Question by foxtrot: A reason for securitizing mortgages is to allow a bank to do what?
Best answer:
Answer by ThatGuy
Securitizing mortgages allows banks to a) minimize risk exposure b) take advantage of lower capital requirements.
a) When a bank makes a loan, it is exposed to the risk that the borrower may default. However, through the process of securitization the bank sells the loan to what is called a ‘conduit’ (likely for price greater than the principal of the loan, but less then the overall expected value after the loan has been paid), which then packages the loan with others to form a ‘bond.’ In this process the bank has profited from the loan but is not exposed to any risk attributed to the borrower.
b) Banks are held to certain capital requirements, i.e. they have to hold a certain level of capital to support their loans. However, they have to hold less capital to back up investments in securities. Hence, a general strategy is to make a loan, securitize it, then buy into a senior tranche of the new security. Thus the bank has transformed a loan into a less risky asset (the bond pools risk) with which it needs to hold less capital against.
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