Covered bonds may soon become a part of the Indian financial markets.

The National Housing Bank (NHB) has sown the seeds for development of covered bond market by setting up a working group to look into the entire gamut of issues around the introduction of this hybrid instrument.

A covered bond is basically an on-balance sheet, asset backed and bank funding instrument. It combines the features of a mortgage backed securities (MBS) and normal secured corporate bonds. In many developed markets, residential and commercial mortgages are the most common asset type funded by covered bonds.

A covered bondholder gets added comfort from the dual recourse to the underlying asset pool as well as to the issuer's balance sheet. It is this dual recourse that brings the covered bondholders to a privileged position. In MBS, the recourse for an investor is only the underlying pool of assets and not the issuer's balance sheet.

“We expect the working group (on covered bonds) to submit its report by end November,” Mr R.V. Verma, Chairman and Managing Director of NHB, told Business Line here. The working group would also look at international experience and draw upon it, he added.

The Working Group is headed by a SEBI Executive Director and comprises representatives of Reserve Bank of India, Finance Ministry (capital markets division), HDFC, International Finance Corporation (IFC), NHB and rating agency ICRA, Mr Verma said.

He also said that the working group would look into the aspect of introduction of covered bonds without enacting a legislation. Some industry observers feel that a legislative enactment may still be necessary for securing the rights of covered bondholders to the collateral backing such bonds. Regulations may not be enough, they said.

Besides widening the resource base for lenders (in the housing finance industry), the introduction of covered bonds is likely to induce greater discipline to the lending industry. There has been an increased interest in covered bonds in the after-math of the sub-prime crisis that struck the US in mid 2008.

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