Critically evaluate the various types of risks inherent in a Securitization transaction.

(a) In a securitization transaction, investors are exposed to several risks at each stage of the transaction. The various types of risks in any securitization transaction are as follows: (1) Credit risk or Counterparty risk It is the prime risk wherein investors are prone to the risk of bankruptcy and non-performance of the servicer. (2) Legal risks Since in the Indian context it is a recently developed concept there is an absence of conclusive judicial precedent or explicit statutory provisions on securitization transactions. As a result, any dispute over the legal ownership of the assets is likely to result in uncertainty regarding investor pay-outs from the pool cash flow. (3) Market risks Market risks represent risks external to the transaction and include market-related factors that impact the performance of the transaction. Some of these risks are as follows: (a) Macroeconomic risks: The performance of the underlying loan contracts depends on macroeconomic factors, such as industry downturns or adverse price movements of the underlying assets. For example, in the transportation industry a continuous decline in industrial production may lead to a downtrend in the use of services of the Commercial Vehicles (CVs) adversely impacting the cash flow of CVs operators. This in turn, may impact repayments on CV loans. Similarly, a fall in the prices of the CVs may increase chances of default as the borrower may wilfully default the loan and let the finance company repossess and sell the underlying vehicle instead of retaining it and continuing to pay instalments on time. (b) Prepayment risks: A change in the market interest rate represents a difficult situation for investors because it is a combination of prepayment risk and volatile interest rates. With a reduction in interest rates generally prepayment of retail loans increases, resulting in reinvestment risk for investors because investors may receive their monies ahead of schedule and may not be able to reinvest the amount at the same yield. (c) Interest rate risks: This risk is prominent where the loans in the pool are based on a floating rate and investor pay-outs are based on a fixed rate or vice versa. It results in an interest rate mismatch and can lead to a situation where the pool cash inflow, even at 100% collection efficiency, is not sufficient to meet investor pay-outs. Interest rate swaps can be used to hedge this type of risk to some extent.