Securitization - Term Overview

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The concept of securitization refers to the process through which an issuer creates a financial instrument by combining other financial assets and marketing these new instruments to investors. It encompasses any type of financial asset and contributes to liquidity in the market.

Securitization transforms an illiquid financial asset, such as a home, into a more liquid fixed income security. The banking entity transfers the credit risk through credit derivatives to another counterparty. The mortgage loans are usually the transformed financial assets since their contracts stated in the conditions this transformation.

Securitization example

To better understand this concept we will use an example of securitization. If a person decides to start a business that is dedicated to the purchase and sale of homes, by acquiring the first one and renting it, they will get money that will not be enough to continue with the purchase of more homes. Yes, he could mortgage the house he bought and with the money obtained he could buy a second house. Something similar is done by banks, but at the time of mortgaging the home what they do to obtain money is to secure it. To do this, they issue bonds guaranteed by said property, which in the event that they can't pay the bonds due to the bankruptcy of the bank, the buyers of the bonds would end up taking over the house.

Titling is the best way to obtain more liquid assets. From the bank's credit portfolio, a series of assets will be chosen that have sufficient characteristics to be transformed and that are of a similar nature. These securities are accumulated in a portfolio that will be sold to a fund specially constituted for operation. Thus, the bank will be able to dispose of low liquid assets.

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