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Securitisation and Liquidity of Banks Since 2008 Essay

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Updated: Jul 13th, 2021

Liquidity is a feature of an asset that is characterized by its ability to be sold at the market and turned into cash. The banking industry uses loans and other financial obligations as assets that can be used to generate income. Securitization is a form of activity of a bank that is aimed at increasing the liquidity of the bank’s assets. The purpose of this paper is to analyze the relationship between securitization and liquidity of banks and discuss changes in the field of global securitization after the financial crisis of 2008.

Securitization and liquidity

Securitization is a source of additional liquidity for the banks, and this instrument allows them to sell their assents to a third party (Arif, 2017). The process provides a way to generate cash by selling financial obligations such as mortgages. As banks combine a set of existing assets with relatively low liquidity together and create one flow of income, it lowers the risks of non-payment that is associated with individual loans (Kara, Ozkan, and Altunbas, 2016). It allows creating a single portfolio of loans that is much more attractive for potential buyers due to reduced risks (Neumann 2017a). It allows banks to turn long-term, and thus less liquid, financial obligations into highly liquid assets that can be readily sold (Aarons, Ender, and Wilkinson, 2019). Thus, securitization helps to reduce the number of illiquid assents, which results in improving the position of the bank.

Empirical data reinforces the theory and provides evidence that supports the relationship between a bank’s liquidity and securitization. Research has shown that securitization has a positive impact on the performance of banks, decreasing credit risks and increasing profits (Ghosh, 2018). The process has been shown to have a positive influence on diversification and leverage capital, providing a source of stability for the bank (Ghosh, 2018). These relationships play a central role in the application of securitization before, during, and after the world financial crisis of 2008.

The Crisis of 2008

The economic recession of 2008 had a profound effect on all aspects of the world’s economy and had an especially significant negative impact on the banking sector. Excessively relaxed credit standards and low-risk retention together with overly optimistic expectations and high demand for housing led to the formation of a real estate babble (Senarath, 2017). As more and more debtors started failing to repay their mortgages, the system fell into a vicious cycle, leaving the creditor banks with high numbers of unpaid loans. To prevent the economy from collapse, regulatory institutions increased control over the banking activity, creating additional restrictions (Neumann 2017a). As a result, the sector experienced a series of interrelated shocks that limited their ability for development and increased the risks associated with banking.

Together with the tendency of the loans losing their attractiveness as an assent due to high risks, this situation led to a major fall of securitization, paralyzing banking activities. This fact made an additional negative impact on the weakened banking sector. The companies, which were already severely affected by the crisis, lost one of the most efficient instruments for risk management and profit generation (Neumann 2017a). To summarise, the financial crisis and made an impact on all banking activities and affected the availability of the option of securitization for banks around the world.

Post-Crisis Developments

As secularisation is beneficial for the economy, the European Union and other countries made attempts to facilitate the process by creating new policies. The field of global securitization saw less activity in recent years, as the post-2008 recession market situation exhibit less appetite for such activities (Cullen, 2018). The crisis resulted in weaker liquidity conditions for European banks (Scopelliti, 2017). At the same time, these activities are associated with higher default risks, especially during the post-crisis period (Ghosh, 2018). This tendency might be linked with real estate markets that see much less optimistic expectations after the recession.

In contrast to stricter regulations of the time of the economic crisis, the post-recession period is associated with the attempts of the world’s governments to catalyze securitization. To improve the situation, European Opinion has proposed new policies that will facilitate the origination of new loans and thereby will stimulate economic growth (Cullen, 2018). In the UK market, which has recently gone through structural reforms, the policies that are aimed to increase intensives are especially relevant, as they are likely to increase stability (Cullen, 2018). Thereby such an approach might help avoid future crises in real estate markets, especially if it is concentrated more on the process itself through improved incentives for secularisation (Cullen, 2018). The United States also focused its efforts on compensating for the losses that occurred during the recession via stimulation of banking activities, providing banks with more freedom (Neumann 2017a). Thus, the developments in the developed countries after the crisis are characterized by the attempts to facilitate secularisation and loan origination primarily through alleviated financial regulations.

Following the tendency in the developed countries, China also adjusted its regulatory policies. The Chinese government lowered the level of required minimum risk retention, which is aimed at facilitating securitization, alleviating procedural restrictions for banks in the country (Ngwu and Chen, 2016). It shows that the largest world’s economies all to different extents took the path of decreasing control over the banking sector and taking measures for catalyzing activities such as secularisation.

Conclusion

Liquid assets are preferable to businesses as they can be exchanged for money without losing value. Secularisation gives banks the possibility to increase their position in liquid assets, by selling portfolios of loans at the market. This instrument has a set of benefits for the bank, having a positive effect on its performance, helping to manage risks, and increasing profits. The economic crisis of 2008 paralyzed the banking sector and compromised the ability of banks to turn to secularisation to improve the situation. The post-recession tendencies in the field of global securitization show attempts of the regulatory institutions to facilitate the process to stimulate economic growth.

Reference List

Aarons, M., Ender, V. and Wilkinson, A., 2019. Securitization Swaps: A Practitioner’s Handbook. New York: John Wiley & Sons.

Arif, A., 2017. Web.

Cullen, J., 2018. ‘Securitisation, Ring-Fencing, and Housing Bubbles: Financial Stability Implications of UK and EU Bank Reforms’. Journal of Financial Regulation, 4(1), pp.73-118.

Ghosh, A., 2018. ‘Implications of securitisation on bank performance: evidence from US commercial banks’. International Journal of Financial Innovation in Banking, 2(1), pp.1-28.

Kara, A., Ozkan, A. and Altunbas, Y., 2016. ‘Securitisation and banking risk: what do we know so far? ’ Review of Behavioral Finance, 8(1), pp.2-16.

Neumann, N., 2017. Web.

Neumann, N., 2017. PhD dissertation. Imperial College London. Web.

Ngwu, F.N. and Chen, Z., 2016. ‘Regulation of securitisation in China: Learning from the US experience’. Research in International Business and Finance, 37, pp.477-488.

Senarath, S., 2017. ‘Securitisation and the global financial crisis: can risk retention prevent another crisis? ’ International Journal of Business and Globalisation, 18(2), pp.153-166.

Scopelliti, A., 2017. Securitisation, Bank Capital and Financial Regulation: Evidence from European Banks. Web.

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IvyPanda. 2021. "Securitisation and Liquidity of Banks Since 2008." July 13, 2021. https://ivypanda.com/essays/securitisation-and-liquidity-of-banks-since-2008/.

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IvyPanda. (2021) 'Securitisation and Liquidity of Banks Since 2008'. 13 July.

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