An Asset Backed Security (ABS) is a type of financial instrument that is backed by a pool of underlying assets such as loans, leases, credit card debt, or receivables. These assets generate regular cash flows, which are then used to pay interest and repay principal to investors.
The main objective of issuing ABS is to provide liquidity to the originators (e.g., banks, NBFCs) by moving assets off their balance sheets. For investors, ABS offer opportunities to earn fixed income returns from diversified pools of assets, often with higher yields than traditional debt instruments.
A finance company pools together hundreds of car loans it has issued and securitizes them into an ABS. Investors who buy the ABS receive payments based on the EMIs paid by the car loan borrowers.
In India, ABS are commonly issued by Non-Banking Financial Companies (NBFCs) to raise capital. The Reserve Bank of India (RBI) has laid down specific guidelines on securitization, ensuring transparency and protecting investor interests.