The advent of Basel I capital adequacy proposal led to the growth of securitization transactions by making certain assets off-balance sheet. A bank could hold less capital on an overall basis in the Basel I regime. However, this led to an increase in the concentration of credit risk in the books of the concerned financial institutions. This is because commercial banks securitized their best quality loan portfolio and as these items turn off-balance sheet, the overall portfolio riskiness increased substantially. In order to cope with the situation, the Basel II framework dealt with the securitization transactions in a comprehensive manner. This paper attempts to provide a brief overview of the implications of Basel II in respect of securitization transactions.

Asset securitization is a process in which a distinct legal entity, a Special Purpose Vehicle (SPV), issues securities (bonds) against an investment in an underlying asset pool. The pool of assets collateralizes securities. Pools may differ, with regard to the nature of their underlying assets. The assets are generally secured by personal or real property (automobiles, real estate or equipment loan). However, in some cases they might be unsecured (credit card, consumer loans).

To initiate the securitization process, a pool of homogeneous assets such as mortgages, credit card receivables or automobile loans is created. Homogeneity is essential to enable a cost-efficient analysis of the credit risk of the pooled assets and to achieve a common payment pattern. The originator of a securitization scheme can be a bank or a financial institution. If a bank is the originator it may take the assets from its own loan portfolio, but securitization of assets that are purchased from a third party bank or that are non-bank assets (e.g., receivables of commercial companies) is becoming more prevalent.

In the second step, the pool is sold to a SPV, which finances the purchase by issuing securities backed by the pool of assets and which are the sole assets of the SPV. At that stage further parties, together with a rating agency, are often involved to give advice to the originator, analyze the credit quality of the portfolio, and structure the transaction. If an underwriter participates in the scheme, the securities may pass through his books before being sold to investors.

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