WHAT IS SECURITIZATION

“A bank selling its bad loans!! This might

sound strange, but it has been made
possible by securitization”

Securitization is the process of conversion of

existing assets into marketable securities. In
other words, securitization deals with the
conversion of assets which are not
marketable into marketable ones.
 EXAMPLE
 Suppose Mr. X wants to open a multiplex and is
in need of funds for the same. To raise funds,
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.
 This will benefit investors as they will have a
claim over the future cash flows generated from
the multiplex. Mr. X will also benefit as loan
obligations will be met from cash flows
generated from the multiplex itself.
 LOOSE CREDIT
A company extends credit to a large
number of customer and tends to boost
sales by giving the ability to purchase the
merchandise even to those customers
who don’t have cash . Unfortunately it
leads to late payments and even defaults.
It is basically money lent by a lender or bank
to an individual who needs to pay up loan
installments he has defaulted to another
bank. Such a person with a bad credit history
known as a sub-prime borrower gets a
reprieve through the services of these banks
or lenders who see a huge market for sub-
prime mortgage.
 When the housing boom between 2001 and 2005, happened in
the United States due to the low interest rates among other
factors, property prices saw a phenomenal hike. Hence, many
of the economically weaker borrowers who had defaulted
installments saw a dramatic rise in their property value.

 The lenders and banks targeted this section of the market

sensing the market potential of this rise in property value. They
lent money for these individuals to pay back their loans. The
picture was rosy for these lenders until the bubble burst and
the property market crashed. Many of these sub-prime
mortgage lenders had to declare bankruptcy.
 Suppose you need to borrow money to buy a house, you
go to a bank The bank gives you the money you needed
to purchase the house (indicated by the green arrow in
the figure below), and you promised to repay back the
money, with interest, over a certain length of time (red
arrow).
 Today, it is quite uncommon for the bank that
originally made the loan to you to be the
institution that actually receives your interest
payments.

 Suppose A (belonging to the sub prime category

i.e. with a poor credit history) needs money and
takes loan from B (a sub prime loan) and keeps
any of his asset as security. Now B in order to
make more money issues security in form of
bonds etc. to investors in the market which is
backed by or on the basis of the monthly
payments that A would be making to B, and this
security issued by B would be termed as
MORTGAGE BACKED SECURITY.
 While the US is grappling on how to resolve the issue,
the sub prime crisis has spread and seeped into other
parts of the world.  
 Contradictory information about sub prime crisis and its
impact in India.  For a while now Indian companies and
policy makers have denied that sub prime crisis will
impact the Indian economy.
 For instance, a news article writes Infosys thinks the
mortgage crisis will not impact them.
There is another  news item where India’s central bank,
the Reserve Bank of India, has expressed concern about
the sub prime crisis impacting the Indian economy.
 US economy is likely to bounce back as it is an
"innovative and knowledge-based society."

 India and China could not offset the impact of

the slowdown of the US economy, as total
annual consumption of both of these two
emerging countries was around $1.75 trillion,
much below over $9 trillion US consumption.

 It is true that we have gone into this sub prime

crisis on a very strong footing. Among other
emerging markets, we are one of the best
performers. That gives us some amount of
cushion to work with.
Thus in this reference I would say that as
 In India, a borrower, once a defaulter is
considered always a defaulter. Banks are
generally skeptical to lend to borrowers with a
poor credit history and even with security it can
still be difficult. Hence indiscriminate lending and
continuous defaulting seems a distant possibility
in India, which alone can cause a sub-prime
mortgage crisis.
 We won't be affected much as foundation of
Indian economy is sound. I am confident we can
sustain our growth momentum at 9-9.5% despite
the international situation.
 Conclusion

Therefore looking at the US scenario we can conclude that

the three factors responsible were
 Bad Loans: During the housing loans banks and other
institutions lend money to people who are now defaulting
on the loans
 Risky Borrowers: A lot of people overextended
themselves they borrowed more money than they can
afford to pay back.
 Mortgage Backed Security
Thus its safe to say sub prime mortgage crises will get
worse before it gets better. And if you happen to have
one of these loans you better look out because the
interest rates are going to go up.