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ASSET SECURITISATION

Securitisation of assets is an addition to the existing channels for recycling of funds by business entities. What is securitisation? It is a process through which the future income or receivables (the money that is to become due in future) of an organisation, are transformed and sold as debt instruments (such as bonds with a fixed rate of return). In respect of banks, a part of their loan portfolio can be packed together and off-loaded in the form the debt instruments (called pass-through certificate) to the prospective investors with the provision that the inflow of cash in the form of recoveries shall be distributed amongt the investors. This allows the securitising organisation/bank to get funds upfront, which can be put to more productive use in the business. Intermediaries in the securitisation transaction There are various entities involved in the securitisation transaction which include the Originator (the party/bank which has a pool of assets which it can offer for securitisation and is in need of immediate cash). Special Purpose Vehicle (SPV - the entity that will own the assets once they are securitised), usually, in the form of a trust. It is necessary that the assets should be held by the SPV as this would ensure that the investors’ interest is secure even if the originator goes bankrupt. The servicer is an entity that manages the asset portfolio and ensures that payments are made in time. The credit enhancer can be any party which provides a reassurance to the investors that it will pay in the event of a default. This could take the form of a bank guarantee also. The other parties include he credit rating agencies, the credit enhancement providers and the investors. Process of Securitisation • Original lender (bank or FI) selects and then sells various types of loans to another institution (which may promote a subsidiary for this purpose called Special Purpose Vehicle, which is a sort of Trust); • The special purpose vehicle- SPV (called issuer also) makes the payment to the original lender for the loans purchased under the arrangement; • These loans are converted into a pool of securities like debentures (called Pass Through Certificates) by SPV. • These PTCs are then sold to individual or institutional investors, who are willing to make investments; • • The original lender may keep on getting recoveries from the original borrowers; He passes on these recoveries to the SPV.

• The issuer in turn passes on these recoveries to the individual/institutional investors as per the arrangement made.

et cetera and future cash flows like ticket sales. housing loans. the conversion of existing assets into marketable securities is known as asset-backed securitisation and the conversion of future cash flows into marketable securities is known as future-flows securitisation. A bank selling its bad loans! This might sound strange. credit card payments. This article explains the concept of securitisation and how it can change the banking business in India. The concept Securitisation is the process of conversion of existing assets or future cash flows into marketable securities.'Banks will have to unload bad loans to Asset Reconstruction Companies by FY2007' read a leading business newspaper headline sometime back. Mr X can sell his future cash flows (cash flows arising from sale of movie tickets and food items in the future) in the form of securities to raise money. Mr X will also benefit as loan obligations will be met from cash flows generated from the multiplex itself. Suppose Mr X wants to open a multiplex and is in need of funds for the same. This will benefit investors as they will have a claim over the future cash flows generated from the multiplex. The process and participants . but it has been made possible by securitisation. In other words. car rentals or any other form of future receivables. Some of the assets that can be securitised are loans like car loans. securitisation deals with the conversion of assets which are not marketable into marketable ones. To raise funds. For the purpose of distinction.

interest and prepayments received ) received from the obligors are passed onto the investors (investors who have invested in the PTCs) on a pro rata basis once the service fees has been deducted. These securities issued by the SPV to the investors and are known as pass-through-certificates (PTCs). ABC Bank in this case) to a special purpose vehicle (SPV). 2002. This requires a bank to hold assets (loans given) till maturity. Consider a bank. Securitisation is a way of unlocking these blocked funds. The assets being transferred to the SPV need to be homogenous in terms of the underlying asset. The loans given out by this bank are its assets. To free these blocked funds the assets are transferred by the originator (the person who holds the assets.The cash flows (which will include principal repayment.Section 5 of the Securitisation and Reconstruction of Financial Assets and Enforcement of Security Interest Act. The SPV will act as an intermediary which divides the assets of the originator into marketable securities. and monitoring whether there is any deterioration in borrower's creditworthiness. a bank makes a loan. The bank gives loans to its customers. the bank has a pool of these assets on its balance sheet and so the funds of the bank are locked up in these loans. What this means is that only one type of asset (eg: auto loans) of similar maturity (eg: 20 to 24 months) will be bundled together for creating the securitised instrument. The customers who have taken a loan from the ABC bank are known as obligors. ABC Bank. The funds of the bank are blocked in these loans and to meet its growing fund requirement a bank has to raise additional funds from the market. collecting principal and interest. In the traditional lending process. mandates that only banks and financial institutions can securitise their financial assets. Thus. . The SPV is a separate entity formed exclusively for the facilitation of the securitisation process and providing funds to the originator. maturity and risk profile. maintaining it as an asset on its balance sheet.

