SECURITIZATION IN ISLAMIC BANKING

Islamic securitization can be basically defined as a legal structure which satisfies the requirements of
Islamic Finance and replicates the economic purpose of a traditional asset-backed securitization
structure whereby the rights over receivables are transferred from the owner-originator to a special
purpose vehicle (SPV/Issuer), which in turn issues notes that are sold to investors. It involves asset
transfers from an originator into a trust or similar SPV with Sukuk issuance by that SPV and
payments on the Sukuk derived from the payments received in respect of those transferred assets.
Since most Islamic financial products are based on the concept of asset backing, the economic
concept of asset securitization is particularly amenable to the basic tenets of Islamic finance.So
basically Islamic securitization can follow the principles of conventional securitization. However, the
underlying asset pool or portfolio of receivables in a securitization should, in essence, match one of
the accepted Islamic financing schemes. For instance, conventional mortgages and credit cards,
which are typical conventionally securitized assets, do not comply with Sharia, as they are interestbearing loans. For a structure to comply with Sharia, some degree of ownership must be transferred
to the investor. Transfer of registered title is not necessary, rather a collection of ownership rights that
would allow the investors to perform duties related to ownership (if desired) or rights granting access
(subject to notice) over the asset would be sufficient to satisfy Sharia.
Investors participate in profits and losses generated by the assets placed in the securitization pool as
Islamic Finance rules prohibit interest-based financing, investors are allowed to support or invest on
the basis of partnership, but not on the basis of interest.
So Islamic Securitization is the creation of securities (or Sukuk:
evidence ownership of a pool of tangible assets or a pool of tangible and intangible assets, either
fixed or revolving, that generates cash flow plus any rights or other facilities designed to assure the
servicing or timely distribution of proceeds to the security holders; and ) that:
by their terms convert into cash within a finite time period.
Structure of Islamic Securitization
Various parties are involved in an Islamic Securitization transaction. Key players in various issues
are:
The originator or the issuer of Sukuk, who sells its assets to the SPV and uses the realized funds.
Originators are mostly governments or big corporations, but they could be banking or

non-banking Islamic financial institutions. The issuers may delegate, for a consideration or a
commission, the process of arranging the issue.
The SPV an entity set up specifically for the securitization process and managing the issue. It
purchases assets from the originator and funds the purchase price by issuing Sukuk. Sometimes, the
SPV is also referred to as the issuer.
Investment banks as issue agents for underwriting, lead managing and book-making services for
Sukuk against any agreed-upon fee or commission. These services are provided by syndicates of
Islamic banks and big multinational banks operating Islamic windows.
Subscribers of Sukuk mostly central banks, Islamic banks and non-bank financial institutions and
individuals who subscribe to securities issued by the SPV.
This list shows us the fact that an Islamic securitization structure perfectly mimics a conventional
securitization in relation to the parties involved.
A widely used Islamic securitization structure, which also illustrates the exact same structure with the
Sukuk issue made by the German state of Saxony-Anhalt in 2004,would resemble the following
scenario:
The originator of the assets (e.g. the owner of office buildings) sells the assets to an SPV. would
resemble the following scenario:
The SPV raises financing to purchase the assets by issuing Ijara Sukuk171
The Ijara Sukuk represent equity interest in the SPV, and in turn, in the assets. (i.e. leasing bonds)
to investors. The amount raised by issuing the Sukuk is equal to the purchase price.
The SPV leases the assets back to the seller/originator. The seller makes periodic lease payments
to the SPV, which should match the SPVs obligations under the Ijara Sukuk.
At maturity, the SPV sells the assets back to the originator (i.e. lessee or previous seller/owner of
the assets). The amount should cover any liabilities owed by the SPV under the Ijara Sukuk.
The figure below illustrates how an Islamic securitization structure based on ijara basically works:

The cash flow produced is similar to any bond. The lease payments are similar to coupons and the
repurchase proceeds paid at the end of the term constitute the principal.
Unlike conventional securitization, the implementation of Islamic securitization requires a two-stage
fundamental verification process, which assesses the Sharia compliance of (i) the type of assets in

