Tranching answers a real question: a pool has an average risk, but investors do not want average risk, money funds and insurers want a claim safer than the pool, and credit funds will take one much riskier for a much higher yield. The structure manufactures both from the same collateral.
Vocabulary. A special purpose vehicle (in India, a trust) buys the pool, isolating it from the originator's bankruptcy, and funds the purchase by issuing tranches. The waterfall is the contractual priority in which collections are applied each period. Time tranching distributes principal sequentially (A until retired, then B, then C) manufacturing a short average life and a long one from one pool. Credit tranching distributes losses in reverse, the most junior absorbing first.
How does the waterfall protect investors, and how do you check it?
The four forms of credit enhancement, in the order they absorb loss:
- Excess spread: the pool earns more than the notes pay. It is the first line of defence, and it arrives period by period rather than as a stock.
- Over-collateralisation (OC): the pool balance exceeds the notes issued. A ₹500 crore pool funding ₹470 crore of notes carries ₹30 crore of OC.
- Subordination: the junior tranches are a loss buffer for the senior ones.
- Reserve fund / cash collateral: a funded cash account, drawable on shortfalls.
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And the mechanism that turns those buffers into protection: triggers. A cumulative-loss, delinquency or coverage trigger, when breached, changes the waterfall, most commonly by trapping excess spread that would otherwise be released to the originator and using it to accelerate ("turbo") the senior notes. Worked Example 7 shows the counter-intuitive result: with identical losses on identical collateral, the trigger is worth more to the senior than several points of subordination, because it stops value leaving the structure while there is still value to keep.
The tie-out discipline. A waterfall is an accounting identity before it is anything else. Three checks must hold exactly, and if any fails the model is wrong however sophisticated it looks: principal paid to all tranches = principal collected (in a clean CMO, also = the sum of original tranche balances); interest paid + residual released = net interest collected; and where there are losses, principal collected + losses = original pool balance once resolved.
How does securitisation work in India?
The India frame (R6). Indian securitisation runs under the RBI's Master Direction. Securitisation of Standard Assets Directions, 2021 (read the current version; specifics are perishable and this module cites the framework, not a quoted figure). Two structures: PTC (pass-through certificates issued by a trust, the true, tranched securitisation) and DA (direct assignment, a bilateral pool sale with no tranching). Two safeguards define the regime: the minimum retention requirement (MRR), forcing originator skin in the game against originate-to-distribute; and the minimum holding period (MHP), forcing seasoning on the originator's own book before sale. Both are the 2008 lesson written into rules. Structurally, India has no large agency guarantor, so almost all Indian ABS is credit-enhanced by the originator and the enhancement stack does all the work; and the market's purpose differs too, it is a funding channel for NBFCs and HFCs (M5.02) and a priority-sector-lending acquisition channel for banks.