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Securitisation is a key financial process that allows financial institutions to convert illiquid assets into tradable securities. It plays a crucial role in modern capital markets, offering liquidity, risk transfer, and access to funding.
Securitisation is the process of pooling financial assets—such as loans, mortgages, or receivables—and converting them into marketable securities sold to investors. These securities are backed by the underlying assets and generate returns from the repayments made by the original borrowers.
This mechanism enables banks and financial institutions to:
Offload risk from their balance sheets
Unlock capital for further lending
Provide investment-grade instruments to investors
Here’s a step-by-step breakdown of how securitisation works:
Asset Pooling
A bank or originator bundles together similar financial assets (e.g., home loans, auto loans).
Creation of a Special Purpose Vehicle (SPV)
These assets are transferred to an SPV, which is legally separate and created solely for the purpose of issuing securities.
Issuance of Securities
The SPV issues securities (e.g., MBS, ABS) backed by the asset pool. These securities are sold to investors.
Repayment Flow
As borrowers repay their loans, the SPV collects the cash flows and distributes them to investors.
This framework isolates risk and ensures smooth cash flow from borrower to investor.
There are several types of securitised instruments, depending on the nature of underlying assets. Each type serves different financing needs and attracts distinct classes of investors based on risk appetite and return expectations:
Mortgage-Backed Securities (MBS)
Backed by pools of residential or commercial mortgage loans. These securities generate returns from monthly principal and interest payments made by borrowers. MBS are commonly issued by housing finance companies and are considered relatively low-risk when backed by high-quality loans.
Asset-Backed Securities (ABS)
Based on non-mortgage assets such as credit card receivables, auto loans, personal loans, or student loans. ABS helps lenders recycle capital and manage risk exposure across various consumer credit categories. They are more diverse and may carry slightly higher risk than MBS.
Collateralised Debt Obligations (CDOs)
Comprise pools of various types of debt—such as bonds, loans, or other ABS—structured into tranches with different risk-return profiles. CDOs cater to institutional investors seeking tailored exposure, but they are more complex and carry higher credit and liquidity risks.
Each type of securitisation differs in terms of underlying asset class, repayment structure, risk exposure, regulatory treatment, and investor suitability.
Here’s why securitisation is commonly used by financial institutions:
Liquidity Creation: Converts illiquid assets into marketable securities.
Risk Diversification: Shifts credit risk from originators to investors.
Funding Access: Enables banks to raise capital without issuing equity or taking on new debt.
Improved Balance Sheets: Offloading assets reduces capital requirement burdens.
Market Efficiency: Introduces new investment avenues for capital markets.
Scenario: A bank has ₹1,000 crore in home loans.
It transfers this portfolio to an SPV.
The SPV issues MBS worth ₹1,000 crore to investors.
Investors buy these securities and receive monthly interest and principal payments from home loan borrowers.
This enables the bank to recover funds immediately while transferring repayment risk to investors.
Here’s a quick look at the pros and cons of securitisation:
| Pros | Cons |
|---|---|
Enhances liquidity |
High structural complexity |
Transfers credit and interest risk |
Risk of mispricing and incorrect credit ratings |
Improves capital efficiency |
Potential systemic risk (e.g., 2008 crisis) |
Creates investment opportunities |
Dependent on accurate modelling and assumptions |
Securitisation is a powerful financial tool that bridges lending institutions and capital markets. While it offers multiple benefits—such as liquidity, capital relief, and market expansion—it also carries risks that must be carefully managed through regulation and transparency. Understanding its structure and implications is essential for investors, regulators, and financial institutions alike.
This content is for informational purposes only and the same should not be construed as investment advice. Bajaj Finserv Direct Limited shall not be liable or responsible for any investment decision that you may take based on this content.
Mortgage-Backed Securities (MBS), Asset-Backed Securities (ABS), and Collateralised Debt Obligations (CDOs).
Asset segregation via SPV, risk transfer, credit enhancement, and structured repayment.
To convert illiquid financial assets into tradeable securities, freeing up capital and distributing risk.
Banks (via capital efficiency), investors (via new products), and borrowers (via more credit availability).
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