The first securitisation transaction in India was done by Citibank in 1991, followed by the Housing Development Finance Corporation (HDFC) in 1992, both involving mortgage-backed securities (MBS). However, in the late 1990s and early 2000s, the market saw securitisation of various asset classes, including auto, commercial, and personal loans. Indian securitisation market has witnessed a remarkable evolution in recent years, transforming from a nascent niche to a dynamic and growing segment of the financial landscape. From its early days dominated by Mortgage-Backed Securities (MBS) to the current rise of Asset-Backed Securities (ABS) and the potential for infrastructure financing, the journey has been one of adaptation and innovation.
What is securitisation?
Securitisation is the process of pooling and selling loans or other income-producing assets to investors as securities. Securitisation can increase liquidity and access to credit in the market, but it can also create complex and opaque products that may pose risks to financial stability. It is commonly used for mortgages, personal, credit card, and student loans. India’s securitisation market is regulated by RBI, SEBI and NHB.
Types:
Direct assignments (DAs) and pass-through certificates (PTCs) are two types of transactions that involve the sale of loan portfolios to investors. The main difference between them is the involvement of a special purpose vehicle (SPV) and the issuance of securities. In a DA, the originator (such as a bank or a housing finance company) directly sells the loan portfolio to another entity (such as another bank) without setting up an SPV. The originator receives an immediate cash payment and transfers the loans' credit risk and servicing rights to the buyer. The buyer does not issue any securities to the originator or other investors. In a PTC, the originator sets up an SPV, which is a separate legal entity, and sells the loan portfolio to the SPV. The SPV issues securities, called PTCs, to the originator and other investors. The PTCs represent the claims on the cash flows from the loan portfolio. The originator may retain some PTCs or sell them to other investors. The SPV pays the interest and principal to the PTC holders from the collections of the loan portfolio. The following table summarises the key differences between DAs and PTCs:
Empirical Insights:
Data shows that the securitisation market in the last five years has grown significantly with a compound annual growth rate approximately equal to 30%. Given the significance of the securitisation market in India, let us explore what lies ahead and what are the gaps that need to be plugged to unlock its potential.
Gaps and recommendations
Indian securitisation market holds immense potential to fuel economic growth and provide diverse financing options. However, compared to developed markets, it faces limitations. Addressing these gaps requires a multi-pronged approach focusing on expanding origination, enhancing transparency, attracting investors, and building a robust market ecosystem. The following table provides a comparison of the securitisation market of India and US.
Currently, the market heavily relies on retail loan securitisation. Expanding to new asset classes like infrastructure projects, MSME loans, and agricultural receivables would bring more players to the table and mitigate concentration risk. Standardised documentation and streamlined processes can further facilitate this expansion, while encouraging new originators through regulatory reforms and training programs can broaden market participation. Harmonising the regulatory framework under RBI and SEBI will bring clarity and consistency to the process. Standardised reporting requirements and clear legal provisions around bankruptcy and enforcement will enhance transparency and instil investor confidence. Retail investors hold the key to unlocking the market's true potential and hence paving way for retail investors to participate in the market would help in maturity of the market. Further while doing so, investor education campaigns and workshops are crucial to raising awareness and understanding of securitised products. Simplified and standardised investment options with clear risk-return profiles cater to their needs, while credit enhancements like guarantees and insurance can further mitigate perceived risk.
Strengthening domestic rating agencies and attracting global servicing companies will bring in expertise and best practices. Fostering a vibrant secondary market through trading platforms and liquidity measures will make securitised instruments more attractive investments. Further, technology plays a pivotal role in streamlining processes and mitigating risks. Automating origination and servicing, leveraging data analytics for credit assessment and risk management, and providing digital investor onboarding platforms will ensure operational efficiency and transparency. Harmonising tax treatment across asset classes, creating government-backed credit enhancement platforms, and strengthening legal infrastructure for faster dispute resolution will provide further impetus to market growth. Additionally, collaborating with international bodies and adopting best practices from developed markets can accelerate progress. Further recent risk warnings from the RBI highlight the interdependence between NBFCs and the traditional banking system, emphasising the need for robust risk management strategies. Here's where securitisation can emerge as a powerful tool, not just for growth, but also for mitigating systemic risk and enhancing financial stability. Securitisation offers a risk transfer mechanism, allowing NBFCs to transform these unsecured borrowings into tradable securities, distributing risk among a wider pool of investors and reducing concentration within the banking system. By implementing these interconnected recommendations, we can unlock the true potential of the Indian Securitisation market, paving the way for economic growth, financial inclusion, and a wider range of financing options for individuals and businesses alike.
(Saravanan is a professor of finance and accounting at IIM Tiruchirappalli, Venkat is the Executive Chairman and Co-Founder at Sernova Financial, UK and Williams is the Head of India at Sernova Financial)
