* There are only 2 banks in Sri Lanka that can perform true securitization transactions. They were the subject of my LL.M. Thesis “Does the regulatory framework in Sri Lanka permit use of structured debt instruments?” 

As the interest rate environment in Sri Lanka continues to decline, banks and investors are scouting for innovative ways to generate income. Securitization, though nascent, has gained traction as a formidable tool for income generation for both parties. However, it is crucial to delve into the opportunities it presents and understand the risks involved, especially considering the unique contours of the Sri Lankan market.

Opportunities for Banks

For banks, securitization can offer a number of opportunities. First, it can help to free up capital. When banks securitize loans, they are able to sell those loans to investors and receive cash in return. This cash can then be used to make new loans or to strengthen the bank's balance sheet. This is particularly relevant in Sri Lanka, where leasing companies, facing difficulty through the flight to safety due to the economic crisis of 2022/2023, have turned to securitization for liquidity.

Second, securitization can help to reduce risk. When banks sell loans to investors, they are no longer responsible for the credit risk of those loans. However, this has not been fully realized in the Sri Lankan context, where the common feature of securitization deals is the originator guaranteeing payment irrespective of their own collections, making these deals closer to loans than true securitizations. This is often seen in leasing company securitizations. 

Third, securitization can help to increase liquidity. When banks securitize loans, they create liquid securities that can be traded in the secondary market. This can make it easier for banks to raise capital and manage their assets. Yet, in the Sri Lankan context, all past securitization transactions have been unrated, with the credibility of the originator playing a crucial role in cash flow.

Opportunities for Investors 

For investors, securitization can offer a number of opportunities. First, securitized products can offer attractive yields. Because securitized products are backed by a pool of loans, they typically offer higher yields than traditional fixed-income securities.

Second, securitized products can offer diversification benefits. When investors buy securitized products, they are not just investing in one loan. They are investing in a pool of loans, which can help to reduce their overall risk.

Third, securitized products can offer liquidity. Securitized products are often traded in the secondary market, which makes it easier for investors to buy and sell them.

Risks for Investors

 While securitization can offer benefits to both banks and investors, it is important to note that there are also risks involved.

Investors face the following potential risks:

1. Prepayment risk: If interest rates decline, borrowers may be able to refinance their loans at lower rates. This could lead to prepayments, which could reduce the amount of money that investors receive from the securitization.

2. Credit risk: The loans that are securitized may not be repaid in full. This could lead to losses for investors.

3. Liquidity risk: Securitized products may be difficult to sell if there is not a lot of demand for them. This could lead to losses for investors if they need to sell their securitized products quickly.

Risks for Borrowers

While securitization can offer benefits to banks and investors, it's important to be aware that there are also implications for borrowers. When loans are securitized, the borrowers' obligations may transfer to a different entity, which could lead to some administrative changes. However, it's important to note that the terms of the loan itself do not change for the borrower. Even if the original lender (the originator) defaults or goes bankrupt, the responsibility for loan repayment remains with the borrower, and the servicing of the loan may simply be transferred to another party.

This could potentially lead to some administrative complications for the borrower, but it doesn't affect the terms of the loan or the borrower's obligation to repay it. Borrowers should ensure they fully understand any potential changes to the administration of their loans in a securitization process.

The Future of Securitization in Sri Lanka

The furthest Sri Lanka got in terms of legislation for true securitization was a Bill titled "REGULATION OF ASSET BACKED SECURITIZATION" in May 2009. I have a full scanned copy of this - please don't hesitate to reach out if you want a copy.

Looking ahead, there are interesting developments on the horizon for securitization in Sri Lanka. The government is planning to establish a special company to manage non-performing loans from banks, with the Central Bank of Sri Lanka seeking the assistance of the International Monetary Fund for this initiative. This move could lead to the securitization of these bad loans, creating a new class of assets for investors. In this scenario, investors would have the opportunity to invest in securities backed by a pool of non-performing loans, providing potential returns if the value from these loans can be recovered. With this development, securitization could play a key role in mitigating the burden of bad loans on Sri Lanka's banking sector, marking a new chapter for this financial instrument in the country.

The only real question is will the law be drafted broadly enough to allow securitization of performing assets by all Banks and NBFIs (Non-Bank Financial Institutions)?

Conclusion

As someone who wrote a Master of Laws dissertation on securitization in Sri Lanka, titled "Does the regulatory framework in Sri Lanka permit use of structured debt instruments?”. I believe that this is a promising area for growth in the Sri Lankan financial market. With careful planning and execution, securitization can help to boost economic growth and create new opportunities for both banks and investors. However, a clear understanding of the Sri Lankan context is essential to maximize these opportunities and mitigate risks.