Why Asset-Backed Securities are the future of investing in India?

Firstly, let’s understand what are asset-backed securities and how they work!

For everyone who is new to this space, I’m attaching a video link so that you can understand, what are they and how do they function, and to save up time for those that already know this.

https://www.youtube.com/watch?v=TYm9nCn_vrU

Now that you know what, they are and how they function, let’s understand what are the possible benefits of investing in these products.

Benefits of Investing in Asset-Backed Securities-

1. Higher Returns to investors! (From 8% - 23%)

2. Wider access for loans to people that initially did not receive them- due to the creation of tranches based on credit quality!

3. Alternative sources of investments since these pools are backed by varying assets! ( Gold, Furniture, Vehicles, etc)

4. Lower default risk, in case a wider pool of people is chosen with sufficient credibility!

How would our investing help?

Instead of investing, think of it as ‘lending’. Hence, instead of the banks lending it to the businesses directly, your funds will be pooled to gather a large sum of money and disbursed and in turn, you will receive all the interest and principal payments.

This, in turn, will reduce pressure on the government organizations which are required to raise funds either through banks or other modes and will facilitate higher circulation of funds, and in turn a better economic output.

What about the risk? And would it lead to another financial crisis of 2008?

Thankfully, since the big crisis, the BASEL Committee has ensured that the regulations are stricter and enforced with adequate oversight.

Without getting into much depth, the primary reason for the occurrence of the ‘2008- Financial Crisis’ was not the heavy use of ABS but actually the banks' team which did not perform their duties of verifying the customers' backgrounds.

Primarily, defaults occurred due to 3 reasons-

1. The majority of loans were NINJA Loans (Given to people with no source of Income) and Liar Loans (Where the backgrounds and documents of loan borrowers were not thoroughly verified. The main aim of loan generators was to generate more quantity since compensation structures were structured favoring quantity over quality.

2. Regulators also did not verify the pool ratings, since these ratings were based on the credit quality of borrowers initiated during earlier times, and not considering the new speculation going around in the market.

3. Lastly, the banks had no issue in generating poor-quality loans since they did not retain any risk.

However, since then, there have been stricter regulations introduced to ensure reliability and lower defaults.

For example, according to Section 15G in states, the banks are required to hold 5% of the risk in raw form, without hedging or transferring/mitigating risk.

But apart from the US Regulations, the Indian regulators, SEBI, and RBI have ensured to be more proactive and enforce even stricter regulations to avoid or to even let a mere probability of a global crisis exist.

They have established the following rules to ensure investor safety and protection-

1. Minimum Holding Period- Where NBFC’s are not allowed to securities products until a certain threshold amount of time has elapsed, to ensure that there is sufficient repayment data available to investors.

2. It provides First Loan Default Guarantee (FLDG) to the bank to a certain extent (8–15%) of the limit sanctioned in the form of a security deposit with the bank so as to maintain its stake in the loan portfolio.*

So ready to invest yet?

#ABS #Investing #Future #Assetbackedsecurities

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