Final answer:
Securitization is the process of pooling similar assets to create securities backed by those assets, reducing banks' financial risks and the need for significant funds to make loans. However, it may also lead to relaxed lending standards, as seen with subprime 'NINJA' loans.
Step-by-step explanation:
The process of pooling a group of assets with similar features and issuing securities that are collateralized by the assets is known as securitization. This practice enables banks to offload the risk of loans from their balance sheets and diversify their exposure to financial risks. Banks can sell local loans and purchase mortgage-backed securities based on home loans in various parts of the country. This reduces the financial vulnerability that could arise from a decline in the local economy. Moreover, for homebuyers, securitization means that local banks do not need significant extra funds to extend loans because loans are planned to be held only for a brief period before they are sold and pooled into financial securities.
However, there is a downside to securitization. Banks that intend to sell loans may have less incentive to scrutinize borrowers, thereby increasing the likelihood of making subprime loans. In the mid-2000s, this practice led to the issuance of 'NINJA' loans—mortgages extended to borrowers without sufficient proof of income, employment, or assets.