the underlying reference portfolio and the generation of investment returns, and (ii) the transaction
structure, which includes the configuration of credit enhancement (and other forms of credit and
liquidity support) and the form of ownership conveyance.
Securitization under Islamic law bars interest income and must be structured in a way that rewards
investors for their direct exposure to business risk, i.e., investors receive a share of profits
commensurate to the risk they take on in lieu of pre-determined interest. However conventional
securitization, which originated in non-Islamic economies, invariably involves interest-bearing debt.
Note holders would typically hold (secured) contingent claims on the performance of securitized
assets, which entitle them to receive both pre-determined interest and the repayment of the principal
amount.
Apart from that, one should know that while equity in contrast to interest-bearing bonds appears to
be a permissible financial asset that can form part of the pool, such equity must not represent
ownership of an institution dealing with interest or manufacture of haram tems, such as alcohol,
(gambling) or pork.For Islamic institutions, underlying assets that can be securitized include lease
financing (e.g. of housing, aircraft, equipment, household items, cars etc.), equity ownership (in
Sharia compliant assets) and, in certain cases, Murabaha receivables (provided that the Murabaha
receivables comprise less than 50% of any asset pool).
The number of applicable structures to Islamic securitization is also limited comparing to
conventional securitization. In general, the relationship between an underlying obligor and the
originator should fall within one of the usual accepted Islamic financing schemes (Murabaha,
Mudaraba, Ijara, Istisna, etc.). For example, when structuring a Sharia compliant mortgage
securitization, the underlying assets must be Sharia compliant mortgages (usually structured around
Ijara the typical Islamic mortgage structure or Istisna mortgages concerning properties under
construction). In the case of a Sharia auto finance securitization, the underlying finance contract
must be structured in accordance with Murabaha or Ijara principles.
It should also be noted that to comply with Sharia principles for a traditional Sukuk issuance, the
structure to be used must transfer a minimum level of ownership in the assets before Sharia scholars
can be satisfied and approve the issuance. Finally, one should be careful in relation to credit
enhancement mechanisms while structuring a permissible securitization transaction according to
Sharia. Credit enhancement is an integral part of conventional securitization process. When credit
enhancement is for a fee that is related to the quantum of facility, this comes dangerously close to
riba and is rightly frowned upon by Sharia scholars.
182 So Islamic institutions should be very selective in using credit enhancement methods; (as) using

some of them may change the character of the transaction.

So Islamic law does not rule out the use of credit enhancement per se as long as it is optional for
investors and does not change the overall character of the transaction. For instance, tranche
subordination of conventional securitization can be replicated by a lease buy-back (ijara) transaction
under Sharia law.
Like credit enhancement, liquidity enhancement too comes under a cloud in the Islamic framework.
While this is easily achieved in an interest-based scenario, the Islamic framework provides for shortterm () interest free loans. Thus, while liquidity enhancement could be provided by independent
financial institutions in the conventional framework, this is possible in Islamic securitization only when
there is no financial reward for the provider.
To sum up, securitization in Islamic Finance is better referred to as monetization of the underlying
assets. While the sale of conventional receivables is a sale of debts, the sale of Sukuk is a sale of
shares of an asset.However, irrespective of religious conditions, Islamic securitization offers the
same economic benefits conventional structured finance purports to generate, such as the active
management of designated asset portfolio due to greater control over asset status, enhanced assetliability management and term structure transformation, as well as the isolation of certain assets in
order to make them self-financing at a fair market rate.
At this stage, we will look at the securities created within the processes of Islamic securitization, i.e.
Sukuk

SECURTIZATION IN COMMERCIAL BANK.

How Securitization Works
Securitization is the fancy title for the selling of a pool of assets to a trust, which turns
around and finances the purchase by selling securities to the market. These securities are
backed by the original assets.
An investor who purchases company stock has a claim to the company's assets and future
cash flows. Similarly, an investor who purchases a securitized debt product has a claim
against the future repayment of the underlying debt instruments (which is an asset in this
case).

There are always a minimum of four parties in the debt securitization process. The first is
the borrower, who originally took out a loan and promised to repay. The second is the loan
originator, who receives the initial claim to the borrower's repayments.
The second party is able to realize, immediately, most or all of the value of the loan contract
by selling it to a third party, usually a trust. The trust is financed by securitizing the loan
contract and selling it to investors (the fourth party).
If you follow the chain, a securitized debt product eventually sends loan repayments to a
fourth party in the form of investment returns.

Early Debt Securitization

The first mercantilist corporations served as vehicles of sovereign debt securitization for the
British Empire during the late 17th and early 18th centuries. Research from Texas Christian
University (TCU) showed how Britain restructured its debt by offloading it to corporations
with political backing, which in turn sold shares backed by those assets.
This process was so pervasive that, by 1720, the South Sea Company and East India
Company held nearly 80% of the Crown's national debt. These corporations essentially
became special purpose vehicles (SPVs) for the British treasury. Worry about the frailty of
those corporate shares, however, led the British to stop securitizing and focus on a more
conventional bond market.

1970s Debt Securitization

The debt security market was essentially non-existent between 1750 and 1970. During
1970, the secondary mortgage market began to see the first mortgage-backed securities
(MBS) in the United States. This process would have been unthinkable without
the Government National Mortgage Association (GNMA or Ginnie Mae), which guaranteed
the first mortgage pass-through securities.
Prior to Ginnie Mae, investors traded whole loans in the secondary market. Since these
mortgages were not securitized, very few investors were willing to accept the risk of default
or interest rate fluctuations. The market was illiquid.
Government-backed pass-throughs were a revelation to secondary mortgage traders.
Ginnie Mae was soon followed by two other government-sponsored corporations, Fannie
Mae and Freddie Mac. By 2000, the MBS market was $6 trillion strong.

Fannie Mae fueled the fire when it issued the first collateralized mortgage obligations
(CMOs) in 1983. Congress doubled down on CMOs when it created the Real Estate
Mortgage Investment Conduit (REMIC) to facilitate the issuance of CMOs.

Other Debt Securities

Most debt securities are loans, which normally form the paper assets of most banks.
However, any receivables-based financial asset can support a debt security. Other forms of
underlying assets include trade receivables, credit card receivables or leases.