The Reserve Bank of India recently penalised a couple of lenders for undertaking synthetic securitisation activities. Meanwhile, globally, synthetics have become banks’ workhorse product for bundling & selling loans. V Shunmugam explains how synthetic securitisation can provide capital relief for corporate credit risk.
l What is synthetic securitisation?
Every bank eventually encounters the same obstacle: credit demand increases while capital remains limited. The common solution has been to sell loans and start anew, as India’s securitisation market did with a record Rs 2.5 lakh crore in FY2026. However, selling a loan also means losing the borrower, which banks will be reluctant. Overseas, lenders have long used a different approach—keeping the loan on their books but selling only the risk of default through a process known as synthetic securitisation. On February 17, 2026, the Basel Committee on Banking Supervision released a study revealing two key points: first, these transactions have expanded rapidly over the past decade and now provide vital capital relief for corporate credit risk; second, they are more prudently structured than pre-crisis securitisations, though their risks still require oversight. India currently prohibits these practices.
l What is being sold here?
The bank selects a pool of loans and buys protection against losses on it from an outside investor, either through a guarantee or a credit derivative such as a credit default swap. The Basel Committee describes these as transactions in which the bank transfers all or part of the credit risk of a pool of assets while retaining ownership of the assets themselves. The borrower is never informed, and the assets are never handed to a new servicer. Only the credit risk travels. That is what makes it synthetic.
l Conventional vs synthetic securitisation
In a conventional deal, the bank sells the assets to a special purpose entity, which issues securities. Ownership and cash flows change hands as a result.
In a synthetic deal, nothing leaves except a promise to pay when borrowers default. Three things follow:
n The bank keeps the client and the fee income;
n It raises no funding;
n Its balance sheet does not shrink.
Conventional securitisation is about liquidity, whereas synthetic securitisation is about capital.
l Who absorbs the losses?
Losses are divided into tranches. The first-loss piece, thin by design, absorbs the earliest defaults. The mezzanine tranche above it absorbs unexpected losses. The senior tranche is hit last. S&P Global Ratings finds that European banks typically retain the senior slice, about 80-95% of the reference portfolio, and sell a mezzanine tranche of up to roughly 15%.
l Does it really free up capital?
Once the regulator approves that the significant risk has shifted, the bank only needs to hold capital against the remaining risk. This lowers risk-weighted assets and frees up capital for new lending. The Basel Committee estimates protected assets across the euro area, the US, the UK, and Canada at 750 billion euros, about 1.1% of total bank assets. According to the Bank for International Settlements, issuance has increased fivefold since 2016, with over a 100 banks now involved. In India, this could apply to infrastructure, mid-corporate, and MSME lending.
l Who sells the protection?
The Basel Commitee notes that the investor base mainly consists of non-bank financial intermediaries, such as private credit funds, hedge funds, pension funds and insurers. According to the International Association of Credit Portfolio Managers, 14 global insurers and reinsurers provided protection on 82 transactions in 2024. The International Finance Corporation guarantees such portfolios in Latin America. Returns have ranged from 6-12% above cash, narrowing by 200-300 basis points during 2024.
l What would India need first?
The RBI’s securitisation of Standard Assets Directions of September 24, 2021 define synthetic securitisation and place it among prohibited structures. Lifting the ban would require fulfillment of the following conditions:
n A supervisory test for genuine risk transfer, with prior approval;
n To begin with, only funded, cash-collateralised structures should be allowed;
n The protection sellers should be limited to regulated insurers, pension funds and alternative investment funds;
n Loan-level disclosure and mandatory first-loss retention by the originator;
n A capital floor should be determined so that relief never outruns risk.
The US market opened only after the Federal Reserve clarified the treatment of credit-linked notes in September 2023. Until then, American banks had no certainty that a note issued off their own balance sheet would earn capital relief, so few tried; once the guidance came, with a ceiling on the relief any one bank could claim, issuance climbed steeply. Sequence matters more than speed.
The writer is partner, MCQube.