Reform Securitization to Improve Growth, Financial Stability

Securitization can help alleviate tight financing conditions, diversify risks

Europe stands to benefit most from stronger securitization practices

Reforms to securitization markets should target supply, demand

Securitization creates a financial instrument by bundling financial assets, such as individual loans, and then selling different tiers of the repackaged instruments to investors. The process transforms a pool of otherwise illiquid assets into tradable securities, enabling investors to purchase a small share of a large asset pool. One example is mortgage-backed securities.

What securitization can do

A healthy market for securitization can confer important financial benefits, and revitalizing this source of financing has emerged as a key area of focus for policymakers, according to new analysis from IMF economists.

As a means of efficiently channeling financial and economic resources, securitization supports economic growth and financial stability by enabling issuers and investors to diversify risk. By opening up new avenues for raising capital, securitization can aid in diversifying the funding base of the economy. Securitization can also help free up bank capital, which in theory allows banks to extend new credit to the economy, the IMF said.

These issues are particularly relevant in Europe where capital markets are underutilized as a funding source for the economy, and banks remain under pressure to deleverage and are reluctant to lend in an environment with so much economic uncertainty.

“Restarting and expanding securitization would create room for banks to fund small and medium-sized enterprises,” said José Viñals, the IMF’s Financial Counsellor and Director of the Monetary and Capital Markets Department.

Maximize the benefits, minimize the risks

However as the global financial crisis showed, securitization can create risks to financial stability. Poor underwriting standards for loans, flawed ratings, and incentives that allowed intermediaries to issue securities without assuming any of the risk were coupled with a fragile and highly-leveraged investor base.

Yet global securitization markets expanded without causing economic or market disruptions in the three decades leading up to the late 1990s, according to the IMF. It was only in the years just prior to the global financial crisis that issuance patterns changed dramatically, once financial intermediaries realized significant fees could be earned by repackaging low quality...