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Significant Risk Transfer: Market, Structures, Economics and Risks

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Vinod Kothari and Dayita Kanodia | Finserv@vinodkothari.com 

Introduction

Known by various alternative names as “synthetic risk transfers”, “credit risk transfers”, “on balance sheet securitisation” or “synthetic securitisation”, Significant Risk Transfers (SRT) have a history of over 25 years but have recently grown faster than other components of either traditional securitisation or credit derivatives.  The pool value of banks’ synthetic securitizations has surpassed $670 billion, and the global sales of SRTs are expected to expand 11% annually on average over the next two years. 

This article discusses SRT Transactions, the state of the market, different structures used, risks, capital benefits, and the regulatory permissibility of such transactions in different countries. Finally and quite significantly, this article makes a case as to why India, which is one of the very countries in the world presently prohibiting such structures, should rethink.

Market Overview

As per a report published by the International Association of Portfolio Managers, by the end of 2024, over € 700 bn of securitized loans were protected by $ 75 bn (9%) of SRT tranches, some 70% being issued by European banks. Further, the International Association of Credit Portfolio Managers reported that between 2016 and 2023, nearly 500 SRT transactions protected underlying portfolios adding to $ 1 trillion in loans, ranging from corporate loans to auto loans. 

Period 2016- 2024 portfolio under SRTs totaled Euro 1311 billion (or roughly USD 1500 billions). In 2024, Europe, excluding the UK, took Euro 152 billion out of the Euro 260 billion protected portfolio. 

Thus, nearly half of the SRT deals have originated from EU countries. The proportion was even larger historically, but US banks started aggressively getting into SRT Transactions in 2025. 

SRT transactions have existed even before the Global Financial Crisis. In 2021, EU regulators extended the benefit of lower regulatory capital consuming “simple transparent and standard” (STS) securitisation treatment to synthetic transactions too. This has proved to be the game changer.

Asset classes

While corporate loans still represent almost two-third of the underlying pool assets (63%) in 2024, composition of other asset classes were: SMEs (13%), auto loans (7%), residential mortgages (3%), and specialized lending (3%). As in the past, in 2024 some 80% of issued synthetic securitizations support commercial lending to Corporates and SMEs. 

Investors

Specialised credit funds, aka private credit funds,  and debt fund managers are the largest investors. The following graph shows the composition of SRT investors: 

Some Recent transactions

The following are examples of some of the recent SRT transactions:

Banco Santander IFC transaction (2024)

The International Finance Corporation (IFC), a member of the World Bank Group, announced that it will provide a credit guarantee of $93 million to Banco Santander Mexico so that it can allocate more resources to financing small and medium-sized businesses (SMEs) in the country.

Aareal Bank (2025)

Aareal Bank, a German Bank completed its first SRT transaction, synthetically referencing a portfolio of performing European commercial real estate loans. With this transaction, Aareal Bank offered investors an opportunity to take exposure to a €2 billion CRE portfolio, which is equivalent to approximately 6 per cent of Aareal Bank’s overall CRE portfolio. 

Basic Structure of SRT 

Synthetic securitisation uses credit derivatives or similar devices to transfer the risk of a mezzanine tranche(s) of the credit risk of a pool of assets to capital markets by embedding such risk into credit-linked securities. The word “synthetic” is used in distinction to a traditional securitisation, which may be called “cash securitisation” or “true sale securitisation”. In every traditional or cash securitisation, there is a pooling of credit assets to constitute a reasonably diversified pool. The pool is then tranched into multiple tranches, such that, usually, the first loss tranche is retained by the originator, and mezzanine and senior tranches are moved to capital markets through a special purpose vehicle. The result is funding as well as risk transfer. The first loss piece, retained by the originator, neither leads to funding, nor risk transfer. However, for the mezzanine and senior tranches, there is a movement of money from the investors to the originator through the SPV, and risk transfer in the opposite direction. In synthetic securitisation, the purpose is not funding: the purpose is risk transfer. Therefore, the first loss piece still typically stays with the originator, but the risk in the mezzanine is moved to capital markets through the issue of credit-linked securities. The transfer of risk, without funding, may happen using credit default swaps, or guarantees

Structural Variations 

SPV versus non-SPV structures

Over three-quarters of the reported trades in 2024 are issued without SPV. The percentage of protected tranche notional issued directly by banks increased from some 25% in 2016 to 73% in 2024.

SPV Structure:

In the case of an SPV structure, an SPV is brought in as an intermediary between the investors and the originator. In case of cash or traditional securitisation arrangements, an SPV is brought in to hold the assets as a repository for the investors. In synthetic structures, there is no transfer of assets at all, an SPV is commonly used for the following reasons: 

  1. The funding raised by the investors is held and invested by the SPV. If there were no SPV, the funding would be held by the Originator, which would expose the originator to a counterparty risk as the originator would become the obligor for the securities. 
  2. Further, the rating of the securities would consequently be capped at the originator’s rating due to the counterparty risk in case of an SPV structure.
  3. If the SPV was not there, the originator would issue the securities, which may impose withholding tax requirements on the originator. Which is why, typically for a cross border issuance, the SPV is located in a tax haven jurisdiction that will avoid tax implications. 

The structure of SRT transactions has not changed from what it was before the GFC.  For example, n December 2001, DBS Bank Singapore introduced its first synthetic securitisation transaction involving a reference portfolio of approximately S$2.8 billion of corporate loans. The transaction used credit default swaps to transfer credit risk to an SPV, ALCO 1 Limited, without a true sale of assets. The SPV issued around S$224 million of multi-currency, multi-tranche notes (rated from AAA to BBB), while DBS retained the first-loss and super-senior exposures. The deal enabled regulatory capital relief and risk-weighted asset optimisation, and is widely regarded as one of Asia’s earliest synthetic CLO-style transactions outside Japan, marking a milestone in regional structured finance markets. Although this transaction was undertaken more than two decades ago, the structure used primarily remains the same. The following diagram illustrates a common SRT SPV structure:

Non – SPV Structure:

As explained above, typically an SPV is required in cash or traditional structures for holding the asset, isolating it from the originator, protecting the assets from bankruptcy risks of the originator. A rating arbitrage, that is, any of the securities of the SPV being rated higher than the originator, is not theoretically possible if any of the securities represent a claim against the originator. In synthetic structures, there are no actual assets, only synthetic; therefore there is no need to protect the assets (meaning assets of the investors). However, synthetic CDOs do have assets to the extent of funding contributed by the investors. If this funding were to be prepaid or invested in the originator the claims of the investors are backed up by the claim against the originator, and hence, are subject to the rating cap of the originator. 

It is understandable that the cash assets of a synthetic structure is only a fraction of the synthetic assets and hence the need for originator bankruptcy isolation is less prominent. A number of synthetic transactions have found it less necessary to involve a facade between the originator and the investors and have gone ahead with non- SPV structures. In this structure, the securities are issued by the originator himself and therefore represent a claim against the originator. 

There are various Non-SPV structures observed in the market, Unfunded bilateral guarantee/CDS with no SPV, Funded bilateral guarantee/CDS with no SPV, Funded Credit Linked Note issued by originator with no collateral. 

The table below shows the difference between SPV and Non-SPV structures:

SPV StructureNon-SPV Structure
Counterparty riskIn the case of an SPV structure, the entire money paid by the investors will be held by the SPV. This ensures that the investors are protected from the counterparty risk w.r.t the originator since any amount paid by them is held by a bankruptcy remote vehicle. In this case, the investor will be exposed to both the risk of default in the assets as well as counterparty risk of the originator, as opposed to the SPV structure, where the counterparty risk is eliminated. 
Rating CapThe SPV is a separate bankruptcy remote entity, and hence no cap on rating because of the counterparty risk of the originator. The rating of the securities will be capped at the rating of the originator due to counterparty risk.

Other structures

  1. Blind portfolio structures

In a blind reference pool SRT, the bank does not reveal borrower details to the investor or protection provider, and the investor only has access to high-level characteristics of the reference loan portfolio (such as industry distribution, credit ratings, or geographic exposure). Under this type of structure, investors face higher uncertainty as they must rely on the bank’s understanding of standards and risk management practices instead of conducting their own loan-level risk analysis. 

  1. Funded Structures

In case of funded structures, the originator and the investor enter into a bilateral credit protection contract which may be drafted as a guarantee or a credit derivative. The investor then places a collateral equivalent to the maximum payment obligation under the contract. The money from this collateral amount deposited is only paid to the originator when losses hit the protected tranche. The collateral amount remaining after absorbing the losses is returned to the investor. 

