Structured Asset Finance is the bundling of investments in order to spread the risk and to minimize the costs for the customers. As the name suggests, it involves an element of “structuring” by changing the nature of assets in some way to keep them safe and provide other benefits. Numerous financial institutions offer this service and trade heavily in structured assets. This aspect of the financial industry is prone to regulatory delays, which can create problems when financial firms fail to act responsibly and regulators fail to keep up.
One aspect of structured wealth finance is securitization to reduce the risks associated with leasing, loans and other activities by securing the underlying asset. Financial firms can use a variety of instruments for securitization; In a simple example, an asset can itself be a security, as seen on many car loans. Companies can also create new financial products such as mortgage-backed securities. Such activities can allow companies to extend more and larger loans as part of their practices, and they can also trade their loans as financial products rather than holding them in portfolios.
Another activity is tranching, which enables companies to classify investments within a pool. Tranches can be an important part of structured wealth financing, as they enable the creation of pools of securities that do not necessarily pay off immediately. Investors can buy different components to get more or less security. Tranches can enable further risk diversification and the development of more financial products than would otherwise be available.
Large corporations rely on structured asset finance to buy big ticket items such as commercial aircraft, mining equipment, and boats. Most companies do not have the cash to purchase such assets directly or do not want to tie up the available cash in one asset. Instead, they turn to financial institutions for funding options. Since an individual institution does not want to bear the risk of buying it, it provides its institutional and corporate customers with financing through structured asset financing.
Structured wealth finance can also be applied to consumer finance. Consumers who may not qualify for credit or who may receive poor terms and conditions can participate in structured wealth finance for access to credit. Their loans are pooled with those of high credit borrowers, creating a mixed pool of investments that a bank can rebundle and sell. Buyers of such pools or shares in them take the risk because the majority of the investments can have a good rating and therefore the failure of a small percentage of the loans does not completely devalue the investment.
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