The Reserve Bank of India (RBI) has unveiled a pivotal policy move aimed at transforming India’s distressed debt landscape. In a step expected to significantly boost liquidity and foreign investor interest, the RBI will now permit market-based securitisation of stressed loans, not just standard loans with regular repayment records.

This move, welcomed by analysts and investors alike, is being hailed as a landmark effort to develop India’s junk debt market, which has remained shallow due to the lack of attractive instruments and a limited buyer base.

What is Securitisation of Stressed Assets?

Securitisation is a financial process through which banks or financial institutions pool together loans—which may be either performing or non-performing—and sell them to investors in the form of marketable securities. These securities provide investors with a share of the loan repayments, and in the case of stressed loans, high yields in exchange for higher risks.

Earlier, securitisation in India was restricted mainly to standard assets, but this reform now allows market-determined pricing for securitising even bad loans or non-performing assets (NPAs).

How Will It Help Banks?

Banks have long been burdened by rising bad loans—particularly in the retail unsecured segments like personal loans and credit card dues. Selling these loans to Asset Reconstruction Companies (ARCs) usually required a 90–95% haircut, causing massive write-offs.

Now, banks can bundle these bad loans into tradable securities, giving them the option to:

• Reduce NPAs from their balance sheets

• Avoid extreme haircuts

• Attract capital through market instruments

What’s in It for Investors?

The biggest draw for investors—especially foreign portfolio investors (FPIs) and private credit funds—is the high-yield nature of these instruments.

“These securities will provide better returns than typical high-yield or junk bonds, making them attractive to distressed funds,” said Ajit Velonie, Senior Director at Crisil Ratings.

According to data from India Ratings and Research, securitisation of standard loans alone surged by 25% in FY24-25 to reach ₹2.3 trillion (approx. $26.74 billion). With the inclusion of stressed assets, this volume is expected to grow further.

Why Global Investors Are Watching

Global distressed debt investors from the U.S. and Europe have already shown interest in India’s high-yield debt space. With regulatory backing and improved liquidity, India’s junk bond market is expected to broaden significantly.

Sankar Chakraborti, CEO of Acuite Ratings and Research, noted that emerging markets like India are attractive for distressed funds seeking high returns on complex, illiquid assets.

Wider Impact on India’s Financial Sector

Hari Hara Mishra, CEO of the Association of ARCs in India, highlighted that the move will:

• Create high-yield investment avenues

• Help banks clean up their balance sheets faster

• Enhance liquidity and depth in debt markets

This marks a strategic pivot for India, especially after a decade of struggles with corporate NPA clean-up. As corporate lending slowed, banks focused heavily on retail credit, leading to a spike in small-ticket defaults.

Retail Lending & Delinquencies on the Rise

According to RBI data, personal loans and credit card debt formed 52% of new bad loans in banks' retail portfolios from April to September 2023. The overall bad loans ratio in the sector, which touched a 12-year low of 2.6% in September 2023, is projected to rise to 3% by March 2026.

This shift increases the relevance of packaging stressed retail loans into market instruments, giving banks a viable offloading option and spreading risk to the capital markets.

Challenges in Implementation

While the move is promising, it isn’t without hurdles. Pricing of stressed securities remains complex and needs granular evaluation.

Manisha Shroff, Partner at Khaitan & Co, pointed out that pricing determination will depend on:

• Asset quality and type

• Historical recovery rates

• Default probabilities

• Market sentiment and risk appetite

Additionally, slow legal recovery mechanisms, procedural delays in insolvency proceedings, and complex regulatory frameworks could temper the pace of market growth.

The Road Ahead: Unlocking a New Asset Class

The RBI’s initiative is being viewed as an attempt to develop a new asset class in India—one that stands between standard debt and non-tradable NPAs sold to ARCs. This segment could:

• Enable more transparent pricing

• Create investment products for global distressed funds

• Encourage new financial instruments like junk debt ETFs in the future

This could also lead to rating agency involvement, third-party verification, and eventually a more robust secondary market for bad-loan-backed securities.

Conclusion: A Transformational Move

RBI’s bold move to allow securitisation of stressed loans has the potential to reshape India’s financial ecosystem. With greater investor participation, more structured debt markets, and an influx of private capital, India is inching closer to building a resilient and mature credit market.

While pricing, regulation, and recovery challenges need to be ironed out, the benefits for both banks and investors are substantial. With India’s economic momentum and the global hunt for yield, this new window of opportunity could set the stage for a vibrant junk debt market.

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