Wednesday, 27 October 2021

What is the mechanism and obstacles in securitization?

 Securitization is defined as the process for the creation of asset’s pool with the help of marketable illiquid financial assets like as loans or receivables. Basically it is process of repackaging of illiquid marketable assets into the marketable securities. These kinds of assets include residential mortgages, credit card receivables, automobile loans, and all other kind of receivables.

But the question is what the mechanism of securitization is? Here is the guide to explain the full mechanism of securitization and the obstacles in the process of securitization. So let’s get started:

What is the mechanism of securitization?

Following are the brief steps for the mechanism of securitization:

Asset’s pool creation

The very first step in order for the securitization is the creation of the pool of assets. The process of securitization can only begin with the pool creation of the assets by segregating the assets which are backed by same kind of mortgages in terms of risk, interest rates, maturity, and also the concentration unit.

For example, all the illiquid marketable assets with similar mortgages units will be calculated in the single unit.

Transfer to SPV

Next step in the mechanism of securitization is transferring to Special purpose Vehicle. After getting the assets pooled, the next step in the securitization process is to transfer it to the special purpose vehicle which is especially created for this purpose only.

Sale of the securitized paper

The special purpose vehicle further helps in designing of a specialized instrument on the basis of their nature of tenure, interest rates, etc on the basis of asset’s pool. These instruments are eligible to Pay through Certificates or pass through certificates.

Administration of assets

The administration of assets in subcontracted returns back to originator. This further collects principal and interest from underlying assets and after this transfers it back to SPV which work as a conduct.      

Recourse of Originator

The performance of the securitized paper relies much on the performance of the underlying assets and unless specified in the case of default, they return back to the originator from SPV.

Repayment of the fund

SPV will get the power to repay for the funds in the form of principal and the interest which arises from the pool of the assets.  

Credit rating to instruments

Sometimes, it is possible to perform the credit rating can be done before the sale of the securitized instruments in order to assess the risk of the issuer.

So these are the steps for the mechanism of the securitization.

Now we will discuss on what kind of the issues or the obstacle that can rise in the process of securitization.

Obstacles in securitization

Following are the major obstacles that one can face in the growth of the securitization of the instrument especially in the context of India:

Stamp Duty

In India, Stamp duty is one of the major obstacles in the process of securitization of the instrument. Under the Act of Transfer of Property, 1882, the debt of mortgages stamp duty can go even up to 12% in some of the Indian states and this impeded the growth of the securitization in India. Also, one should keep in mind that since pass through certificate does not evidence any debt only able to receivables, they are exempted from stamp duty.

Also, India, recognizing the special nature of securitized instrument in multiple Indian states has reduced the stamp duty on them.

Taxation

Another obstacle in the process of securitization in India is Taxation. This is also one of the major concerns for securitization in India. In the case of absence of any specific provision which is related to the securitized instruments in Income Tax Act, the opinion of experts in this case differs a lot.

Some experts believe that SPV as a trustee that need to be taxed in a representative capacity while others are having their view that instead of SPV, the investors should be taxed based on their share of income. There is also the need for the clarity on the issues of Capital gain implications on passing payment to the investors.

Accounting

It is also a major obstacle to account and report the securitized assets in the book of originator. Reporting and accounting of the securitized assets in the originator book is specially a concern in India. Though Securitization is slated to an off balance sheet instrument still in reality, the receivables are removed from the balance sheet of the originator. This can give rise to the issues epically in the case when the assets are transferrable without recourse.

Lack of standardization

There is a need for a proper format or the standard of the securitizations. But in India, there is no proper standardization of the securitization. This is also an obstacle which is hampering the growth of the securitization. In India, all the originators are having their own format for the administration and the documentation, and thus it is lacking the sense of standardization.

Inadequate Debt market

Absence of well developed debt market is also a concern for the growth of the securitization in India. The lack of existence of the well established debt market hinder the growth of the secondary market of the assets backed securities or the securitized instruments.

Ineffective foreclosure laws

For last several years, there has been making efforts for the creation of the effective foreclosure laws still till now; there are no such foreclosure laws in order to support the lending institutions. This is what that makes the securitized instruments specially the mortgages backed securities to be less attractive as lenders faces much issues while in transferring the property in event of default by the borrower.

The bottom line

So this is the mechanisms and some obstacles in the growth of the Securitization in India!

 

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