Bank loans and securitization 135
From loans to trading and securities sales, several business lines present opportuni-
ties and challenges in terms of on-line deals. One of the challenges is the development
and use of model-based real-time systems that can make a significant contribution
to credit enhancements; for example, real-time evaluation of fair value of asset-backed
commercial paper, trade receivables and liabilities incurred by insured parties.
Because of its capillarity, the Internet helps credit insurance companies to deliver
more personalized information to their clients, as well as reducing paperwork costs
related to processing information – a good deal of the work being done on-line. The
Internet also assists insurers to improve efficiency in underwriting, distribution,
administration, and claims settlement. Similar statements can be made about banking.
These and similar activities help the bottom line because they are reflected in lower
costs. It should, however, be kept in mind that information technology requires lead-
ership, skill, and expenditures – and many institutions do not fulfill the requirements
for leadership and expertise. Whether we talk of A-IRB and its models, of database
mining, or of the use of a capillary network like the Internet, technology is an
enabling tool. It is not a substitute for human ingenuity and know-how.
6.7 An introduction to securitization
The process of securitization generally refers to borrowing backed by securities. In
addition to the issue of debt securities by final borrowers, securitization includes
bank debt securities to fund lending. Owing to its wider and wider acceptance as a
financial instrument, and the fact that since the late 1990s securitization is used to
arbitrage the capital requirements of Basel I, this process is changing the nature of
financial relationships both:
For the lender, and
For the borrower.
In the general case, securitization increases the degree of liquidity of loan portfolios in
commercial banks, retail banks, and savings and loans. Tradable loan agreements enable
individual investors to manage their portfolios more flexibly; they also give them an
array of options in their choice of bonds. But, as we will see, there is also a downside.
To start with a brief historical reference, Samuel W. Straus is credited with originat-
ing, in 1909, the first mortgage security with a senior claim. Securitization of mortgages
prospered during the following two decades, but second liens made these instruments
fragile; credit quality tends to suffer as securities issuance rises. Moreover, the Great
Depression took them off the financial map.
Securitization of mortgages restarted in 1970, when the US government-sponsored
National Mortgage Association invented the ‘Ginnie Mae passthrough’. This has been
a mortgage-backed security that over three-and-a-half decades has grown into a huge
market. After savings and loans (S&L), or any other institution financing mortgages,
establishes the contract with the homeowner, it usually:
Brings it into a mortgage pool, and
Asks investment banks to make an offer for securitizing the mortgages in the pool.