Securitization of Financial Assets: A Potent Panacea to Non-Performing Assets

Securitization of Financial Assets

With the burgeoning of globalization & liberalization, there has been a paradigmatic shift in the role of the banking and financial sector in monetized economies. There is an important reason to believe that a large number of non-performing assets in financial institutions is an important reason for the causation and deterioration of financial crisis. But is the NPA crisis an invincible enemy which cannot be mitigated? Thankfully, Asset securitization is the answer to the detestable NPA problem in the economy which can significantly help to bring the NPA crisis to its knees.

Asset securitization is considered an effective way to deal with NPA. The key issue in restricting securitization is the selection of NPA. It is to be noted, that many NPAs are significantly caused by a short-term cash flow shortage. But an opportunity can be presented to a bank if a significant quantity of funds can be committed to asset securitization which can emphatically have a good chance to covert NPAs into quality assets.

In financing terms, the advantages of asset securitization are tremendous. First and foremost, the financing costs are low. It is no news that disposing of NPAs requires huge cash flows, additionally, management of the same incurs humungous costs. Alternatively, in asset securitization, the user costs of the financing proceeds are relatively low. Compared to bank loans, relatively high-interest rates can be significantly avoided.

Additionally, compared to equity financing, the financing costs can be reduced while the enterprise’s organizational structure is maintained. Further, through asset securitization, the limit imposed by the credit rating of the NPAs themselves may be overcome through credit enhancement, to issue securities of a higher rating.

One of the biggest problems with lending out loans is the high risks associated with it. Consequently, NPAs too pose a huge risk to a banking structure. In contrast, an asset portfolio can reduce the risks of a single NPA. According to the investment portfolio theory, without reducing the anticipated return rates, combining negatively correlated securities can cause the risks of the securities portfolio to be less than the risks of any one type of security held.

As aforementioned, the credit rating of NPAs is relatively poor and the risks of default are quite high, but due to securitization, assets are of different risk levels which can be combined into an asset pool. Securitization allows different types of NPAs to enter one asset pool to achieve risk hedging; and, through accelerated transfer, separation, and centralized disposal of the NPAs by the capital market, the percentage of non-performing loans can be directly reduced.

Additionally, Risk remoteness emphatically eliminates the risks of the payment of the returns associated with the financed party. This leads to the major development in the design of an asset securitization structure i.e. establishment of a special purpose vehicle (SPV). This particular financed party removes the underlying assets from its hands by transferring the same to the SPV through a “genuine sale”. Subsequently, the SPV can use these as security to issue the securities. This emphatically helps in raising additional capital and a chance to gain profit through its gains.

Securitization, can additionally also allow the rapid removal of NPAs from the balance sheet. It allows quick sanitization of the on-balance-sheet assets and digestion of the accumulated risks from the sliding economy. This in turn leads to optimization of the asset-to-liability structure and strengthening of business operation capabilities, risk management capabilities, and core competitiveness.

Additionally, the market-based and mass disposal method has a scaling effect, reducing the economic and time costs of disposing of NPAs. As it is known, a huge percentage of NPA on the balance sheet of the bank speaks ill of its management and mitigation policy and in return hurts its credibility. Thus, asset securitization provides an ideal and profitable way of clearing the bad bank books.

NPA securitization can also increase an organization’s capital sources. Asset securitization can provide enterprises with a new means of financing. This effectively allows enterprises to break their current over-reliance on bank borrowing. Thus, Securitization effectively expands enterprises’ revenue sources. Through NPA securitization, an enterprise generally can revitalize existing funds, without in general increasing liabilities. Additionally, mitigating liabilities, it helps secure a low-cost fund source, increasing asset liquidity for a bank.

Is asset securitization a potent solution solely for the banking sector? Certainly not. Asset management companies too can profit from such lucrative ventures. Thus, specializing in the disposal of NPAs can present asset management companies with even greater opportunities.

Through NPA securitization, asset management companies can earn asset management fees, handling fees, and other such intermediary service fee income. This will deeply satisfy capital regulations and leverage the regulatory requirements of an asset management company.

Unlike in some countries where Assets Reconstruction Companies have been set up for the purpose of the bailout, in India, the Government has proactively initiated certain measures to control its burgeoning Non-Performing Assets crisis. In order to mitigate the Non-Performing Assets and quicken recovery, the Government of India in 1985 had set up SICA/BIFR, Debt Recovery Tribunals, and Debt Appellate Tribunals under the Recovery of Debts Due to Banks and Financial Institutions Act, 1993.

In an environment where market risks are relatively huge, currently, a pandemic struck the economy presents such a picture, that non-performing loan securitization products can provide new investment products for the capital markets.

In addition to capital markets, it emphatically can also provide products like open investment channels and increased product choice. While helping enterprises in effectively resolving non-performing loans, such products can satisfy different investors’ risk appetites and their ever-diversifying investment demands.

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Tags: financial assets, non performing assets, financial asset management, real assets and financial assets, liquid financial assets, npa non performing assets, non performing assets of banks, securitization of financial assets, non performing assets in banking sector, npa in banking