Abstract
Asset securitization via special purpose entities involves the process of transforming assets into securities that are issued to investors. These investors hold the rights to payments supported by the cash flows from an asset pool held by the said entity. In this paper, we discuss the mechanism by which low- and high-quality entities securitize low- and high-quality assets, respectively, into collateralized debt obligations. During the 2007–2009 financial crisis, asset securitization was seriously inhibited. In response to this, for instance, new Basel III capital and liquidity regulations were introduced. Here, we find that we can explicitly determine the transaction costs related to low-quality asset securitization. Also, in the case of dynamic and static multipliers, the effects of unexpected negative shocks such as rating downgrades on asset price and input, debt obligation price and output, and profit will be quantified. In this case, we note that Basel III has been designed to provide countercyclical capital buffers to negate procyclicality. Moreover, we will develop an illustrative example of low-quality asset securitization for subprime mortgages. Furthermore, numerical examples to illustrate the key results will be provided. In addition, connections between Basel III and asset securitization will be highlighted.
Highlights
Asset securitization involves the process by which securities are created by a special purpose entity (SPE)—hereafter, known as an entity—and issued to investors with a right to payments supported by the cash flows from a pool of financial assets held by the entity
The first is towards the originator for acquiring the assets while the second is for using the assets for securitization into collateralized debt obligations (CDOs), a type of user cost
A bank might view the Basel III risk-based capital charge applied to HQAs as being excessive and might engage in securitization activities of these receivables to benefit from a slightly lower capital charge resulting from other aspects of the risk-based capital rules
Summary
Asset securitization involves the process by which securities are created by a special purpose entity (SPE)—hereafter, known as an entity—and issued to investors with a right to payments supported by the cash flows from a pool of financial assets held by the entity. The policy directions set out in [6] form part of the BCBS’s broader agenda of reforming bank regulatory capital standards to address the lessons of the crisis These proposals build on a series of reforms that the BCBS has delivered through Basel III and explain the approaches under consideration by the BCBS to revise the securitization framework (see [6, 21] for further discussion). Our paper quantifies the effects of unexpected negative shocks such as rating downgrades on asset price and input, CDO price and output, and profit in a Basel III context (see, [19]).
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