What happens to my money in an SDI (Securitized Debt Instrument) if the underlying borrowers default?

Risk cannot be completely eliminated in Securitized Debt Instruments, but structural safeguards like over-collateralization heavily mitigate your actual principal loss during mass defaults. When an NBFC issues an SDI, they bundle a specific subset of loans into a separate, ring-fenced structure.

To protect investors, regulators mandate a strict skin in the game requirement, typically around 16% to 20% over-collateralization. This means if investors contribute Rs 80, the NBFC places loans worth Rs 100 into the pool. That extra 20% absorbs the first hit if any loans turn into Non-Performing Assets, shielding your principal and interest up to that threshold.

Let me give you a real-world example of how this plays out during a crisis. Recently, severe floods in Punjab impacted nearly 50% of the borrowers for a specific NBFC featured in an SDI pool. Because the default rate breached the 20% safety buffer provided by the NBFC, the investors did face a loss.

However, thanks to that over-collateralization, the investors' principal loss was capped at 15%, despite a massive 50% default rate in the underlying asset pool. Regulators also require a 6months seasoning requirement, meaning the underlying loans must have performed well on the NBFC's balance sheet for at least half a year before being securitized. So while you can lose money in extreme scenarios, the structural buffers ensure your losses are significantly lower than the actual default rate of the pool.

Disclaimer: All information shared above are strictly for educational and informational purposes only. It should not be construed as financial or investment advice.