  1. Unfunded structures

Unfunded SRTs are transactions not secured by financial collateral. The investor (protection provider) does not make any upfront payments to cover potential losses and is only required to compensate the bank if a credit event occurs. The protection provider is considered to have a high enough credit quality to mitigate the counterparty risk and is subject to eligibility criteria in Europe. The protection providers are typically, in Europe, insurance companies, pension funds, or multilateral development banks. The bank originating the SRT is exposed to counterparty credit risk.

  1. SRT with replenishment period

SRTs with a replenishment period allow a bank to add new loans to the loan portfolio as old loans mature, subject to eligibility criteria. Typically, the loans will come from the same portfolio and share the original loan’s credit characteristics. The risk for the investor is potential asset quality deterioration of the reference pool, as the likelihood of credit losses could increase from lower asset quality loans being added, or from changes in the risk profile of the reference pool.

Economics of Risk Transfer

Consider a room with bombs placed in 5 different regions, as opposed to all the bombs placed in one place. The probability of a person stepping on the bomb will be far less in the first case than in the second one. The same is the case with assets. 

The economics of risk transfer in securitisation are rooted in the principles of integration and differentiation that underpin structured finance. A diversified set of underlying assets is first aggregated into a single pool, enabling risk to be spread across a broader portfolio rather than remaining concentrated at the individual loan level. This pooled risk is then differentiated through tranching, whereby cash flows and credit risk are allocated among distinct tranches with varying risk-return profiles. Such structuring facilitates more efficient risk allocation and diversification, making the protection buyer better off as compared to obtaining guarantees or credit protection on each loan on a standalone basis, where risk remains fragmented and less efficiently distributed. 

Thus, integration and differentiation ensure that correlation risk, or the risk that other assets also default on a default by one asset, is minimal. 

Risks of SRT

The following are some of the risks associated with SRT Transactions:

  1. System-wide leverage and risk migration
    SRTs transfer credit risk from banks to non-bank financial institutions (notably hedge funds and credit funds) that are typically less constrained by capital requirements and can employ higher leverage. This can increase aggregate leverage in the financial system, even if bank balance sheets appear safer. In many cases, banks also provide leverage to SRT investors, meaning part of the risk may remain indirectly within the banking system.
  2. Interconnectedness and contagion risk
    By redistributing bank-originated credit risk across banks, asset managers, hedge funds, insurers, and custodians, SRTs deepen inter-sector linkages. The private and opaque nature of many SRT deals makes it harder for supervisors to map exposures, raising the risk that stress in one segment (e.g., leveraged funds) propagates rapidly across the financial system.
  3. Investor concentration and rollover risk
    The SRT investor base is highly concentrated. Credit funds and asset managers account for a majority of demand, with a small group of large investors holding a dominant share of outstanding exposure. Further, since SRT maturities (typically 3–5 years) are often shorter than the underlying loan tenors, banks face rollover risk that is if investor appetite dries up, banks may experience a sudden increase in RWAs, capital pressure, and higher funding costs.
  4. Weaker underwriting incentives over time
    Strong demand for high-yield SRT tranches may attract more risk-tolerant investors, encouraging aggressive deal structuring or looser credit standards. Increased competition for SRT issuance can lead to sub-par due diligence, potentially worsening the quality of underlying loan pools and increasing vulnerability to credit shocks.

Regulatory capital

In an SRT transaction, a bank buys protection for the mezzanine tranche by issuing CLNs to investors. Under securitization treatment, the senior tranche carries 20 percent RWA, and the first-loss tranche carries 1,250 percent RWA. The RWA for the mezzanine tranche becomes zero because the bank is no longer exposed to the losses from this tranche.

The following examples illustrates maintenance of capital in case of SRT vs non-SRT transactions:

Non-SRT (in USD million)SRT (in USD million)
Asset Pool100Asset Pool100
RWA ratio50%First Loss Tranche %0.50%
RWA50RWA ratio1250%
Tier 1 Capital10.50%RWA6.25
Tier 1 Capital Required5.3Mezzanine Tranche %4.50%
RWA ratio (as risk transferred, backed by cash)0%
RWA0
Senior Tranche95%
RWA ratio20%
RWA19
Total Capital Required2.7

Thus, the capital required to be maintained in case of SRT structures is significantly lower as compared to non-SRT structures thus allowing originators capital relief. This, however, is a function of the size of the junior tranche. In the same example as above, if the thickness of the junior tranche was 3%, the required capital would have gone up.

Regulatory Permissibility of SRT

In India, synthetic securitisation, which is defined as a structure where the credit risk of an underlying pool of exposures is transferred, in whole or in part, through the use of credit derivatives or credit guarantees that serve to hedge the credit risk of the portfolio, which remains on the balance sheet of the NBFC, is prohibited. [para 5(3) of the Reserve Bank of India (Non-Banking Financial Companies – Securitisation Transactions) Directions, 2025]. Accordingly, SRT transactions where there is only a transfer of the risk and rewards without the transfer of the asset are prohibited in India. 

The below table shows the regulatory permissibility of SRT in various jurisdictions:

CountriesRegulatory Permissibility of SRT
IndiaProhibited
AustraliaNot eligible for capital relief
UKPermissible
Hong KongPermissible
CanadaPermissible
IndonesiaProhibited
ChinaProhibited
JapanPermissible within regulatory limits
EUPermissible
KoreaProhibited
SingaporePermissible

Over the years, SRTs have become a very potent tool for regulatory capital and risk management. SRTs have also permitted private credit funds to acquire exposure on loan portfolios without organically creating them. The regulatory antipathy for synthetic securitisation was the multiple layers of risk transfers as seen during the GFC. This was, however, more in case of structured finance CDOs and arbitrage transactions. SRTs are currently mostly related to on-balance sheet assets – hence, the question of any unwarranted risk transfers or risk build up do not arise. Of course, any securitisation transaction creates an interconnection between the banking system and capital markets, but that is also a cushion against risk as it has a potential for risk of contagion. 

Bibliography

  1. 2026 Regulatory Reviews Mark Inflection for Securitisation SRT Market | FitchRatings
  2. Rated Securitisations: Using SRTs to Optimise Financial Balance Sheets | FitchRatings
  3. Global SRT Insurance Survey – Select Results | IACPM
  4. Recycling Risk: Synthetic Risk Transfers | IMF
  5. Unveiling the impact of STS on-balance-sheet securitisation on EU financial stability |European Systematic Risk Board
  6. 2025 wrapped: Structured finance year in review | Structured Credit Investor

Uneasy Ease: RBI Proposes Exemption in Approval Mode  for Type I NBFCs

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The RBI’s proposed relief to exempt pure investment companies from exemption from regulation is not a cakewalk but a hurdle race.  It is not an exemption that comes in auto mode; you need to earn the right to be exempt. Some of the important pre-conditions that the RBI has proposed are:

  1. No automatic exemption: It is not that you qualify, and come out of registration. In fact, those proposing to come out have to make an application, based on the financials for the last 3 years. In these financial statements, there must be no direct or “indirect” access to “public funds” (including loans from loans from directors/shareholders), nor should there be any lending within the group or outside. This position shall be supported by auditors’ certificate. It is with these conditions that the RBI may, on being satisfied about the business model, grant exemption.
  2. Customer includes my own group: The meaning of ‘customer interface’ has been clarified to say it includes customer-oriented activity like lending or providing a guarantee, including to ‘entities in the Group’, its shareholders, its directors, or providing any other “product or service” to a customer. “Any other product or service” typically refers to customer-centric financial distribution services like mutual funds, bonds, etc.
  3. Money from director/shareholder will be “public” funds: For the purpose of determining public funds, any amount received from the directors and/or shareholders of the NBFC shall also be treated as public funds. 
  4. Timelimit for making application by existing NBFCs: Type I NBFC registered with RBI as on April 1, 2026, and fulfilling the prescribed criteria for exemption, may make an application to RBI, for deregistration within a period of six months, by September 30, 2026. There is no clarity on what will happen after this date. Also, it is not clear whether existing NBFCs may change their liabilities profiles to meet the exemption conditions, and apply for exemption in future. 
  5. Discretion of RBI: RBI shall consider the requests for deregistration if it is satisfied that NBFC is functioning with a conscious business model to operate without availing public funds and without having customer interface. Hence, the fate of deregistration is in the hands of the regulator.
  6. Exclusion from aggregation: The asset size of unregistered type I NBFCs shall not be consolidated with other entities in the group for determining the classification of such group NBFCs as base/middle layer entities. See details below.
  7. Overseas investment requires registration: Unregistered Type I NBFC, in case it intends to undertake overseas investment in the financial services sector, it shall require registration
  8. Continued Supervision from RBI: Exemption is only from registration requirement; however, they would continue to be subject to the provisions of Chapter IIIB of the RBI Act, 1934 (primarily, transfer to reserve funds). Further, the RBI has reserved the right to issue necessary instructions specifically to ‘Unregistered Type I NBFCs’ in case any concerns/ risks are observed.
  9. Conditions for new entities: New entities intending to claim the exemption must satisfy these conditions- No access to public funds, no customer interface, less than ₹1000 Cr asset size, passing of annual Board resolution to not access PF and CI, disclosure in financial statements. Further, in case of violation of conditions on public funds and/or customer interface, the statutory auditor shall submit an exception report to the RBI. 

