Mortgage-backed securities: Why India shouldn't fear their debut as a leap into the unknown

The transaction was modest in size but significant in meaning. For the first time, Indian home loans were transformed into a transparent, exchange-listed instrument with market price discovery. In a system long dominated by bank balance sheets, this was a small but meaningful widening of the path for housing finance.

The case for deepening India’s mortgage-backed securities market rests on the sheer scale and quality of housing finance itself. Outstanding housing loans now exceed ₹30 trillion, comprising about one-fifth of total non-food bank credit, and have grown at a steady 12–14% annually over the past decade, driven by urbanization, household formation and rising formal incomes rather than speculative excess. Asset quality has remained robust, with home-loan delinquencies typically well below 2% even during stress.

However, this large, long-term and stable asset class is funded in a strikingly narrow way, with over 85% of housing credit staying on the balance sheets of banks and housing finance companies, financed largely through deposits and wholesale borrowings. Securitization plays only a marginal role, with total annual volumes of ₹1.5–2.5 trillion across all assets and residential mortgages accounting for just 15–25% of that flow.

In stock terms, securitized housing loans are only a low single-digit share of outstanding credit. The result is a growing mismatch in which long-dated, low-risk housing assets are funded primarily through shorter-term though increasingly competitive liabilities, strengthening the case for a gradual market-based complement to balance-sheet funding.

The RMBS listing should not be mistaken for a dramatic shift in policy or philosophy. It does not signal a wholesale embrace of securitization-led housing finance, nor does it mirror the US model where mortgage bonds dominate funding. Instead, it reflects India’s instinct for incrementalism by strengthening the financial system step by step, testing investor appetite and expanding cautiously without undermining stability.

A central reason for this lies in regulation. India has deliberately constrained the originate-to-distribute model that underpins large securitization markets elsewhere.

Lenders are required to hold housing loans for a minimum period before securitizing them and must retain a slice of the credit risk even after selling securities. For residential mortgage-backed securities (MBSs), minimum risk retention is typically around 5%.

These rules ensure that lenders retain ‘skin in the game,’ aligning incentives and discouraging careless underwriting. These safeguards also make securitization less lucrative as a volume-driven business.

The contrast with the US market is instructive. In the US, housing finance migrated decades ago from banks to capital markets, supported by government-sponsored enterprises and standardized government-backed mortgage securities.

That system delivered deep liquidity and long-term fixed-rate mortgages, and allowed the Federal Reserve to influence housing directly by buying mortgage bonds during crises.

It also sowed the seeds of a massive crisis. When underwriting standards eroded, the originate-to-distribute machine amplified risk across the financial system, culminating in the 2008 financial crisis. Cheap credit came at the cost of systemic fragility.

Indian policymakers have drawn clear lessons from that experience. Neither the government nor Reserve Bank of India has shown any appetite for large-scale government guarantees or for turning housing credit into a heavily traded asset class. The emphasis has instead been on resilience through conservative underwriting, balance-sheet accountability and gradual market development.

Are we, then, missing an opportunity by not pushing harder? The answer is both yes and no. A deeper MBS market could recycle bank capital faster, draw in long-term savings and potentially lower mortgage rates.

There is also a macroeconomic argument. As housing finance grows larger, its interaction with monetary policy becomes more important. In bank-dominated systems, policy transmission depends heavily on deposit conditions and bank balance-sheet health. A modest, well-regulated MBS market could support India’s vast housing needs and give RBI an additional lever during downturns.

These benefits are real, and over time, they may justify gradual expansion. However, the costs of haste are equally real. A large and liquid MBS market could weaken the link between origination and accountability.

In an economy where legal enforcement can be slow and income documentation uneven, that separation carries risks. More importantly, India’s relatively stable housing cycles and absence of a housing-led financial crises are not accidents; they are the product of conservative design choices.

The RMBS launch, therefore, should be seen as a measured experiment. It suggests that India is ready to deepen its housing finance market as a move towards financial maturity. Executed carefully, such issuances can build confidence, allow standardization and create a modest investor base. If rushed, they could engender stability risks.

For now, India appears to be striking a sensible balance. The move towards market-based housing finance is not a departure from prudence. It is a sign of evolution.

The scale that housing loans have reached, funding pressures ahead and the need to mobilize resources before constraints become binding all argue in favour of an MBS market. Its success should not be judged by how quickly volumes grow, but by whether housing finance becomes incrementally more diversified, transparent and durable without courting the vulnerabilities that others have learnt to regret.

The author is professor, Madras School of Economics