asset-backed security

How can a bank lend out money today, then turn around and lend out fresh money tomorrow, without waiting years for the first loan to be paid back? That question is exactly what asset backed securities were invented to answer.

Here is how it works. A bank in Lagos gives out hundreds of car loans. Instead of sitting on those loans for the next four years waiting for drivers to pay monthly, the bank bundles them all together into one package. It then sells that package to investors as a security. The investors pay the bank money now, and in exchange they receive the monthly repayments that all those car owners make, plus interest, over time.

So the bank gets its cash back immediately and can lend again, and the investors get a steady stream of income backed by real loans that real people are paying off. That bundle of loans, wrapped up and sold as an investment, is the asset backed security. The asset is the pool of loans. The security is the paper investors hold.

In the United Kingdom, this is common with mortgages, student loans, and even mobile phone contracts, all sliced and packaged for investors on the London market. For a Nigerian in London sending money home, it helps to know that the same investment logic sits calmly behind many pension funds and bond funds that hold Nigerian diaspora savings, whether the underlying assets are UK car loans or Nigerian trade receivables.

The risk to watch is simple. Your return depends entirely on whether the people in that bundle keep paying. If too many car owners or homeowners default at once, the whole package can lose value fast, which is a big part of what happened during the 2008 global financial crisis with mortgage backed securities in America.