Conditions for deregistration application

Analysis of options available to Type 1 NBFCs

Type of NBFCOptions Available
NBFCs holding Type I Registration as on April 1, 2026Option 1: Apply for deregistration

Option 2: Continue to remain as Type I NBFC
Entities that fulfil the conditions for Unregistered Type I NBFC, after April 1, 2026Option 1: Satisfy the conditions under 66A and remain unregistered [see box on Conditions Subsequent]

Option 2: Apply for registration as Type I NBFC
NBFCs not having a customer interface and public funds and having an asset size below ₹1000 crores, but not registered as Type IOption 1: Apply for deregistration

Option 2: Apply for registration as Type I NBFC to avail regulatory exemptionOption 3: Maintain status quo
NBFCs not having a customer interface and public funds and having asset size above ₹1000 crores, but not registered as Type IOption 1: Apply for registration as NBFC Type I

Option 2: Apply for registration as NBFC Type II, in case of changes in business model

What happens to NBFCs not availing public funds and having customer interface but not registered as Type 1?

Several NBFCs that have been registered with the RBI before the concept of Type 1 was introduced in 2016 may not have the CoR as a Type 1 NBFC in spite of the fact that as on date they don’t have access to public funds nor any customer interface. Such an NBFC with an asset size less than ₹1000 crores will still have an option to apply for deregistration, subject to the satisfaction of the conditions prescribed. However, such NBFCs in case they decide to maintain the status quo will not be eligible for the regulatory exemption available to Type 1 NBFCs. 

What about new entities that meet PBC criteria?

If an entity carries investment activity with owned funds, within a limit of ₹1000 crores, does it need RBI registration? The answer seems to be – no. Such a company obviously does not have to go through the rigour of seeking registration first, and then qualifying for an exemption.

The company in question still has to satisfy the exemption conditions; and the auditor will need to give an exception report. The meaning of exception report is that if there is a breach of any of the conditions of exemption, or there is any breach of any other provisions of the law, the auditor shall be required to make an exception report.

Notably, CARO Order also requires auditors to comment on adherence to RBI regulations, which, in future, will include these conditions too.

Whether assets of multiple group entities will be aggregated?

Is the requirement of asset size being within ₹1000 crores based on stand-alone financial statements, or will the assets of companies within the group be aggregated, as is done for the purpose of determination of the middle layer status of companies?

It seems that the aggregation requirement is not there for the Type 1 exemption.

The basis for this is FAQ 13, which states as follows:

Q13. As per regulations of the Reserve Bank, total assets of all the NBFCs in a Group are consolidated to determine the classification of NBFCs in the Middle 11 Layer. What shall be the treatment given to ‘Type I NBFCs’ and ‘Unregistered Type I companies’ in this regard? 

Ans: For aggregation purposes, the asset size of ‘Type I NBFCs’ shall be considered but asset size of ‘Unregistered Type I NBFCs’ shall not be considered. It is emphasized that ‘Type I NBFCs’ shall always be classified in Base Layer regardless of such aggregation. 

What if I have accepted intra-group loans/granted intra-group loans, but resolve not to do so in future

Are the exemption conditions, that there is no access to public funds and no customer interface, merely a statement of intent, or must also be borne out by the conduct in any of the past 3 financial years? Looking at the definition in para 6 (14A), which reads “Not accepting public funds and not intending to accept public funds”, and likewise, “Not having customer interface and not intending to have customer interface”, it appears that the exemption conditions are both a statement of fact as well as intent. If one is negated by the fact, a mere statement of intent may not help.

However, assume there are isolated instances of intra-group loans taken or intra-group loans given. The transactions are not indicating a “business model”, at least the ones on the asset side. Are we saying that the breach of the conditions of  “no public funds” and “no customer interface”, at any time during the last 3 years, will disentitle the exemption?

We do NOT think so. There are two reasons to say this:

  • First, no one can cleanse the past. There is no reason to deny the exemption if the Company has cleaned up the asset side and liability side by 31st March, 2026, and resolves not to make neither of the “two sins” ever in future. Taking any other view will be unreasonable and not keep up to the intent of the regulator.
  • Secondly, the language itself is clear: Para 38A (2) (iii) talks about the status of public funds and customer interface in the last 3 years. Para 38A (2) (iv) and (v) refer to auditors’ certificate and the board resolution, both referring to the position as on date, and not the past. Therefore, if the past has been undone by 31st March, 2026, we see a strong reason to qualify the exemption, except if the level of activity is indicative of “conscious business model”

Three financial years: which years?

In our view, since the deregistration application has to be made within September 30, 2026, the audited financials for FY 25-26 must have been prepared. Hence, the last three financial years that would be considered are FY 23-24, 24-25 and 25-26.

VKC comments:

It is usually hard to get a relief from a regulator, as relief is seen as a prize that you earn. If the idea was based on the premise that what does not matter for the financial system, and is still being regulated, is a burden both for the regulator and for the regulated, there would have been a more welcoming approach to exemption. Specifically:

  • The extension of the definition of “public funds” to include borrowings from shareholders and directors is quite unreasonable. For private companies, deposits from shareholders and directors are exempt by law; in the case of public companies too, loans from directors are exempt. Even if we don’t lean on the law, what is taken from directors and shareholders cannot partake the character of “public”. There cannot be an element of public interest in intra-group transactions, and as a financial regulator, RBI could not have been concerned with intra-group financial accommodations.
  • The definition of “customer” service to include loans to group entities is equally unexplainable. The tested definition of “customer” in case of banks/financial entities is someone who customarily avails the services of such an entity. The only intent of the regulator could have been the conduct of business concerns, primarily customer service. A group entity borrowing from another group entity is not expecting customer service standards.
  • Both the definitions have been related to the historical balance sheets, with no apparent continuing exemption route. This, hopefully, will be made a continuing exemption, so that entities may carry financial and business restructuring to qualify for exemption.

The Swap that does it all: RBI introduces total return swaps on corporate bonds

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– Dayita Kanodia & Siddharth Pandey | finserv@vinodkothari.com

Budget 2026 proposed to introduce Total Return Swaps (TRS) for corporate bonds, purportedly as a measure for synthetic trading in corporate bonds. However, given the very slow pick up of credit default swaps, the much easier and globally prevalent version of credit derivatives, will the more esoteric TRS really make a difference? We explain what TRS is, how it differs from a CDS, give a sense of the global data on TRS as a part of OTC credit derivatives, and discuss how much the new measure will impact India’s bond market.

On February 6, RBI, in furtherance of the announcement in the Statement on Developmental and Regulatory Policies dated February 6, 2026, issued the draft revised Master Direction – RBI (Credit Derivatives) Directions, 2022. (‘Draft CD Directions’). The Draft CD Directions permit TRS to be issued to eligible persons.

Background

India’s credit derivatives market has historically remained shallow, with hardly any transanctions involving credit default swaps. This has resulted in limited hedging options focused only on default risk and an absence of tools for transferring market and price risk.

This contrasts sharply with global trends. As of mid-2025, the notional outstanding volume of OTC derivatives exceeded USD 840 trillion, with credit derivatives, despite being smaller in absolute size than interest rate or FX derivatives, recording the fastest year-on-year growth at approximately 23%.

It may be noted that as of 1996, which is when credit derivatives had almost started emerging and gaining strength, TRS transactions were significant and took up almost 32% of the market share. However, the percentage of TRS dropped. Over time, CDSs overtook the position because CDSs are more definitive and limit the risks of the protection seller. In 2025, as per 118th edition of the OCC’s Quarterly Report on Bank Trading and Derivatives Activities based on call report information provided by all insured U.S. commercial banks and others, the TRSs had become a smaller segment representing 4.9 per cent of the credit derivative market.