Normally the originator carries out this activity. The reason for the same being that since PTCs are new to the Indian market only informed big players are capable of taking on the risk that comes with this type of investment.The difference between rate of interest payable by the obligor and return promised to the investor investing in PTCs is the servicing fee for the SPV. guarantee. other financial institutions. Though various steps are taken to take care of this. The administrator or the servicer is appointed to collect the payments from the obligors. The servicer follows up with the defaulters and uses legal remedies against them. pension funds. evaluation of their quality is of utmost importance. provident funds. and not on the basis of rating of the originator. insurance companies. In India only qualified institutional buyers (QIBs) who posses the expertise and the financial muscle to invest in securities market are allowed to invest in PTCs. In the case of ABC bank. The way the PTCs are structured the cash flows are unpredictable as there will always be a certain percentage of obligors who won't pay up and this cannot be known in advance. state industrial development corporations. the SPV can have a servicer to collect the loan repayment installments from the people who have taken loan from the bank. This is carried on by rating the securitised instrument which will acquaint the investor with the degree of risk involved. The investors can be banks. financial institutions (FIs). So particular transaction of securitisation can enjoy a credit rating which is much better than that of the originator. etc used by the originator. scheduled commercial banks. some amount of risk still remains. et cetera fall under the definition of being a QIB. In order to facilitate a wide distribution of securitised instruments. Mutual funds. High rated securitised instruments can offer low risk and higher yields to investors. The low risk of securitised instruments is attributable to their backing by financial assets and some credit enhancement measures like insurance/underwriting. mutual funds. The rating agency rates the securitised instruments on the basis of asset quality. . government etc.

securitisation can transform banking in other ways as well. This form of funding credit growth cannot continue forever. these assets are removed from the bank's books and the money generated through securitisation can be used for other profitable uses. But at the same time the incremental credit deposit ratio for the past one-year has been greater than one. So the question that arises is. like for giving new loans. . the originator can get funds from new investors and additional funds from existing investors at a lower cost than debt. Impact on banking Other than freeing up the blocked assets of banks. how are the banks funding this increased credit offtake? Banks essentially have been selling their investments in government securities. the banks have been able to cater to the credit boom. The growth in credit off take of banks has been the second highest in the last 55 years. For an originator (ABC bank in the example). primarily because banks have to maintain an investment to the tune of 25 per cent of the net bank deposits in statutory liquidity ratio (SLR) instruments (government and semi government securities).Once assets are securitised. with the deposit inflow being less than the credit outflow. securitisation is an alternative to corporate debt or equity for meeting its funding requirements. The growth of credit off take though has not been matched with a growth in deposits. What this means in simple terms is that for every Rs 100 worth of deposit coming into the system more than Rs 100 is being disbursed as credit. By selling their investments and giving out that money as loans. As the securitised instruments can have a better credit rating than the company.

need to ensure that more deposits keep coming in. they cannot sell any more government securities to generate liquidity. What is happening right now is that banks and FIs have been selling their NPAs to ARCIL and the same banks . ICICI bank. And given the pace of credit off take. some banks could reach this level very fast. SBI and IDBI hold second and third positions. A K Purwar. HDFC [ Get Quote ]. PNB. Citicorp (I) Finance. HDFC Bank and some other banks have shareholding in ARCIL. Banks can securitise the loans they have given out and use the money brought in by this to give out more credit. Chairman of State Bank of India [ Get Quote ]. It sold 134 cases worth Rs. which are typically publicly/government owned. Once the banks reach this level of 25 per cent. Asset Reconstruction Company of India Limited (ARCIL) was the first (till date remains the only ARC) to commence business in India. thereby helping banks to focus on core activities. in a recent interview to a business daily remarked that bank might securitise some of its loans to generate funds to keep supporting the high credit off take instead of raising interest rates. So banks. securitisation also helps banks to sell off their bad loans (NPAs or non performing assets) to asset reconstruction companies (ARCs). Not only this.The fact that they have been selling government paper to fund credit off take means that their investment in government paper has been declining. thereby freeing the banking system to focus on normal banking activities. ARCs.the second largest bank in India. IDBI. A lot of banks have been selling off their NPAs to ARCIL. in order to keep giving credit. Karur Vyasya Bank. ICICI Bank [ Get Quote ]. Another way is Securitisation. Karnataka Bank [ Get Quote ]. One way is obviously to increase interest rates.8450 Crore. act as debt aggregators and are engaged in acquiring bad loans from the banks at a discounted price. ARCIL is keen to see cash flush foreign funds enter the distressed debt markets to help deepen it. On acquiring bad loans ARCs restructure them and sell them to other investors as PTCs. has been the largest seller of bad loans to ARCIL last year. SBI.

it so happens that the seller is the loan side of the same institutions and buyer is the treasury side.may be the way of achieving economies of scale. ARCIL's Chief Executive as saying. but the present structure of the banking system is not suitable for reaching these businesses. when they have to shift to Basel-II norms. A recent report in a business daily quotes . . One private bank. Rajendra Kakkar. ICICI.either to raise more capital or to free capital tied up in NPAs and other loans through securitisation. Blocking too much capital in NPAs can reduce the capital adequacy of banks and can be a hindrance for banks to meet the Basel-II norms.and FIs are picking up the PTCs being issued by ARCIL and thus helping ARCIL to finance the purchase. A recent survey by the Economist magazine on International Banking." So the risk from the balance sheet of banks and FIs is not being completely removed as their investments into PTCs issued by ARCIL will generate returns if and only if ARCIL is able to affect recovery from defaulters.bundling many loans together and selling the resulting cash flow. banks will have two options. "We have got a buyer. securitised $4. Thus. But most Indian banks are more interested in competing for affluent customers".3 million of micro-loans last year. Securitising micro-loans. we have got a seller. says that securitisation is the way to go for Indian banking. That represents an enormous potential market for both local and foreign banks. As per the survey. Banks are expected to sell off a greater amount of NPAs to ARCIL by 2007. "What may be more important for the economy is to provide access for the 92% of Indian businesses that do not use bank finance. In closing Securitisation is expected to become more popular in the near future in the banking sector.