Structured Finance supports companies with complex financing needs through intricate instruments. It caters to corporations with substantial requirements beyond standard loans and mortgages. This financing approach involves sophisticated arrangements to fulfill significant financial demands. Investors play a crucial role in providing the necessary funding for structured finance, which injects substantial capital into businesses.
Conceptually, Structured Finance encompasses various complex financial products employed by large companies to address their intricate needs. It serves as a powerful tool during crises, emergencies, and when dealing with sizable financial requirements. Structured Finance offers extensive funding options, enabling companies to handle contingencies effectively and seize new opportunities.
This financing method originated in the mid-1980s to assist entities with illiquid assets but reliable cash flows. Instead of using physical assets as collateral, these entities leverage their cash flow as security, utilizing their liquid assets derived from physical infrastructure for funding purposes. Structured Finance presents a favourable arrangement for companies, allowing them to tap into an alternative funding source.
The essence of Structured Finance lies in Securitisation, where a pool of assets is consolidated to create intricate financial instruments that cater to specific needs of corporations and investors. It facilitates the transfer of credit risk from the seller to the buyer, providing risk management benefits. Notable examples of Structured Finance products include Asset-Backed Securities (ABS), Commercial Mortgage-Backed Securities (CMBS), Residential Mortgage-Backed Securities (RMBS), Collateralised Debt Obligations (CDOs), and Credit Default Swaps (CDSs).
Although CMBS may not be prevalent in Nigeria, they serve as a prime example. CMBS are fixed investment products backed by mortgages on commercial properties, distinct from residential real estate. The mortgages supporting CMBS are classified into tranches based on credit risk, with higher-quality tranches receiving interest and principal payments and carrying lower risk. Conversely, lower tranches offer higher interest rates but absorb more risk as the tranches descend in rank.
Structured Finance and its products have emerged as alternative financing sources for borrowers with substantial capital requirements, especially when traditional options are insufficient. Corporations and governments employ these tools to manage risk, expand their market presence and capitalise on opportunities in complex and evolving emerging markets.