Meaning of TRS

In simple terms, a TRS swap transfers the entire volatility of returns of a reference asset from one party to another. TRS is a kind of derivative contract wherein the protection buyer agrees to transfer, periodically and throughout the term of the contract, the actual returns from a reference asset to the protection seller (“floating returns”), and the latter, in return, agrees to transfer returns calculated at a certain spread over a base rate (“fixed returns”) Total returns include the coupons, appreciation, and depreciation in the price of the reference bond. On the other hand, the protection seller will pay a certain base rate, say, risk free rate, plus a certain spread. The protection seller in the case of a TROR swap is also referred to as the total return receiver, and the protection buyer is similarly called the total return payer. The figure below illustrates the essential mechanics of a total return swap.

Impact of TRS
TRS swaps originate from synthetic equity structures, where economic returns of an asset are transferred without any actual investment in the underlying. The structure separates economic exposure from legal ownership. In a TROR swap, the economic impact is such that the total return receiver assumes the position of a synthetic lender to or investor  in the bonds  of the reference obligor, while the total return payer becomes a synthetic lender to the counterparty. Consider the illustration below:

  • Party PB invests in the unsecured bonds of entity X carrying a fixed coupon of 9.5 per cent. 
  • PB then enters into a TROR swap with PS, under which PB agrees to transfer the actual returns from the bonds of X and, in return, receive MIBOR plus 100 basis points.
  • Under the terms of the swap, PB periodically transfers the coupon income, plus any market price appreciation minus any market price r depreciation in the bonds, while PS periodically pays MIBOR plus 100 basis points. 
  • Although PB technically holds the bonds of X, in substance PB has neither exposure to X nor to the returns generated by X. Instead, PB is economically exposed to PS at MIBOR plus 100 basis points, which is equivalent to having invested in PS at that rate.
  • Conversely, PS, despite not holding the bonds of X, is economically exposed to the actual returns from X’s bonds (net of MIBOR plus 100 basis points). The effect of the TROR swap is therefore to synthetically create a fully refinanced investment in the bonds of X, giving a return equal to the actual returns in the bonds, and having a funding cost equal to MIBOR plus 100 basis points.

Thus, the true impact of a TROR swap is the synthetic replacement of exposures. Consequently, the advantages of a TRS can be:

  • Off-balance sheet exposure: TRS creates synthetic assets without recording loans or bonds on balance sheets improving leverage ratios and capital efficiency.
  • Regulatory Arbitrage: TRS has been used to bypass investment or lending restrictions, such as exposure norms, concentration limits, etc.
  • Provides very high leverage: In the above illustration, the synthetic investment made by the O in the bond is highly leveraged, assuming no margin has been put by the PS.
  • Alternative to a Repo: Assume PB holds a bond and is looking at having it funded. It sells the bond to Q and simultaneously enters into a TRS transaction, paying MIBOR + spread and receiving the actual returns of the bond. Hence, PB continues to have an economic stake in the bond whereas for accounting purposes, the bond may be removed from the balance sheet of PB.

TRS structures have been used globally across a wide range of asset classes, including equities, bonds, loans, real estate and property interests, credit-linked notes, and portfolios or indices of such assets. Hence, a TRS is a credit derivative only when the reference asset is a credit asset, otherwise it is a generic total return derivative. The Draft CD Direction framework deliberately confines TRS usage to specified debt instruments in order to prevent synthetic funding and balance-sheet arbitrage.

CDS Vs TRS

AspectsCDSTRS
Basic DefinitionA credit derivative contract where a protection seller commits to pay the buyer in the event of a credit event.A credit derivative contract where a payer transfers the entire economic performance of an asset to a receiver (protection seller).
Risk TransferredTransfers only the credit risk associated with a specific obligation. 
The protection seller is only concerned with the risk of default or increase in credit spreads of the asset. That is, the reference transaction only shifts the risk of credit spreads		Transfers the total volatility of returns, including credit risk, interest rate risk, and market risk. 
The receiver gains exposure to all gains and losses (coupons, appreciation, and depreciation).
Cash Flow MechanicsThe buyer makes periodic premium payments to the seller until maturity or a credit eventInvolves a periodic exchange of cash flow, the payer gives returns and appreciation; the receiver gives a benchmark rate + spread and depreciation.

No fixed premium; the premium  is inherent in the difference between actual returns and the agreed-upon spread
Synthetic ImpactUsed primarily for credit insurance or hedging against specific default.Used to synthetically replace the entire exposure of the parties, causing the receiver to assume the position of a synthetic lender to the reference obligation.

Types of TRS

Total Return Swaps can be categorized into several types based on their underlying assets and funding structures:

  • Index-Based TRS: Instead of a specific bond, the returns are linked to a diversified index (e.g., a broad-based index of 100 high-yield corporate bonds). The RBI specifically allows these if the index is composed of eligible debt instruments and published by an authorized administrator.
  • Equity Swaps: A type of TRS where the reference asset is one or more equity securities. Here, the total return payer pays the return from the equity or the portfolio, and in turn, receives a base rate spread.
  • Property Derivatives: The TRS methodology has been applied to swapping the returns of property investments also, allowing investors to synthetically invest in properties or property indices. 
  • Structured TRS:  Here, the reference assets would be a pool of loans or bonds. The transaction will make uses of the credit-linked notes.

See further details on TRS in the book on Credit Derivatives and Structured Credit Trading by Mr Vinod Kothari

Regulatory framework for TRS

The Draft CD Directions permit the use of TRS while adding multiple safeguards to ensure that TRS functions strictly as a credit risk transfer instrument and not as a means of synthetic funding, balance-sheet arbitrage, or regulatory circumvention. The regulatory framework governs four key aspects:

  • Eligible participants,
  • Permissible reference assets,
  • Permitted purposes for which these instruments may be used, and
  • Prudential safeguards.

Eligible participants for TRS

Para 4.1.2(iii) of the revised Directions stipulates that at least one counterparty to every credit derivative transaction must be a market-maker. For this purpose, market-makers are defined to include 

  • Scheduled Commercial Banks, 
  • Large NBFCs (including HFCs and SPDs) with a minimum net owned fund of ₹500 crore, and
  • Specified financial institutions such as NABARD, SIDBI, and EXIM Bank.

This requirement ensures that TRS transactions are intermediated by regulated entities with adequate risk management capabilities.

In alignment with this overarching requirement, the Draft CD Directions prescribe the following specific eligibility conditions for TRS:

  • TRS may be offered only by market-makers, ensuring that such transactions are undertaken by regulated entities with adequate risk management capabilities.
  • Residents (other than individuals) may enter into TRS without any restriction on the purpose, allowing both hedging and non-hedging purposes.
  • Persons resident outside India may enter into TRS only for the purpose of hedging, and such TRS may be offered to them exclusively by market-makers.

Reference entities and reference assets for TRS

In addition to prescribing eligible participants, the Draft CD Directions impose strict controls on the nature of reference entities and assets that may be used for TRS transactions. These controls are intended to ensure transparency, prevent regulatory arbitrage, and avoid the creation of complex or opaque synthetic exposures.

Reference entity: 

A reference entity refers to the issuer whose credit risk and economic performance form the basis of the TRS contract. For TRS, the reference entity shall be a indian resident entity that is eligible to issue Reference assets under the Draft CD Directions.

By limiting reference entities to domestic issuers of eligible debt instruments, the framework ensures that TRS activity remains in the Indian corporate debt market, which was also the regulatory intent.

Reference assets: 

A reference asset refers to the underlying corporate bond or debt instrument issued by the reference entity or an index of underlying debt instruments specified in a total return swap contract. The Draft CD Directions specify the following as eligible reference assets for TRS:

  • Money market debt instruments;
  • Rated INR-denominated corporate bonds and debentures;
  • Unrated INR-denominated corporate bonds and debentures issued by Special Purpose Vehicles (SPVs) set up by infrastructure companies; and
  • Bonds with call and/or put options.

At the same time, the Directions expressly prohibit TRS on certain instruments, including asset-backed securities, mortgage-backed securities, credit-enhanced or guaranteed bonds, convertible bonds, and other hybrid or structured obligations. This exclusion reflects regulatory caution against layering derivatives on complex or credit-enhanced products that could obscure risk transfer.

Index-based reference assets

The Draft CD Directions also permit a TRS to reference an index, provided that:

  • The index comprises only eligible debt instruments as specified above; and
  • The index is published by a financial benchmark administrator duly authorised by the RBI under the Reserve Bank of India (Financial Benchmark Administrators) Directions, 2023

Although such index based reference asset has been introduced for CDS and TRS, no such index for debt securities exists currently. Accordingly, such an index must be developed. 

