Securitization

Securitization is a financial process that involves pooling various types of debt or other assets and converting them into marketable securities. Like a skilled craftsman fashioning a mosaic from diverse and colorful pieces, securitization transforms illiquid assets, such as mortgages, loans, or receivables, into tradeable securities that can be bought and sold by investors, allowing for the diversification of risk and the creation of new investment opportunities.

Example

A bank may have a portfolio of residential mortgages that it wants to offload from its balance sheet to free up capital and reduce risk. The bank pools these mortgages, creating a mortgage-backed security (MBS), which it then sells to investors. As the homeowners make their monthly mortgage payments, the cash flows from these payments are used to pay the investors who own the MBS. Securitization can help financial institutions manage risk, improve balance sheet liquidity, and generate income from the sale of these securities.