Securitization is as crucial to an economic system as structured financial markets. It results in issuers devising monetary instruments by combining different fiscal assets, as well as market levels of the merged tools, to investors (Wæver, 2015).
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Such a practice may include any form of monetary asset and supports liquidity in the market by allowing small investors to acquire a large pool of assets. This process may entail merging contractual obligations, for instance, credit card debts, loans, and other assets that form receivables. Mortgage-supported security acts as a good case of securitization (Elul, 2016). Through merging mortgages into a single pool, issuers may choose to split it into small portions depending on their underlying risk of default and sell the bits to investors. Devoid of securitization of mortgages, it might be impossible for a retail investor to own a large pool of mortgages.
Securitization compels banks to compete with other financial institutions with the aim of winning as many major borrowers as possible. Attributable to ensuring that monetary assets become tradable, securitization decreases agency outlays, thus making financial markets more resourceful. It also enhances liquidity for the essential monetary claims hence lessening risks in the financial system.
Securitization provides more intensified investment options and appealing risk-return profiles than other forms of assets, for example, government bonds. In a case of loan default where the money collected by the collateralized debt obligation is inadequate to pay every investor, the ones at the lowest tranches are the first to incur losses (Buchanan, 2016). The last investor to lose money from default is the most secure. Securitization offers creditors a chance to reduce their risk through the distribution of possession of debt obligations.
Buchanan, B. G. (2016). Securitization: A financing vehicle for all seasons? Journal of Business Ethics, 138(3), 559-577.
Elul, R. (2016). Securitization and mortgage default. Journal of Financial Services Research, 49(2-3), 281-309.
Wæver, O. (2015). The theory act: Responsibility and exactitude as seen from securitization. International Relations, 29(1), 121-127.