Preventing Regulatory circumvention:

Para 4.5.1(ii) of the Draft CD Directions expressly provides that market participants shall not undertake credit derivative transactions, including Total Return Swaps, involving reference entities, reference obligations, or reference assets where such transactions would result in exposures that the participant is not permitted to assume in the cash market, or where they would otherwise violate applicable regulatory restrictions. This provision prevents the use of TRS to bypass exposure limits, concentration norms, sectoral caps, or investment restrictions applicable to the participants.

Additional safeguards for TRS used for hedging

Where a TRS is entered into for the purpose of hedging, the market-maker is required to ensure that the user satisfies the following conditions:

  • The user has an existing exposure to the relevant reference asset
  • The notional amount of the TRS does not exceed the face value of the reference asset held by the user, and
  • The tenor of the TRS does not extend beyond:
    • The maturity of the reference asset held by the user, or
    • The standard TRS maturity date is immediately following the maturity of the reference asset.

These safeguards reinforce the principle that hedging-oriented TRS must remain strictly co-terminous and proportionate to the underlying exposure, thereby avoiding over-hedging or speculations. Further, the Draft CD Direction specify that the settlement rules and standard documentation will be specified by shall be specified by the Fixed Income Money Market and Derivatives Association of India (FIMMDA), in consultation with market participants. However, the market participants are allowed to, alternatively, use a standard master agreement for credit derivative contracts.

Will it impact the bond markets in India?

Will this new instrument have an impact on bond markets in India? The first instance of guidelines on credit derivatives was issued in 2011; this failed to have any impact at all. Then, after the report of the Working Group, new Credit Derivatives Directions were issued in 2022. These also, at least based on anecdotal market information, have not had any significant traction at all.

CDS is much more standardised than TRS; as we have noted above, TRS is only 4.9% of the global credit derivatives market. Will the Indian market, which has not yet picked up credit spread trading in the form of CDS, delve into a far more esoteric TRS trade? Was it based on any reasoned or surveyed market feedback that this regulatory change was inspired? These questions, a priori, are difficult to answer. However, like a new flavour of ice cream, you never know until you try it.

Other Resources:

  1. Draft Credit Derivatives directions: Will they start a market stuck for 8 years?
  2. Page on Credit Derivatives
  3. Book on Credit Derivatives and Structured Credit Trading

The NBFC that doesn’t have to be: CICs and Principal Business paradox

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– Dayita Kanodia, Assistant Manager | finserv@vinodkothari.com

Holding Companies whose primary intent is to invest in their group companies have lately faced a paradox with respect to the requirement of registration as a  Core Investment Company (CIC). 

CICs are entities whose principal activity is the acquisition and holding of investments in group companies, rather than engaging in external investments or lending exposure outside the group. Para 3 of the Reserve Bank of India (Core Investment Companies) Directions, 2025 (‘CIC Directions’) prescribes the quantitative thresholds for classification of an NBFC as a CIC. In terms thereof, an NBFC that holds not less than 90% of its net assets in the form of investments in group companies, of which at least 60% is in equity instruments, is classified as a CIC and is required to obtain registration from the RBI, unless exempted.

Conceptually, a CIC is a sub-category of a Non-Banking Financial Company (NBFC) (para 3 of the CIC Directions), just like Housing Finance Companies, Micro Finance Institutions, etc. The threshold criteria that NBFCs are required to satisfy is the principal business criteria (PBC), pursuant to which at least 50% of the total assets of the entity must consist of financial assets and at least 50% of its total income must be derived from such financial assets. 

The PBC has historically served as the foundational threshold for determining whether an entity is an NBFC. Once the entity satisfies this principal requirement of carrying out financial activity, the sub-category is to be determined based on its line of business, which, lately, has seen quite a varietty – fron tradtional variants such as investment and lending activities (ICC), to housing finance (HFC), to financing of receivables (Factoring companies), the more recent inclusions are account aggregators (AA), mortgage guarantee companies (MGCs), infrastructure finance compaies (IFC), etc.  Each of these NBFCs first, and then they fall in their respective class. For instance, HFCs are a type of NBFCs that primarily focus on extending housing loans and hence, must have a minimum housing loan portfolio of 60% and an individual housing loan of 50%. 

Accordingly, all categories of NBFCs must first be ascertained to be carrying out financial activities as their primary business, and thereafter, the specific product helps to determine the category. Consequently, holding companies or CICs should ideally also adhere to the 50-50 criteria first and thereafter meet the 90-60 criteria for CIC classification. 

However, there is a common perception among the market participants that CICs, irrespective of meeting such PBC, in case they reach the 90-60 criteria, will be required to obtain registration as a CIC. Several news reports also note this perception. 

This perception among the market participants that CICs are not required to adhere to the PBC criteria stems from para 17(3) of the CIC Directions, which explicitly provides that:

“CICs need not meet the principal business criteria for NBFCs as specified under paragraph 38 of the Reserve Bank of India (Non-Banking Financial Companies – Registration, Exemptions and Framework for Scale Based Regulation) Directions.”

It may be noted that the above-quoted provision, which has recently been made a part of the CIC Directions pursuant to the November 28 consolidation exercise, was earlier included in the FAQs released by RBI on CICs.  FAQs are RBI staff views; whereas Directions or Regulations are a part of subordinate law; however, in the consolidation exercise, a whole lot of FAQs and circulars became a part of the Directions.

Going by the intent of the NBFC classification and categorisation, the above-quoted provisions seem more relevant for registered CICs, implying that CICs once registered need not meet the PBC on an ongoing basis. CICs predominantly hold investments in group companies and therefore satisfy the 90–60 thresholds, but often do not derive any financial income from such investments. Group investments, being strategic in nature, are rarely disposed of, and the dividend income from such investments depends on the dividend/payout ratio, which may be quite low. In several cases, such entities continue to earn income, say, by way of royalty for a group brand name. Even the slightest of non-financial income will seem to breach the PBC criteria, which may challenge the continuation of registration of the CIC as an NBFC. In order to redress this,  the provision under para 17(3) of the CIC Directions provides that CICs need not meet the PBC criteria on an ongoing basis. 

What is the basis of this argument? The definition of a CIC comes from para 3, which says as follows: “These directions shall be applicable to every Core Investment Company (hereinafter collectively referred to as ‘CICs’ and individually as a ‘CIC’), that is to say, a non-banking financial company carrying on the business of acquisition of shares and securities, and which satisfies the following conditions.” Para 17 (3) is a note to Para 17, which apparently deals with conditions of continued registration. 

Given that CIC is a category of NBFC, it would be counter-intuitive to say that the regulatory requirement requires holding companies to go for registration as a CIC even if they do not meet the PBC for an NBFC. In fact, if an entity is not an NBFC because it fails the principality of its business, it would not even come under the statutory ambit of the RBI by virtue of section 45-IC.

Accordingly, without going by just the text of the regulations, in our view, considering the regulatory intent, the following could be inferred:

  1. If there are group holding companies which have intra group investments, but also have operating income from one or more sources, such that the operating income is more than finanical income, these companies are not NBFCs at all. If they are not NBFCs, they cannot be CICs irrespctive of the extent of investment/loans as a part of their asset base. As we say this, we emphaise that the operating income shoudl be substantive and should be indicating a strategic business intent, rather than a pure one-off or passive income.
  2. CICs are a type of NBFC.
  3. Holding companies will be classified as a CIC in case they first meet the 50-50 criteria for NBFC and thereafter the 90-60 criteria as well. The registration requirement may then be ascertained based on the asset size and access to public funds by the CIC.
  4. A CIC (registered or unregistered) need not meet the PBC criteria on an ongoing basis. 

Other Resources:

  1. New regulatory framework for Core Investment Companies: RBI means to exempt: will there be any takers?
  2. Can CICs invest in AIFs? A Regulatory Paradox
  3. RBI introduces stringent norms for Core Investment Companies

Unified Investment Limits and Enhanced Exit Flexibility for FPIs

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Manisha Ghosh, Senior Executive | finserv@vinodkothari.com

Investment limits under Voluntary retention route (Rs. 2,50,000 crore) for investment in corporate bonds and G-secs have been merged and made a part of the limit assigned for regular investments by FPIs under General Route (15%, 2% and 6% of outstanding stock of Corporate debt securities, State Government securities and Central Government respectively); as a result, FPIs that commit to keep funds for at least 3 years may escape the restrictions applicable in case of corporate bonds relating to minimum residual maturity requirement and issue-wise limits on single FPI (not exceeding 50% of any issue). This introduces significant scope for those FPIs that are sure of staying invested in India for a long term, avoiding opportunism while granting them significant operational flexibility.

