Question

In managing interest rate, credit and liquidity risks, discuss how FIs use securitization to their benefit. In your discussion, list the benefits and costs of securitization by using an example of a bank securitizing its credit card or mortgage receivables. In performing securitization of these loans, 

(a) how has the bank changed its interest rate, credit and liquidity risk exposures using credit card asset backed securities as an example and 

(b) does securization diminish or enhance the banks' intermediation function and why or why not?

Answer 1

(a) & (b)

As part of securitization, Financial Institutions offloads the exposures in Loans to a Special Purpose Vehicles (SPV).

 

In the process, FIs exposures to Loans is reduced in return of cash (liquidity). Hence, this reduces the Bank's exposure to credit risk also providing liquidity to the Bank. With exposure in Cash now, Interest Rate Risk of the FI is also reduced. However, the above risk reduction also leads to reduced profitability as FI's will not generate higher NIM's while sitting on a cash.

 

Hence, securitization should be used by FI's strategically to de-risk the Balance Sheet, diversify the Loan Book

(a) & (b)

As part of securitization, Financial Institutions offloads the exposures in Loans to a Special Purpose Vehicles (SPV).