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What are covered bonds?

Covered bonds are debt securities issued by a bank or Non-Banking Financial Company (NBFC) which are collateralized against a pool of assets. In case of failure of payment from the issuer, the amount can be recovered from the pool of assets.

The structure of a covered bond is explained below.

  1. Bank or NBFC issues bonds to the investors.
  2. As a recourse(safety measure), a cover pool of secured loans is also taken.
  3. The bank or NBFC pays the principal + interest to the investors at the end of maturity of the bond.
  4. If the bank or NBFC fails to make the payment, the amount can be recovered from the cover pool.

The cover pool of secured loans consists of Housing loan, vehicle loan, gold loan etc.

Unlike secured corporate bonds which provide recourse against the issuer, covered bonds provide a dual recourse – that is, first recourse against the issuer, and bankruptcy-protected recourse against the assets of the issuer (Cover Pool) too. Generally, due to the cover provided, Covered bonds are expected to provide a credit rating upliftment, over and above the credit rating of the issuer.

Covered bonds cannot be pledged as collateral with Zerodha. To know more about this, please click here.