The Indian market has witnessed a sharp and sustained decline in FPI investments over the past few years, reflecting a clear shift toward net outflows. The data reflects a structural decline in FPI investments over the period, transitioning from strong inflows in 2020 to persistent net withdrawals from 2022 onwards. The brief stabilization in 2024 appears temporary rather than a trend reversal, suggesting continued caution or reallocation by FPIs in recent financial years. 

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IT Outsourcing Under the RBI’s 2025 Directions: What Has Changed?

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By Archisman Bhattacharjee & Avikal Kothari | Finserv@vinodkothari.com  

Introduction

On November 28, 2025, the Reserve Bank of India (“RBI”) issued the Reserve Bank of India (Non-Banking Financial Companies – Managing Risks in Outsourcing) Directions, 2025 (“Outsourcing Directions”), thereby repealing the erstwhile directions governing IT outsourcing and financial services outsourcing. For the purposes of this article, our discussion is confined to Chapter IV of the Outsourcing Directions, which specifically deals with outsourcing of information technology (“IT”) services. While the Outsourcing Directions largely represent a consolidation of the existing regulatory framework as also clarified by the RBI in its Consolidation of Regulations – Withdrawal of Circulars dated November 28, 2025, they also provide enhanced clarity and structure to the regulatory expectations applicable to IT outsourcing arrangements of NBFCs. This article seeks to examine whether, and to what extent, any additional or expanded obligations have been introduced by the RBI under the consolidated framework.

Applicability

Chapter IV of the Outsourcing Directions, dealing with IT services outsourcing is applicable on NBFC-ML and above, which was also the case for the Erstwhile IT Outsourcing Directions

Transitional Timeline for Compliance of Existing IT Outsourcing Arrangements

The erstwhile IT Outsourcing Directions had become applicable with effect from October 1, 2023. Under the Outsourcing Directions, the RBI has now prescribed a specific transition mechanism for existing IT outsourcing arrangements. In this regard, para 2 of the Outsourcing Directions provides that:

“These Directions shall come into force with immediate effect

Provided that for Non-Banking Financial Companies covered under the scope of these Directions, as mentioned in paragraph 3, their existing Information Technology (IT) outsourcing agreements, regardless of whether they are due for renewal on or after the effective date of these Directions, shall comply with the provisions of these Directions either at the time of renewal or by April 10, 2026, whichever is earlier.”

Given that the Outsourcing Directions are primarily in the nature of a consolidation exercise and do not introduce materially new obligations, the timeline up to April 10, 2026 appears to be intended to provide NBFCs with a reasonable window to align their existing IT outsourcing agreements with the consolidated framework. Accordingly, NBFCs should utilise this transition period to review, amend, and, where necessary, renegotiate their existing IT outsourcing contracts to ensure full compliance with the Outsourcing Directions within the prescribed timeline.

Against this backdrop, it becomes important to examine the substantive requirements laid down under Chapter IV of the Outsourcing Directions in relation to outsourcing of IT services to third-party vendors. The following section discusses the key regulatory expectations and compliance obligations applicable to NBFCs when engaging third-party service providers for IT outsourcing.

  1. Expanded scope of Service Provider Definition

The definition of “service provider” as defined under paragraph 58(3) of the Outsourcing Directions is expansive and extends beyond the primary contracting entity to include sub-contractors, third-party vendors, and entities forming part of the service delivery chain. Further the Outsourcing Directions under paragraph 58(4)have also now defined the term “sub-contractor” to mean:

“… those providing material / significant IT services to the service provider and is specific to the material / significant IT services arrangement that the NBFC has entered into with the service provider”

Accordingly, a sub-contractor that provides material or significant IT services to a service provider, where such services are critical to the delivery of the outsourced arrangement to the NBFC, would also fall within the ambit of the Outsourcing Directions. For instance, where an NBFC avails a SaaS solution from a third-party service provider, any entity that supplies core software or technology to such SaaS provider, without which the service cannot be effectively rendered, may be regarded as a material service provider for the purposes of the Outsourcing Directions. 

While the erstwhile IT Outsourcing Directions did prescribe certain obligations in respect of sub-contractors (and the obligations of NBFCs vis-à-vis their primary service providers largely remain unchanged under the Outsourcing Directions), the current framework introduces greater clarity on who qualifies as a “sub-contractor.”

Actionables for NBFCs:
NBFCs should reassess their existing IT outsourcing landscape to identify all arrangements that fall within the expanded scope, including indirect or layered service delivery models. Vendor inventories should be updated to capture not only primary service providers but also material sub-contractors and supply-chain entities involved in the provision of IT services.  Furthermore, NBFCs are advised suitably amend its existing policies to clearly specify the framework and criteria for identification of sub-contractors. This may, inter alia, include requiring service providers to furnish a list of their appointed sub-contractors along with details of the functions performed by each, and undertaking an assessment, in consultation with the relevant service provider, to determine whether such sub-contractors are material or non-material.

  1. Audit and Due Diligence 

The Outsourcing Directions require NBFCs to conduct risk-based due diligence of IT service providers, this includes tracking system performance, uptime, service availability, Service Level Agreement,  compliance and incident response on an ongoing basis. Regular risk-based audits of service providers, including sub-contractors, have been formalised, with an option to rely on pooled audits or recognised third-party certifications, though this does not dilute the NBFC’s responsibility for data security and system availability. NBFCs must also periodically review the financial and operational strength of service providers to identify any deterioration in performance, security or resilience. Access rights have been strengthened, requiring service providers to provide unrestricted access to relevant data and premises for NBFCs, auditors and regulators. 

Actionables for NBFCs:

NBFCs should strengthen vendor due diligence processes and establish mechanisms for periodic review of service providers. Oversight frameworks should extend to subcontractors and material supply-chain entities, with clear accountability resting on the primary service provider. Overall, the changes make due diligence an ongoing obligation rather than a one-time exercise, requiring NBFCs to strengthen internal monitoring structures, audit planning and vendor risk management practices. 

Further, considering that the RBI has mandated compliance of the agreements with the Outsourcing Directions by April 10, 2026, it is advisable for NBFCs to undertake a comprehensive review of the service level agreements and other contractual arrangements executed with all its material IT vendors to ensure alignment with the requirements set out under paragraphs 33, 34, 73 and 74 of the Outsourcing Directions.

Additionally, prior to April 10, 2026, NBFCs are suggested to conduct audits of its material service providers to verify:

  1. compliance with the contractual obligations agreed between the NBFC and the respective vendor; and
  2. adherence by such vendors to the applicable requirements prescribed under the IT outsourcing framework.

Alternatively, the Company may also rely on globally recognised third-party certifications made available by the service provider in lieu of conducting independent audits.

Where, based on such review or audit, the NBFC forms the view that a vendor is not in compliance with the contractual terms or applicable regulatory requirements, the NBFC should require the vendor to implement corrective action within defined timelines and, where necessary, amend or renegotiate the existing agreements to ensure alignment with the Outsourcing Directions. 

Further, the NBFC should appropriately document such reviews, audits, and remediation measures and place the same before the senior management, in accordance with the requirements of paragraph 78 of the Outsourcing Directions, and/or before such a committee as may be identified under the NBFC’s IT Outsourcing Policy. Any material or adverse developments should also be escalated to the Board in alignment with the requirements of paragraph 78 of the Outsourcing Directions.

In cases where remediation or contractual modification is not feasible, the Company should maintain an exit plan/exit strategy, including identification of alternate service providers and/or arrangements for bringing the outsourced services in-house, so as to ensure continuity of critical operations and minimal disruption to customers.

Conclusion

The Outsourcing Directions mark a significant step by the RBI towards consolidating and strengthening the regulatory framework governing IT outsourcing by NBFCs. While the underlying obligations remain broadly consistent with the erstwhile regime, the transition period up to April 10, 2026 provides NBFCs with a critical opportunity to holistically reassess their IT outsourcing arrangements, rationalise vendor ecosystems, and embed robust contractual, operational, and governance safeguards. NBFCs that proactively undertake structured reviews, strengthen vendor risk management, and institutionalise ongoing monitoring mechanisms will be better positioned not only to achieve regulatory compliance but also to enhance operational resilience and customer trust.

Ultimately, IT outsourcing under the Outsourcing Directions is no longer a purely contractual or procurement function—it is a core governance and risk management responsibility. Treating it as such will be essential for NBFCs navigating an increasingly digital and interconnected financial services ecosystem.

