Question

Securitization changes the systemic (system-wide) risks in the regulated and unregulated “shadow” banking system. What is securitization? Does it pose a problem for effective banking systems?

Short answer

Securitization is a process whereby an illiquid asset is turned into a tradeable asset, an asset that can be traded easily. Yes, it poses a problem for effective banking systems.

Step-by-step solution

Concept Introduction 

Securitization is the effective banking system to pose a problem by increasing profitability which comes at the expense of increase bank risk by expanding risk taking securitization activities by given ability to secure loan and shift associated risk to capital markets.

Explanation  

The shadow banking system is a term that is used to describe the institution which helps in the creation of credit across the globe but they are not regulated like the traditional banking system. They mainly remain unregulated like lenders in rural areas, brokers, credit agencies. The shadow banking system arises because the traditional banks were not able to serve the needs of all parties.

These days many advanced forms of shadow banks have come up like asset-backed commercial paper conduits, credit hedge funds, Structured Investment vehicles, Money market funds, Securities lenders.

They do also perform the traditional function of lending funds but unlike traditional banks, they do not take deposits from retail clients at a large scale. Also, they specialize in their area, unlike banks which have different departments dealing with different services. In a way, these institutions have done great work in credit creation and distribution.

Explanation  

Securitization is the primary altered way in which financial intermediation is organized to provide banks with an innovative way to increase efficiency and performance.

The Bank uses securitization to develop their cost funding, develop risk management, to increase profits

Therefore when analyzed securities bank to increase its profitability, which in return has to bear more risk, has one side it improves profit and by allowing banks to sell less liquid loans and use generated funds to grant new loans.

Final answer

Therefore, yes securitization is an effective banking system to pose a problem, by increasing profitability which comes at expense of increased bank risk by expanding risk-taking securitization activities by giving the ability to securitize loans and shift associated risk to capital markets.