Benefits of Securitisation

Globalisation, deregulation of financial markets and growing cross border business

transactions has reset the ambience among financial institutions, increasing manifold
opportunities for financial engineering. Securitisation increases the lending capacity of an
FI without having to find additional capital or deposits. Securitisation facilitates
specialisation and is gaining wide acceptance as the most innovative form of asset
financing. A significant impact of securitisation is the profiling and placement of
different risks and rights of an asset with the most efficient owners. It provides capital
relief, improves market allocation efficiency, expands opportunities for risk sharing and
risk pooling, increases liquidity, improves the financial ratios of FIs and banks, creates
multiple streams of cash flows for the investors, is tailored to the risk profile of a number
of customers and facilitates asset-liability management. The requirements for capital
adequacy in recent years have also motivated financial institutions and banks to
securitise. On the demand side, investors are motivated to buy these securities as they
view these as having risk characteristics, compatible with the profile.

Benefits to the Originators, especially FIs

For FIs, securitisation is an opportunity offered in the form of capital relief, capital
allocation efficiency, and improvements in financial ratios.

• Lower cost of borrowing: Securitisation reduces the total cost of financing as

assets are transferred to a separate bankruptcy-resistant entity. To that extent FIs
need not maintain capital to maintain their capital adequacy norms. Also, entities
with a riskier credit profile can benefit from lowered borrowing costs.

• A source of liquidity: FIs could face a liquidity crunch either due to their risky
credit profile or delayed receivables. The liquidity provided by securitisation acts
as a very powerful tool, that FIs could use to adjust the asset mix quickly and
efficiently. Further, the risks in an asset portfolio can be identified and
apportioned to arrive at an effective asset mix.

• Improved financial indicators: Securitisation leads to capital relief that improves

the company’s leverage and in turn the Return on Equity. The repercussions of
securitisation on the balance sheet of a company can vary depending on the
strategy for its capital structure and its appetite for increasing or decreasing
leverage.

• Asset-Liability Management: Securitisation offers the flexibility in structuring

and timing cash flows to each security tranche. It provides a means whereby
customised securities can be created which helps in matching the tenure of the
liabilities and assets.

• Diversified fund sources: By securitising its receivables, the instrument of which

could be sold to global investors, the originator has an opportunity to diversify its
funding source.
 • Positive signals to the Capital Markets: Lenders are at times trapped in a situation
where they cannot rollover their debt due to downgrading of their ratings,
possibly due to economic changes. Under these circumstances, securitisation
enables lenders like FIs to increase the rating of debt much higher than that of the
issuer through the intrinsic credit value of the asset. This enables the FIs to obtain
funding.

• An avenue for divestiture: Securitisation offers an optimal exit route for entities
that wish to exit a business comprising of financial assets without going through
the mergers and acquisition route.

Benefit to the SPV

• An SPV which services its ultimate investors properly gains appreciation in the
Capital Market. In course of time, they can be appointed as Trustees for other
assets as well.

• In case the cash flows fall through, the SPV is protected, since the Security of the
assets is vested in him.

• The SPV gets a regular fee based income for acting as the intermediary.

Benefits to the Investors

Investors purchase risk-adjusted securities based on its level of maturity and seniority.
For instance, an auto loan or credit card receivables backed paper carries regular monthly
cash flows, which can match the requirements of investors like mutual funds.

• New Asset Class: Securitised products provide new investment avenues for
investors to enhance their return or to diversify their portfolio. For instance, an
investor in the United States whose investment is predominantly in US assets can
diversify by investing in securities offered by an SPV in Asia.

• Risk Diversification: As the underlying pool of receivables is spread across

diverse customers the investors need not have a thorough understanding of the
underlying assets. The investor is insulated from customer specific event risk.

• Customisation: Securitisation of financial assets allows tailoring of cash flows to

the risk profile of the investors. A certain stream of cash flow coming from an
underlying asset pool can be broken into tranches and offered as per the investor
risk appetite.

• Decoupling with Originator: The investor is insulated from the credit profile of
the Originator. This separation of the Originator and the investor helps at the time
of bankruptcy or default or credit downgrades.
Disadvantages of the Securitization :

• Securitization is an off-balance sheet item. The originator may thus be able to

hide the true picture of its financial health by securitization of its good assets and
keeping only sub-standard assets in its portfolio.
• Another disadvantage of securitization is its opagueness. For example, a
company may have taken huge liabilities but that may not be reflected in the
balance sheet or conventional financial statements of the company. This is
especially true where the securitisation is with recourse i.e. if the receivables
which have been securitised to the SPV, but later become NPA. In such a case,
the SPV will have the right to recover the dues from the originator. Thus, in such
cases, it may be realized later on that the originator actually had a large amount of
contingent liabilities but these were not reflected in the balance sheet.