As Nigeria looks to boost growth in the wake of the Covid-19 pandemic, securing illiquid assets to inject more liquidity into markets offers a ready-to-use solution to unlock the cash to drive domestic investment and new growth. Loan securitization in the country could also release sufficient liquidity to conclusively deal with the financing requirements of businesses.
Securitization is the process by which a sovereign or corporate entity designs a marketable financial instrument by pooling illiquid financial assets. The aim of securitization is to improve credit availability by converting hard-to-trade, non-tradable assets into securities that can be traded in the capital markets. The creation of new investment vehicles, as well as the release of additional capital, increases market liquidityBy buying securities, for example, investors themselves become lenders, allowing the original holder of the assets to remove these risk assets from their balance sheets – freeing up cash to underwrite more loans. While investors profit as they receive interest on the underlying asset and loans, the whole financial ecosystem also benefits as more cash is released to the market for re-investment and growth.
In a nutshell, securitisation allows an entity to convert illiquid assets such as debt or even property into liquid assets. The process frees up capital for the original owner of the assets. The process also provides income for investors, unlocking new investment opportunities. The risks associated with securitization, on the other hand, include; investors effectively becoming creditors, the potential of default on the underlying loans, and lack of assets transparency. Finally, if loans are paid off early, there is also the risk that investors might not achieve the returns anticipated over the initially projected loan period.
Globally, the benefits realised for capital markets, investors, liquidity, and debt management always outweigh the risks when illiquid asset securitisation is properly managed.
Despite the fact that the global financial crisis of 2008 highlighted the risks associated with asset securitization, the Basel Committee on Banking Supervision (BCBS) published enhancements to the Basel II framework in 2009 to address these concerns. The Basel III framework eventually incorporated these enhancements. As a result, Basel III has effectively addressed the oversight flaws in the governance and management of illiquid asset securitisation that the global financial crisis revealed.
The BCBS, in particular, increased the risk weighting of illiquid securitized assets in comparison to other securitized exposures. To improve due diligence, the BCBS also required banks to meet specific operational criteria that were more detailed and transparent. The capital requirements for illiquid asset securitization have also increased significantly. The most notable change was BCBS’s revision of market risk rules, which increased the amount of capital required to cover trade book securitisation exposures.
Coronation Merchant Bank has developed an illiquid loan securitization management framework closely reflecting current Basel III principles and guidelines. Replicating these frameworks across Nigeria for example, building Basel III requirements into national legislation, would allow all Nigerian financial institutions to develop competent, globally compliant and safe illiquid securitization offerings.
The benefits of a developed and well-regulated securitization industry in Nigeria are three fold; individual, institutional and market.
Firstly, Individual Nigerians would be able to invest in high-value illiquid assets that would otherwise be unavailable to them. This has the potential to increase financial inclusion by bringing more investors and cash into the country’s capital markets, as well as making new investment instruments available to a previously underserved segment of the Nigerian investor population.
Second, Nigerian institutions would be able to contribute to the development of a new domestic asset class, as well as manage it. Aside from increasing their own earnings, the process would significantly increase the amount of liquidity (cash) available in the local market for reinvestment and growth.
Thirdly, this would have a significant impact on the effectiveness and depth of Nigeria’s capital markets, allowing Sovereign and Corporate entities to access more cash. This would result in a significant increase in domestic investment and a much more evenly distributed growth across the economy.
In conclusion, a well-developed regulatory framework for loan securitisation would allow Nigerian financial institutions to unlock cash to support additional domestic investment and economic growth. In addition to deepening the domestic capital market and allowing it to provide new sources of funding to the country’s real sector, a well-regulated loan securitisation industry in Nigeria will improve the flow of credit, which will spur domestic growth.