See our other resources:

  1. RBI regulates outsourcing of IT Services by financial entities
  2. IT Governance: Upgrade needed by April 01, 2024
  3. https://vinodkothari.com/2023/11/it-governance-risk-control-and-assurances-practices-directions-2023/

RBI Issues Draft Directions on Relief Measures in Areas Affected by Natural Calamities for Regulated Entities

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Simrat Singh | finserv@vinodkothari.com 

When nature unsettles the ordinary course of life, the regulatory hand should neither be withdrawn nor clenched; it should extend a humane touch, easing distress and guiding the return of order. In this spirit, the RBI has released draft directions on Relief Measures in Areas Affected by Natural Calamities, setting out a framework under which banks, NBFCs and other Regulated Entities (REs) may provide relief to borrowers impacted by natural calamities or similar external events. The framework enables REs to extend resolution plans to eligible borrowers, while permitting retention of standard asset classification and lower provisioning, benefits that would otherwise not be available if such restructuring were undertaken under the normal IRACP framework.

It may be noted that earlier RBI had issued guidelines for banks in connection with matters relating to relief measures to be provided in areas affected by natural calamities consolidated under ‘Master Direction – Reserve Bank of India (Relief Measures by Banks in Areas affected by Natural Calamities) Directions 2018 – SCBs’ dated October 17, 2018. In 2016, these guidelines were made applicable, mutatis mutandis, to all NBFCs as well, in areas affected by natural calamities as identified for implementation of suitable relief measures by the institutional framework viz., District Consultative Committee (DCCs)/ State Level Bankers’ Committee (SLBCs). However, given that the provisions were drafted considering the banking operations, the implementation by NBFCs was ambiguous and the provisions were often overlooked.

While the proposed framework applies to both banks (Commercial, RRB, Local area banks etc) and NBFCs, there are separate draft Directions issued for each RE. In case of banks the provisions carry additional system-level and public service responsibilities, reflecting their role within SLBCs and DCCs.

Fig 1:  Actionables for NBFCs under the draft directions

Applicability and process flow

The draft directions are proposed to come into effect from 1 April 2026, after the final directions are notified. The framework is triggered upon formal notification of a natural calamity by the Central Government or the concerned State Government.

Where a calamity affects a substantial part of a State, it is proposed that a special meeting of the SLBC  shall be convened within 15 days of such declaration. If the impact is confined to one or more districts, the corresponding DCC(s) are required to meet within the same timeframe. These committees assess the severity of the impact on economic activity, determine objective criteria for identifying impacted borrowers and indicate the nature and extent of relief such as moratoriums that may be extended by regulated entities operating in the affected areas. The decisions taken in these meetings are communicated to regulated entities and are required to be given adequate publicity, primarily by banks, through field outreach and public communication. The relief framework becomes operational in line with such Government notifications and the decisions of the SLBC or DCC, as applicable.

Amendments in the Credit Policy

The draft directions propose that the REs update their credit policies to incorporate a structured and pre-defined framework for dealing with borrower stress arising from natural calamities. The credit policy is expected to provide for resolution in line with the provisions and to set out objective principles governing the terms of relief across different borrower segments and loan categories.

While the precise parameters may vary depending on the nature and severity of the calamity, the decisions of the SLBC/DCC/Governments, the credit policy is expected to lay down a consistent framework to be applied by the REs when extending relief. This includes identifying potential relief measures, specifying verifiable parameters for determining eligibility of borrowers and extent of relief and defining the delegation matrix for approval and implementation. The emphasis is on ensuring timely decision-making, particularly in relation to restructuring of existing exposures and sanction of additional finance.

Eligible Borrowers and Coverage

Relief under the draft Directions is proposed to be available only to borrowers who meet the prescribed eligibility conditions as on the date of occurrence of the natural calamity. To qualify, the borrower’s account must be classified as ‘Standard’ and must not be in default for more than 30 days with the concerned RE in respect of any facility. Other additional conditions may be laid down in the credit policy.

Borrowers who do not meet these conditions fall outside the scope of the calamity relief framework and may instead be considered for resolution under the applicable Resolution of Stressed Assets Directions. In such cases, however, the RE does not receive the benefit of standard asset classification or lower provisioning (see discussion below). The framework extends its shelter only to those borrowers who, till the moment the calamity struck, had kept their financial obligations substantially intact. The protection is not meant to rescue infirm credit, but to steady sound accounts momentarily shaken by forces beyond human control.

Resolution Plan and Permissible Relief Measures

Where a RE decides to extend relief, the resolution plan is to be structured based on an assessment of the borrower’s post-calamity viability. The draft Directions propose a range of relief measures, including rescheduling of repayments, grant of moratorium, and conversion of accrued or future interest into another credit facility. Regulated entities may also consider sanctioning additional or fresh finance to address temporary financial stress, subject to appropriate assessment of viability and credit risk.

Notably, the framework is enabling rather than mandatory. It does not require automatic restructuring of all eligible accounts, thereby allowing REs to exercise credit judgement while operating within the prescribed regulatory parameters.

Timelines for Invocation and Implementation

It is proposed that resolution under the framework must be invoked within 45 days from the date of declaration of the natural calamity, unless an extension is granted by the Regional Director or Officer-in-Charge of the Reserve Bank. This would mean that the aggrieved borrower must approach the lender and the terms of restructuring must be agreed between both of them within the said timeframe. Once invoked, the resolution plan must be implemented within 90 days from the date of invocation.

In practice, this means that following the Government notification and the SLBC or DCC meeting, typically held within the first 15 days from the notification, REs have a limited 30-day window to complete borrower identification, viability assessment, documentation and approval. Failure to adhere to these timelines results in loss of the regulatory benefits available under the framework.

Asset classification treatment

The most significant regulatory benefit under the proposed framework relates to asset classification. Where a resolution plan is implemented in compliance with the Directions, borrower accounts classified as ‘Standard’ may be retained as such upon implementation instead of facing any downgrade. Further, accounts that may have slipped into NPA status between the date of occurrence of the calamity and the implementation of the resolution plan are permitted to be upgraded to ‘Standard’ upon implementation. However, as per the ECL Policy of the RE, generally any restructuring would automatically be treated as a SICR and therefore, the staging may change and a higher ECL would be required to be provided on such restructuring which may nullify the benefit. 

After implementation, subsequent asset classification is governed by the applicable IRACP norms. The proposed framework also addresses cases of repeated restructuring. Where a borrower account is restructured again under these Directions before the reversal of additional provisions (see below), it may continue to be classified as ‘Standard’, subject to recognition of interest on a cash basis from the second restructuring onwards and maintenance of an additional specific provision of five per cent of the outstanding debt for each restructuring, subject to an overall ceiling of 100 per cent.

Income Recognition and Provisioning

For restructured accounts, it is proposed that interest income may be recognised on an accrual basis. At the same time, REs are required to maintain an additional specific provision of 5% of the outstanding debt, over and above the applicable provisioning under IRACP norms. Reversal of this additional provision can happen only where the borrower repays at least 20% of the outstanding debt, the account does not slip into NPA status after implementation of the restructuring and no further restructuring is undertaken during the relevant period. Specifically for banks, if the outstanding debt post-restructuring is only in the form of non-fund-based facilities or facilities in the nature of cash credit / overdraft, the additional provisions can be reversed after one year, post implementation of the restructuring, provided the borrower was not in default at any point of time during the period concerned.

Ancillary relief measures and government support

It is proposed that the REs be required to extend interest subvention or prompt repayment incentive benefits notified by the Government to all eligible borrowers. They must also ensure that any relief already provided, or being provided, by the Central or State Governments is duly factored into the resolution process.

For agricultural loans secured by land, the draft Directions propose acceptance of certificates issued by Revenue Department officials where original title documents have been lost due to the calamity. In areas governed by community ownership arrangements, certificates issued by competent community authorities may also be accepted. REs may also, at their discretion, provide additional relief such as waiver or reduction of fees and charges for borrowers in affected areas, for a period not exceeding one year. Expected proceeds from insurance policies may also be kept while deciding the relief. Additionally for banks it is proposed that they shall open small accounts for displaced borrowers and take immediate action to restore ATM services in the impacted areas. They may operate their natural calamity affected branches from temporary premises under advice to the RBI. For continuing the temporary premise beyond 30 days, banks may obtain specific approval from the concerned Regional Office of RBI. A bank shall also make arrangements to render banking services in the affected areas by setting up satellite offices, extension counters or mobile banking facilities etc. under intimation to the RBI.

