Securitisation is a process by which a bank or company packages its illiquid assets as a marketable security. The marketable security is backed by an asset, such equity or debt (mortgage, car loans, gold loans, credit card debt). The principal and interest on the underlying is paid to the investors on a regular basis, though the method may varies based on the type of security. Debts backed by mortgages are known as mortgage-backed securities, while those backed by other types of loans are known as asset-backed securities.
Thus, the process of securitization involves creating a financial instrument through the following 3 steps:
- Pooling various types of financial asset into a Special Purpose Vehicle (SPV),
- Packaging that as a bond, pass-through security, or collateralized mortgage obligation,
- Marketing these to investors.
The right to principal, interest and other repayments on the asset then passes on to the investors, through the securitisation. Thus, securitization increases predictability, lowers risk, thereby increasing value. For the bank / issuing company, it allows greater access to funding by increasing liquidity in the marketplace, thereby expanding business operations or investments.