Securitisation of Bank Loans and Reasons Why Banks Securitise Some of Essay

Securitisation of Bank Loans and Reasons Why Banks Securitise Some of its Loans - Essay Example 11) further describe securitisation as a financial practice which involves pooling together the various types of contractual debts for instance commercial and residential mortgages, automobile loans or credit card liability obligations and marketing the combined debt as bonds, securities or collateralized mortgage obligation to various investors. The principal and interests accruing from the debt and the underlying security is paid to the investors on regular basis. Securitisation has also been defined by (Samantha, 2005, p. 1) as the process of converting the existing assets or future cash flows into marketable securities. Converting existing assets to marketable securities is known as asset-backed securitisation while securities supported by the mortgage receivable are known as mortgage-backed securities (MBI) (Samantha, 2005, p. 1). Securitisation can help improve the liquidity, reduce risks associated with credit and interest rates; supplement fee income and boost the leverage ra tios. Despite these gains, some financial institutions are reluctant to securitize their loans given the disadvantages of this practice. This paper will first assess the process of securitisation and then make a study into the reasons why banks securitize their loans (Altunbas, Gambacorta and Marques, 2007, p. ... This reduced the available funds thereby limiting the ability of banks to meet the growing demand for loans and could only raise the additional funds from the market. However, securitisation provides a way for unblocking those funds and freeing them to be loaned to customers. The process of securitisation starts with the bank putting together a collection of loans it plans to issue to investors as collateralize notes (Simonson, 1995, p. 77). He asserts that the loans must be homogenous as regards to the underwriting standards of the issuing bank and should have a fixed maturity and in the case of credit card; a fixed revolving balance. Moreover, the pooled loans should have the same risk profile. After the loans have been bundled, the issuing bank comes up with a special purpose trust which acquires the bundled loans. Generally, the trust procures credit enhancement from a third party in the form of assurance in the portion the possible losses. Thereafter, the trust gets into a conta ct with an underwriter who issues the notes; usually at a high rate against the loans (Simonson, 1995, p. 77). Institutional investors are the ones who usually buy the notes as the bank continues the servicing the loans. To understand securitisation, (Simonson, 1995, p. 77) gives an example of a bank, ABC that gives out loans and these are maintained on the balance sheet as its assets. The bank therefore has a pool of funds that are locked up as loans. The customer who has been loaned by the bank is known as obligors. To unblock those funds, the assets have to be reverted back to the originator (ABC bank holding the assets) to a special purpose vehicle (SPV). SPV is also known as the issuer and is usually