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What are Covered Bonds

26 Jul 2023
  • In the ever-evolving world of finance, investors are constantly looking for secure and reliable investment options.
  • One such option that has gained significant popularity in recent years is covered bonds.
  • These financial instruments provide a unique combination of stability, attractive yields, and robust investor protection. 
  • This article will discuss these instruments in detail. Moreover, it will help you explore their types and the reasons to consider investing in them.

What are Covered Bonds?

  • Covered bonds are special debt instruments that are issued by banks and are backed by a dedicated pool of assets, like mortgages or loans, to public entities.
  • These assets act as collateral and provide added security to investors. 
  • So, if the bank defaults, bondholders have a claim on the assets in the cover pool. 
  • This dual recourse feature makes covered bonds a relatively safe investment option, attracting institutional and individual investors.

What are the Types of Covered Bonds?

Two main types of covered bonds are:

  • Legislative covered bonds: These bonds are backed by loans granted to public entities with specific legal provisions that enhance their credit quality. The legislative support provides an additional layer of security, making these covered bonds highly attractive to investors who seek reliability and protection.
  • Contractual covered bonds: These bonds are a type of covered bond where the issuer and bondholders enter into a contractual agreement that outlines the rights and obligations of both parties. This agreement provides additional clarity and certainty regarding the terms and conditions of the bond, which greatly enhances investor confidence and transparency.

 

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What are the Key Features of Covered Bonds?

Some of the main features of covered bonds are as follows:

  • Dual recourse: Covered bondholders have a dual recourse to the issuer and the cover pool assets. This means that if the issuer defaults, bondholders have a claim on the issuer's general and cover pool assets.
  • Ring-fencing: The assets in the cover pool are ring-fenced, i.e. they are legally separated from the issuer's other obligations. This ensures that the assets are solely available to meet the bondholders' claims.
  • High-quality collateral: Covered bonds are backed by high-quality assets, typically consisting of low-risk loans. This ensures a strong level of security for investors.
  • Transparency: The issuers of covered bonds must provide regular and comprehensive information about the cover pool assets. This enables investors to assess the quality and performance of the underlying assets.

Who are the Main Investors in Covered Bonds?

Covered bonds attract a diverse range of investors, including:

  • Institutional Investors: Institutional investors, like pension funds and insurance companies, are drawn to covered bonds because these bonds are a stable and secure investment option.
  • Retail Investors: Individual investors seeking a safe investment option with attractive returns often turn to covered bonds.
  • Central Banks: Central banks may invest in covered bonds as part of their monetary policy operations to manage liquidity in the financial system.

Who Issues Covered Bonds in India?

In India, covered bonds are issued by a few select financial institutions, including:

  • State Bank of India (SBI).
  • Housing Development Finance Corporation (HDFC).
  • National Bank for Agriculture and Rural Development (NABARD).
  • Export-Import Bank of India (EXIM Bank).

Why Should You Invest in Covered Bonds?

Some of the reasons to invest in covered bonds include:

  • Stability: These bonds offer stability and security, which makes them an ideal investment option for risk-averse investors. The dual recourse structure and high-quality collateral enhance the safety of the investment.
  • Attractive yields: They provide higher yields than low-risk investments, such as government bonds. This makes them an appealing choice for investors seeking a balance between income generation and risk mitigation.
  • Portfolio diversification: Investing in covered bonds can help diversify your investment portfolio by spreading risk across asset classes and issuers.

Conclusion

  • To sum up, there are various good reasons to invest in covered bonds. You can safely include them in your investment portfolio. 
  • However, choosing the ideal type of covered bond depends on your return expectations. 

Therefore, you must consult a reliable financial advisor or conduct thorough research before putting your money into covered bonds.

 

Related Articles: The Benefits of Investing in Bonds | Is it worth investing in sovereign gold bonds?

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