Reporting Requirements

It is proposed that the REs shall upload data on relief measures extended under the framework in the prescribed format on a half-yearly basis. The data points include ‘Outstanding eligible for restructuring as on the date of notification of natural calamity’, ‘Credit facilities restructured/rescheduled during the half year’, ‘Additional/fresh loans provided to affected borrowers during the half year’ etc.  The data must be submitted within 30 days from the end of each half-year, i.e., as of 30 September and 31 March, through the CIMS portal. Where no relief measures are extended during a reporting period, a NIL statement is required to be submitted.

See our other resources:

  1. COVID- 19 AND THE SHUT DOWN: THE IMPACT OF FORCE MAJEURE
  2. RBI Trade Relief Directions: How is your company impacted?

Economic Survey 2026: Key Insights on Infrastructure Financing

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Simrat Singh | finserv@vinodkothari.com

This year’s Economic Survey focuses less on the expansion of credit and more on the quality and sustainability of credit. In infrastructure financing for instance, the Survey notes that the emphasis shifts from the sheer scale of investment to project quality and risk allocation. In this short note, we explore major observations of the Survey w.r.t infrastructure financing and microfinance. 

Infrastructure financing

The Survey 2026 treats infrastructure financing not as a question of “how much more to spend, but how to finance better.” The message is clear: public capital expenditure will continue to lead, but the future of infrastructure finance lies in diversification and market-based instruments, with InvITs and REITs playing a pivotal role.

Public capex still has the lion’s share

The Survey firmly reaffirms public capital expenditure as the backbone of India’s infrastructure push. Government capital expenditure has nearly doubled between FY22 and FY26, underscoring the public sector’s continued leadership in financing infrastructure.

At the same time, the Survey highlights why high public spending alone is not sufficient. Weak project preparation, delays in statutory clearances and rigid contracting structures are identified as key contributors to financial stress in infrastructure projects. The underlying message being that better-prepared projects attract better financing. Public expenditure must increasingly focus on de-risking projects upfront, rather than merely funding asset creation.

Moving away from bank-dominated financing

A gradual move away from infrastructure financing being overly dependent on bank credit is observed. While banks remain important, the Survey recognises the limits of using short-term deposits to fund long-gestation infrastructure assets. Instead, financing growth is increasingly coming from:

  1. NBFCs;
  2. Capital markets;
  3. Pooled investment vehicles such as InvITs and REITs

This shift is seen as essential to reduce systemic risk and prevent a repeat of infrastructure-led stress on bank balance sheets.

Infrastructure Investment Trusts

InvITs are no longer presented as a niche product. The Survey positions them as core infrastructure financing institutions, especially for mature, revenue-generating assets.

Their role is threefold:

  1. Attract long-term institutional capital such as pension and insurance funds;
  2. Remove operational assets from bank balance sheets, reducing asset-liability mismatches;
  3. Enable asset recycling, freeing capital for new infrastructure creation.

Importantly, the Survey sees InvITs less as tools for raising fresh debt for infrastructure spending and more as mechanisms for capital rotation i.e. monetising what is already built to finance what needs to be built next.

InvITs and PPPs: Financing the second half of the project life

The Survey draws a quiet but important distinction between greenfield and brownfield risk. While banks still dominate construction-stage financing, InvITs have become the preferred vehicle for post-construction assets, particularly in roads, power transmission, ports, and telecom. Majorly due to the regulatory requirement of having at least 80% completed and revenue generating assets.

This has strengthened PPP outcomes by:

  1. Providing exits to developers; 
  2. Improving liquidity in infrastructure markets;
  3. Making infrastructure a credible asset class for long-term investors

The proposed launch of the first government-owned public InvIT in 2026 signals the government’s intent to embed InvITs deeper into public asset management, not just private monetisation.

Regulation catching up with financing reality

Supporting this transition, the Survey recognises important regulatory reforms for infrastructure financing such as:

  1. RBI’s Project Finance Directions, 2025 (now subsumed into Credit Facilities Directions), which improve stress recognition, align infrastructure definition and prevent evergreening by introducing stage-based disbursal of funds etc. (Our video explaining the project finance directions can be accessed here and our article on the same can be accessed here);
  2. SEBI’s Small and Medium REIT (SM REIT) framework which has lowered the minimum asset size threshold from ₹500 crore to ₹50 crore and introduced a scheme-based structure, allowing multiple sub-₹500 crore asset pools to be housed within a single SM REIT which expands the universe of monetisable real estate assets and facilitates the participation of smaller, stabilised commercial properties in regulated pooled vehicles.
  3. From 1 January 2026, SEBI has classified Mutual Fund and Specialised Investment Fund (SIF) investments in REITs as equity-related instruments. A move which would introduce much needed liquidity in the REIT space.

What the Survey does and does not claim

The Survey is careful not to oversell InvITs. They are not substitutes for public capex, nor solutions for early-stage project risk. Their success depends on stable cash flows and regulatory certainty. But within those limits, InvITs represent a correction in India’s infrastructure finance model, one that shifts risk away from bank balance sheets and towards diverse long-term capital aligned with infrastructure economics.

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Microfinance and NBFC-MFIs in Economic Survey 2026

Microfinance and NBFC-MFIs in Economic Survey 2026

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Simrat Singh | finserv@vinodkothari.com

The Economic Survey 2026 takes an honest view of India’s microfinance sector. Rather than celebrating credit growth alone, it frames microfinance as a household balance-sheet business, where the real test of success is whether borrowing improves stability and resilience at the last mile or not. NBFC-MFIs, as the primary delivery channel, sit at the heart of this assessment. In this short note, we explore major observations of the Survey w.r.t infrastructure financing and microfinance.

Microfinance remains central to financial inclusion

The Survey reiterates the importance of microfinance in extending formal credit to underserved households. Women account for the vast majority of borrowers and most lending continues to be rural. Over the past decade, the sector has expanded rapidly in both outreach and scale, with NBFC-MFIs accounting for the largest share of lending, followed by banks and small finance banks.

This expansion has made microfinance one of the most effective channels for last-mile credit delivery but it has also exposed the sector to sharper credit cycles.

Recent stress reflects excess lending, not weak demand

The slowdown seen in FY25 is presented as a supply-side correction rather than a failure of the model. The Survey attributes the stress primarily to over-lending and borrower over-indebtedness in certain regions, driven by multiple lenders targeting the same customer base after the pandemic. The key takeaway being that access to credit was not the constraint credit discipline was.

NBFC-MFIs: essential but cycle-prone

NBFC-MFIs remain indispensable to microfinance, but the Survey recognises their structural vulnerability during rapid growth phases. Unsecured lending and limited visibility into borrowers’ total debt make the model sensitive to concentration risks. Regulatory responses have therefore focused on restoring balance rather than tightening credit indiscriminately. The RBI’s decision to lower the minimum qualifying asset requirement has given NBFC-MFIs room to diversify, while self-regulatory measures have reinforced borrower-level safeguards. The Survey notes early signs of stabilisation in asset quality and disbursement trends.

The core challenge: understanding the borrower better

A recurring concern in the Survey is the lack of reliable tools to assess household income and repayment capacity. Many borrowers carry obligations beyond microfinance such as gold loans or agricultural credit that are not always visible at the point of lending. The Survey sees digital public infrastructure as a gradual solution. Wider use of digital payments, data sharing frameworks and account aggregators is expected to improve cash-flow assessment and reduce reliance on informal income proxies. Using all this information about its borrowers, the MFIs are expected to improve their credit assessment.

Rethinking what “impact” really means

One of the Survey’s most important observations is its critique of how success in microfinance is measured. While private capital has helped scale the sector, growth-centric metrics can unintentionally encourage repeated lending without sufficient regard for borrower outcomes. The Survey argues for a shift towards welfare-oriented indicators such as income stability, reduction in distress borrowing and sustainable debt levels rather than portfolio size alone. In doing so, it challenges the assumption that more credit automatically translates into better outcomes.

What the Survey ultimately says

The Survey neither dismisses microfinance nor romanticises it. It acknowledges its critical role in inclusion, while warning that unchecked expansion can weaken household balance sheets. Long-term sustainability, it suggests, depends less on how fast credit grows and more on how responsibly it is delivered. The Economic Survey’s message is simple: the future of microfinance lies in lending better, not lending more. For NBFC-MFIs, this means aligning growth with borrower capacity, using data more intelligently and treating household stability, not loan volumes, as the true measure of success.

Read our other resources

Climate Finance: domestic resources insufficient to bridge funding gaps

Representation with respect to NBFC-related Regulatory Issues

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– Team Finserv | finserv@vinodkothari.com

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