A concept very well explain in the movie ‘The Big Short’ in the context of financial crisis of 2008. Securitisation is a process where individual loans are pooled together to create an instrument of security in order to ensure liquidity of otherwise illiquid assets.
For instance, Bank A grants loans to 10 people which are backed by a collateral security. Before the concept of securitisation started picking up around 1990s, the Banks would simply wait for the loans to be repaid over the course of loan term which may be long in some cases. The liquidity came in the banks from the deposits. Therefore, the banks would not have liquidity of these loan assets. However, securitisation allows banks to bundle these loans together and sell it to various investors in tranches. The investors would earn higher interest rate on riskier loans. The likelihood of the investors getting paid would depend on the repayment of the underlying loan by the 10 people.
Banks securitise assets in order to generate liquidity. In India, securitisation is governed under the Securitisation and Reconstruction of Financial Assets and Enforcement of Security Interests Act, 2002 (SARFAESI) wherein only banks and financial institutions are allowed to securitise assets.
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