Banks can securitize debt for several reasons, including risk management, balance sheet, and more leverage on capital and the profits from fee for. Debt securitized by combining certain types of debt instruments and the creation of a new financial instrument in total debt. The types of debt instruments employed may include mortgage loans, commercial mortgages, auto loans or credit card obligations. Banks get a Commission for selling the new bonds.
Banks can benefit from moving the default risk associated with securitized debt on their balance sheets to provide more to use their capital. By reducing their debt load and risk, banks can more effectively use their capital. In securitized instruments created by combining the debt, known as collateralized debt obligations (ALC). The process of securitization creates additional liquidity debt instruments. While it is unusual for individual investors in its debt obligations, insurance companies, banks, investment funds and hedge funds can trade in OOD to return more than the simple yield of Treasury bonds.
Different levels of debt known as tranches, sold to investors. Tranches are grouped by various factors, including the level of risk or tranche of repayment. Tranches often provide assessments that denote their perceived risk. The rating of a tranche determines the amount of principal and interest investors receive when buying this level of debt. Risky tranches require a higher interest rate and the tranches with higher ratings pay less interest. Defaults on mortgage loans mortgage included in many DTE is often called one of the causes of the financial crisis of 2008.
(For associated reading, see: who bears the risk of bad debts in securitization?)