Saturday, February 4, 2012

MBS - Mortgage Backed Securities

Securitisation is a process of liquidizing the assets held with financial institutions. If there are many auto loans given by a bank and instead of raising money through deposits and giving further loans, Banks can also do the following to increase its profits.

- Bundle all the auto loans and form a security.
- Raise the money through prospective clients with the help of other financial institutions.

The risk lies with the bank and this gives more liquidity to the bank and the money generated through this process can be availed in giving further loans.

In India, Securitisation has been there for long. Please visit this site for more details.

Consider the Home loans now. Banks have done the due diligence and have approved home loans for 20 people for 1 crore. The mortgage would be the home for the bank.

Now, If I am a person A thinking having very less money but ready to lend money for a prospective buyer who buys home and wants my part of interest back. Say, I have only Rs. 20000/- and want the interest for that alone to come to me.

Banks think, my whole 20 crores is locked up in the home loans. I also want the liquidity. This way, Investment banks created a security out of the mortgages in the bank and sold in the market and people like Person A bought it. The things that are not bought will remain with bank and investment bank. This gives more returns than FD and Person A is happy in taking the risk. Bank is happy in getting more money and Investment bank is happy on making its commission on forming the product.

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