Asset Backed Securities

The issue of asset backed securities is the process whereby traditional bank assets (for example, mortgages) are sold by a bank to a trust or corporation, which is turn sells the assets as securities. The bank could issue a bond with the pooled assets acting as collateral, but the credit rating of the bank is assigned to the new security, the proceeds of the bond are subject to reserve requirements, and the assets are included in any computation of the bank’s capital ratio.

The bank can avoid these constraints if a separate entity is established (special purpose vehicle, SPV, or trust). The bank sells the asset pool to the SPV, who pays for the assets from the proceeds of the sale of securities.

Effectively, while the process commences in an informal market (the bank locates borrowers and makes the loans), asset backed securitisation means a large number of homogeneous loans (in terms of income streams, maturity,credit and interest rate risks) are bundled together and sold as securities on a formal market.

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