What is securitization?
It’s a process by which a single asset or a pool of assets is transferred from the balance sheet of the originator (bank) to a bankruptcy remote SPV (trust) in return for an immediate cash payment.
To explain through a simple example, suppose there are 100 home loans of 20 years given to 100 borrowers having different credit rating. These 100 assets are pooled and sold to a securitization or Asset reconstruction company (ARC) for immediate cash payment by the Bank. Bank will auction these loan assets (Remember loans are assets for banks and deposits are liability!!) and ARC will buy them. The bank which sells these assets is called originator.
Why a Bank needs to sell these assets:
Simply put Banks try to sell their bad or stressed assets. There are manifold benefits first bad assets are off the balance sheet of the Bank. Secondly, Banks need not make any provisions for these bad and doubtful assets. Thirdly, Banks immediately get Cash which can be utilized for further lending. Fourthly, banks save time and cost in recovering these bad or stressed assets.
How the process works.
As pointed out above,Bank i.e Originator auctions these bad loans. ARCs bid for them and buy them. Thereafter, these loans are transferred to a SPV which is in form of trust by SPV is called Bankruptcy remote which means no creditor of Originator ie of Bank can claim their dues on them.
ARCs now divide these assets into various smaller parts known as security receipts. These security based on the risk are categorized as tranches. Tranches denote the risk associated with a security receipt. For eg Lets say, ARC purchases 100 home loans. 30 out of these are backed by good value of collateral of 80%, 50 are backed by collateral security of 40 $ and 20 are backed by collateral security of 10 %. As one can see first category of 30 are most secured they will be tranche A, similarly the next category of 50 loans will be tranche B and so on. Needless to mention Tranche A is least risky so return on it will be lowest and so on.
These security receipts are sold by ARC to qualified institutional buyers. To clarify again the whole pool of 100 home loans is divided into small parts similarly like units of mutual fund which have NAV (net asset value)
List of ARCs in India:
These securitization or Asset reconstruction companies are controlled by RBI in India and need to be registered with RBI. Some of the ARCs working in India are given below:
- Alchemist Asset Reconstruction Company Limited
- ASREC (India) Limited
- Asset Reconstruction Company (India) Limited
- Assets Care Enterprise Limited
- Edelweiss Asset Reconstruction Company Limited
- India SME Asset Reconstruction Company Limited
- JM Financial Asset Reconstruction Company Private Limited
- Pegasus Asset Reconstruction Private Limited
- Reliance Asset Reconstruction Company Limited