Finance

Securitization has remained one of the most important contrivances in the financial toolkit of banks. It allows banks to allocate their capital requirements more efficiently, access to funding sources that are cost effective, and better means of risk management.

As Greenbuam and Thakor (1987, 1995) observe, securitization permits banks to deviate from the traditional lending operations, allowing them to explore more basic activities bringing them corporate advantages.

Does the rationale for the BankUS securitization differ from other forms of securitization

The rationale for the BankUS securitization differs from other forms of securitization. This is because the bank wants to use securitization not for transforming its risk based assets in to commodity but to in its quest to lower reduce the economic and regulatory capital Bank US had to set aside under the Basel agreement, and to increase its leverage and profitability which is one of the basic rationale for securitization. Bank also wants to use securitization to lower the requirements on risk-based lending.

In addition, BankUS is keen to reduce its credit risks, and by extension, its reputation among investors and rating agencies because it risks being downgraded to an AA rating (Fagan  Frankel 2008).

The bank is currently required to hold 780 million capital having a risk based capital ratio of 8 and Tier 1 risk based capital ratio of 4, this is because the majority of the claims in banks current credit exposure count towards the riskiest asset category. Assets securitization of assets by BankUS would principally help the Bank to keep its rating from falling to Undercapitalized and to improve its profitability by further lowering it cost of equity capital.

BankUS will achieve this by principally by shedding majority of its assets having a poor rating, to which the market yield is comparatively higher than the Aaa rated assets. its capital requirements under the Basel agreement. BankUS wants to use securitization to lower the requirements on risk-based lending.

However, the banks purpose of lowering its cost of capital through securitization is common, only that the specific application is different.

The rationale for BankUS s securitization is the reduction of its credit exposures so as to reduce the economic and regulatory capital. BankUS also hopes to increase its leverage and profitability. In addition, BankUS is keen to reduce its credit risks, and by extension, its reputation among investors and rating agencies because it risks being downgraded to an AA rating (Fagan  Frankel 20).

On the other hand, unlike BankUS, many firms opt for securitization in order to increase capital availability (Cox, Fairchild  Pedersen 2). This is achieved by either reducing liquidity risk from liquid assets or by locking profits. Securitization is also aimed at lowering the cost of capital and isolating unwanted risk. Other rationales of securitization include convexity and duration matching, and the transfer of risk off the balance sheet and into the income statement. Securitization also helps in hedging against states of the world, which many securities are incapable of achieving.

According to Fagan and Frankel, the most commonly used forms of securitization are mortgage backed securities (MBS) (24) and Asset Backed Securities (ABS) (25). Typically, they are used to generate cash upfront for illiquid income generating assets. BankUS is not using this approach because its underlying assets are corporate securities, which are rather liquid. The banks securitization is just to control its credit risk in order to allow for a lower risk-adjustment for the calculation of capital adequacy requirements.

The major reasons advanced for securitization are usually mitigation of risk and arbitrage profits for the originatororiginator this is achieved by providing finance through sale of assets to provide cash flows to pay off investors either with or without credit support from other sources. , aAlthough risk reduction does not happen in practice since the lowest tranche of the securities is usually retained on the originators balance sheet. However, in some instances, it does allow for the transfer of risk from parties that do not want to bear risk to those that do.

Securitization further would help BankUS to split the credit risk associated with its assets in to several tranches, placing such assets with third parties who are willing to absorb it. This would enable the bank to access the markets at higher debt ratings compared with its overall corporate rating and to obtain fund sources at generally more favorable rates. allows for diversification since securitized bonds may be negatively correlated with the portfolio of assets that certain investors hold. Securitization seems to be motivated most by the desire to reduce legal and regulatory capital requirements as was the case for the BankUS securitization. The process of securitization allows the originator to lower the equity it has to retain on its balance sheet and thus to increase leverage and profitability.

In sum, there are significant differences between the rationale for BankUS securitization and other forms of securitization. While most firms seek securitization so as to increase their capital availability, BankUS  s rationale for securitization is to reduce its credit exposure so as to reduce its economic and regulatory capital. However, BankUS  s use of securitization to lower its cost of capital is a common phenomenon in securitization.