This is part of a blog series Can Blockchain Save Our Financial System?
This blog post examines how blockchain technology and smart contracts can add speed, reliability, transparency and automation to the loan securitization process in the financial sector.
To read the previous blog post about the benefits of using open ledger technologies for loan servicing, click here.
To learn about how Bloxable is building the most advanced debt platform using blockchain and smart contracts, visit us here.
Loan securitization is an area that blockchain technologies are particularly useful in. The blockchain platform can be used to build additional layers of security instruments like property titles and mortgage backed securities through smart contracts.
In order to understand how smart contracts can improve the process, we should have a basic understanding of loan securitization.
Loan Securitization
Loan securitization involves pooling together income-producing assets into tradable securities. These securities are usually backed by various types of loans, such as student loans, car loans or home mortgages.
These loans are generated by a lender through the process of loan creation and extending credit to borrowers. Different loans are then pooled together and rated on the basis of risk and interest payments. These combined assets are packaged as securities and then sold off to investors, such as investment banks on Wall Street.
The borrowers get access to the needed financial resources to purchase a home or get an education. The investors receive a steady stream of income for their investment and assumed risk. The loan originating bank gets a commission for creating the security.
Blockchain Applications for Loan Securitization
The blockchain technology will be useful in the securitization process because it has the potential to lower costs, increase transaction speed and improve transparency for all stakeholders. The technology allows greater efficiencies in all parts of the processes for every participant.
The stakeholders that could benefit from blockchain technology include the loan originators, sponsors, and investors. The technology will also help various service providers, rating agencies, trustees and regulators involved in the process.
Blockchain Allows Faster Processing
The blockchain technology has the capacity to bring various stakeholders in the loan securitization ecosystem together on a single platform.
This makes the process of loan origination and servicing faster. When the various stakeholders can all communicate on a single platform, it will drastically reduce delays and lower processing times.
For example, consider the mortgage industry. The average processing times for mortgage loans is currently 60 days. This is because lending banks need to confirm the information provided by the borrower from different sources like credit rating agencies, the borrower’s employer(s), appraisers, home surveyors, title companies, etc. These confirmations can take days and weeks. When all the concerned parties are on the same platform, confirmations can be done in less than a day.
How Smart Contracts Improve Securitization
Loan securitization is a complex process that requires careful review by underwriters. The verification of various data and packaging of loans into securities is strictly regulated by the government agencies. This is partly because of the financial crisis of 2007–2008 where lenders were not following good practices and the whole system nearly collapsed.
Implementing smart contracts into the securitization process will add three major benefits, apart from speed.
Firstly, it makes the sharing of information simple and easy. Any changes made to the blockchain ledger can be audited by the concerned parties in real time. The investors can become aware immediately when payments are made on time or delayed. This improves the transparency of the reporting process.
The second major advantage is automation that can be implemented in the system. Smart contracts can get automatically executed when certain conditions are met by the concerned parties. This will add trust in the system and make it more reliable.
The third advantage is Artificial Intelligence (AI). Expertly designed AI can analyze demands of investors and borrowers to adjust interest rates. The AI can also categorize loans based on collateral and income levels. Finally, AI can also construct a new asset which can be issued as a security in the financial markets.
To read the next blog post about structured finance on open ledger, click here.
