The borrower purchases trade assets from another company, referred to as securitization. The assets can be diverse, but they often consist of many individual bank receivables that are ‘bundled’ and sold as a single lot. As a result, both the buyer and the seller are likely to be in the financial services industry. Credit card receivables, mortgages, hire purchase receivables, and lease receivables are a few examples. The original owner of the assets frequently sells them to free up cash on their balance sheet and allow them to write the new business of the same type.

On the other hand, the buyer will be able to take over the business and is likely under-represented in or new to the industry. Typically, each ‘bundle’ will comprise a series of receivables with comparable maturities and repayment profiles and no history of late payments or non-performance. The assets are obtained swiftly and without marketing, and the acquisition can be financed using a syndicated loan structured to match the assets’ terms. As a result, this syndicated loan is typically favorably received in the market.

However, banks already lending to the seller of securitized assets may be at risk. As previously stated, the sold assets are often those with no history of late payments or non-performance. Suppose a firm makes a series of securitizations. In that case, it may be discovered that the overall quality of its portfolio is degrading since it is selling off its best assets while keeping those that aren’t appealing to buyers.

As a result, the standard loan agreement for a syndicated loan will include provisions restricting or prohibiting securitizations without prior authorization from the banks.

Securitization concerns can arise from high-risk or low-performing assets, especially if a financial institution decides to exit a specific industry. These issues can only be sold at a discount, and the seller will have to write them off. Because the underlying assets are riskier, lending bankers are less interested in them unless they are guaranteed.

Securitization was a massive element of the US capital markets before the financial crisis of 2007–2008. It was at the heart of the recent financial crisis. It is, however, generally unregulated and poorly understood. There isn’t a lot of research on this subject. We review the literature on securitization and highlight the open questions in this study.

In fact, by spreading the risk on such assets, the originator and its creditors may benefit from selling financial assets. Unlike a secured loan, where any collateral deficit triggers an unsecured deficiency claim for that amount, the SPV and its investors only have recourse against the financial assets purchased, not the originator or its other assets, in a securitization. As a result, the SPV and its investors risk those financial assets being insufficient to repay the investors, not the originator or its unsecured creditors. Only the SPV and its investors would be in danger if the over-collateralization were too small in the first place. On the other hand, if the over-collateralization proved excessive in retrospect, most securitization transactions allow the originator to recover the surplus value from the SPV at the end of the transaction.

Overinvestment of securitization funds is possible, and it does happen from time to time. However, the risk of overinvestment does not always imply that securitization is ineffective. Overinvestment is a standard business risk associated with any finance, not just securitization. Securitization, in reality, may afford fewer options for intentional overinvestment than other financing techniques due to the scrutiny required by rating agencies.

To the extent that it occurs, overinvestment only hurts unsecured creditors if the originator goes bankrupt because unsecured creditors of a solvent company are finally compensated. Because originators on the verge of bankruptcy rarely employ securitization, and because the danger of overinvestment is small, there should be few occasions where unsecured creditors are damaged by securitization funds being overinvested.

Furthermore, when looking at securitization transactions, any harm to unsecured creditors in those few circumstances may likely be outweighed by the benefits of securitization. Two such benefits benefit an originator’s unsecured creditors indirectly: securitized debt has a lower-interest-rate cost than corporate debt, so the cost differential can be used to pay unsecured creditors; and securitization can be used to provide needed liquidity to viable originators who are unable to borrow, keeping them out of bankruptcy (and thus enhancing creditor recovery).

With one key exception, securitization is identical to secured financing. The issuing corporation is not accountable for its ABSs in an ABS. It’s as if the monies were not indeed “borrowed” by the corporation. The borrowing must be done through a distinct legal organization. The asset is securitized so that this entity becomes the legal owner. If the firm fails, the cash flows will go to the SPV rather than the corporation. In this sense, with the case of securitization, the bondholders have an ownership interest, but in secured lending, they have a security interest.

Summary

Transforming a group of nonmarketable assets, or predicted future cash flows on the assets, into units of marketable securities to sell the underlying assets in the capital market to earn money for a firm is known as securitization. In the context of banking, securitization is the process of transforming a pool of loans into units of secured marketable securities and selling them to investors to cover a bank’s funding needs. It is converting predicted future cash inflows (such as service revenue and repayments) from a pool of loans into units of secured marketable securities that are sold to investors for a bank to raise capital.

A funding requirement triggers a securitization agreement, and it is nourished by the presence of a healthy capital market. The importance of securitization and its consequences for risk management in bank lending cannot be overstated. Specific objectives underscore securitization’s importance as a capital market instrument. It assists a bank in unlocking and recouping funds held in risk assets, optimizing earnings while increasing return on capital employed, mitigating credit risk, generating an alternative source of cash flow, managing its balance sheet, tapping into rare windows of opportunity, and exploring new investments in and outside lending.