This is the process of issuing marketable securities’ backed by a pool of existing assets such as auto or home loans.
After an asset is converted into a marketable security, it is sold to an investor who then receives interest and principal out of the cash flow generated from servicing of the loan. Financial institutions such as NBFCs and microfinance companies convert their loans into marketable securities and sell them to investors.
This helps them get liquid cash out of assets that otherwise would be stuck on their balance sheets.
Global experience shows that if the value of the underlying asset falls then securitized assets lose value as it had happened during the US ‘sub-prime crisis’-home loans against which it securitized assets were sold to insurance companies and banks lost value, which in turn resulted in a crisis. To prevent such crises, the RBI has taken some precautionary steps in this regard.
It has asked companies to hold securities for a certain minimum period:
(i) While NBFCs need to keep assets for six months, a minimum retention requirement of 5–10 percent to ensure that they have a continuing stake in the performance of securitized assets.
(ii) Micro Finance Institutions (MFI) need to hold them for three months.