What is Structured Finance?
Structured finance deals with financial lending instruments that work to mitigate serious risks related to complex assets. For most, traditional tools such as mortgages and small loans are sufficient. However, borrowers with greater needs, such as corporations, seek structured finance to deal with complex and unique financial instruments and arrangements to satisfy substantial financial needs.
The term “structured finance” is often used to explain the bundling of receivables, although it is more generally applicable to the offering of a structured system to help borrowers – and lenders – accomplish their end goal. The primary goal is to facilitate financing solutions that don’t involve free cash flow and to address different asset classes across various industries, making less risky products available to clients that need them.
The Matter of Securitization
Securitization is the core of structured finance. It is the method by which those in structured finance create asset pools and ultimately form complex financial instruments that are useful to corporations and investors with special needs.
The specific reasons why securitization is valuable include:
- Alternative funding formats for unique or complicated needs
- Reduction of focus on credit
- Managing risk through liquidity and interest rates
- Efficient use of capital available, to capitalize on the potential for greater earnings or profit
- Less-costly funding options, which may be primarily important for borrowers with a less-than-stellar credit rating
- Transfer of risk away from investors
For large corporations looking to borrow substantial sums, a collected group of assets and financial transactions may be necessary. There are lending transactions that can’t be done with a traditional financial instrument. Therefore, structured finance comes into play.
Several structured finance products and combinations of products can be used to accomplish the financing needs of large borrowers. Structured finance products include:
- Syndicated loans
- Collateralized bond obligations (CBOs)
- Credit default swaps (CDSs)
- Hybrid securities
- Collateralized mortgage obligations
- Collateralized debt obligations (CDOs)
Structured finance and its products are important. It provides the scaffolding and space for major borrowers needing a capital injection or alternative source of financing when other, more traditional borrowing options won’t work.
Thank you for reading CFI’s guide on Structured Finance. To keep learning and advancing your career, the following CFI resources will be helpful: