and the scale of it.
More and more financial institutions are switching to securitization and pass on the credit risk of the assets which is shown from their balance sheet to that of various other financial institutions such as insurance companies, banks, and hedge funds. This is done to achieve various purposes. It has been found that it is economical to accumulate funds through securitization.
For banks it is less costly to hold on to these securitized assets as financial regulators have set up different parameters for them in comparison to assets that underpinned them. This principle of “originate and distribute” has come up with several economic benefits too. It diffuses the concentration of the risk by spreading the credit exposure and systemic vulnerability is reduced.
Until the crisis of subprime was disclosed it is mostly considered that securitization only has positive and fruitful effect. But securitization has also been used by some as a means to have minimum parameters of prudent lending, management of risk and investment at a time of small returns.