rbi guidelines on transfer of assets through direct assignment

RBI'S Framework For Transfer Of Loan Assets

Contributor.

As an anticipated measure for the banking and financial sector, the Reserve Bank of India (RBI) has, towards the close of past week, issued the comprehensive framework for the sale or transfer of loan assets. Taking immediate effect from the date of its issuance, the framework titled ' Master Directions - Reserve Bank of India (Transfer of Loan Exposures) Directions, 2021 ' issued vide circular DOR.STR.REC.52/21.04.048/2021-22 dated September 24, 2021 (the ' Master Directions ') is being seen as a pivotal move by the Regulator towards introducing an efficient secondary market for loans and ensuring proper credit-risk pricing, besides improving transparency in the identification of embryonic stress in the banking system as well as resolution of stressed loan exposures.

The Master Directions owes its genesis to the ' Draft Framework for Sale of Loan Exposures ' which was released by RBI in course of the first COVID-19 induced lockdown in the Country. The draft had taken into consideration the recommendations of the ' Task Force on Development of Secondary Market for Corporate Loans ' constituted by RBI under the chairmanship of Mr. T.N. Manoharan in May, 2019 and comments from the stakeholders were invited. One of the key components of the Task Force's recommendation was to separate the regulatory guidelines for direct assignment transactions from the securitisation guidelines and treat it as a sale of loan exposure. The RBI had, accordingly, reviewed the recommendations and thought it prudent to comprehensively revisit the guidelines for sale of loan exposures, both standard as well as stressed, which were earlier spread across various circulars. The erstwhile guidelines or circulars on sale of loan exposures were particular to the asset classification of the loan exposure being transferred and / or the nature of the entity to which such loan exposure is transferred as well as the mode of transfer of the loan exposures. The need for a review also stemmed from the necessity to dovetail the guidelines on sale of loan exposures with the Insolvency and Bankruptcy Code, 2016 (' IBC ') and the Prudential Framework for Resolution of Stressed Assets dated June 7, 2019 (" Prudential Framework "), which has witnessed substantial traction and developments towards building a robust resolution paradigm in India in the recent past.

The consolidation by RBI of a self-contained, comprehensive, and independent set of regulatory guidelines on transfer/sale of loan exposures is being seen as a laudable step in the direction of putting together a ' robust secondary market in loans which can be an important mechanism for management of credit exposures by lending institutions and also create additional avenues for raising liquidity '. This write-up attempts to briefly summarize some key components of the Master Directions.

The Master Directions whilst superseding a host of existing circulars/directions (or a portion thereof) in relation of transfer of loan exposures (Chapter VI), has put forth a unified and singular framework for the sale of loan exposures by banks and other financial institutions. The exhaustive breadth of the framework is quite evident from the Chapters under the Master Directions which not only provide for ' General Conditions applicable to all Loan transfers ' (Chapter II), but also cater specifically to transfer of loan exposures of standard assets (Chapter III) as well as stressed loan exposures (Chapter IV), including their respective and intrinsic modalities. The framework concludes with the imperative of ' Disclosures and Reporting ' (Chapter V) and stipulates the mechanism for the stakeholders in that regard.

Applicability

On expected lines, nearly all constituents of the Financial sector regulated by RBI are mandated to ensure compliance to the Master Directions, both as a transferor as well as transferee of the loan exposures – Scheduled Commercial Banks, all NBFCs (including HFCs), Regional Rural Banks, Co-operative Banks, All India Financial Institutions and Small Finance Banks. In addition, the Master Directions also permits asset reconstruction companies (ARCs) 1 and companies 2 (save a financial service provider 3 ) to be 'transferees' of the loan exposures only if the same is pursuant to the resolution plan under the Prudential Framework and if they are permitted to take on loan exposures in terms of a statutory provision or under the regulations issued by a financial sector regulator.

It would be pertinent to take note that though all lenders permitted to acquire loans are required to ensure compliance to the extant Master Directions; yet, the acquisition of loans pursuant to securitisation are required to be independently dealt under the provisions of RBI's ' Master Directions – RBI (Securitisation of Standard Assets) Directions, 2021 ' dated September 24, 2021 (the 'Securitisation Guidelines'). The coverage of the Master Directions includes transfer of loan exposures through novation, assignment, or risk participation. In cases of loan transfers other than loan participation, legal ownership of the loan shall be mandatorily transferred to the Transferee to the extent of economic interest transferred under the loan exposures.

For the Transferees which are financial sector entities (not falling under clause 3 of the Master Directions) and the ARCs, the prudential norms (asset classification, provisioning norms etc) of their respective sectoral regulators (SEBI, IRDA, PFRDA etc) shall be applicable post-acquisition of loan exposure under the Master Directions.

Basic Ingredients

Before venturing into the other nuances, it is an imperative that one accounts for the understanding of some key 'constructs' which cut across the Master Directions:

• Transfer : Quite apparently, the expression denotes the process of transfer of the economic interest in a loan exposure by the transferor and acquisition of the same by the transferee. The subject matter of transfer being the ' economic interest ' of the transferor in the loan exposure, it is important that the risks and rewards associated with loans are clearly demarcated and separated in favour of the transferee; especially when some portion of the economic interest in the loan exposure is retained by the transferor.

It is significant to take note that the transfer of the said economic interest can be with or without the transfer of underlying contract. Essentially, even loan participation transaction have also been recognised under the Master Directions (for transfer of standard loans) wherein the transferor transfers all or part of its economic interest in a loan exposure to transferee without the actual transfer of the loan contract, and the transferee(s) fund the transferor to the extent of the economic interest transferred which may be equal to the principal, interest, fees and other payments, if any, under the transfer agreement.

• Transferor : Often referred as 'assignor' (in assignment transactions) or 'grantor' (for risk participation), transferor under the Master Directions would include Clause 3 entities which transfer their economic interest in the loan exposures.
• Transferees : These refer to entities in whose favour the economic interest in the loans are transferred and would include Clause 3 entities as well as the ARCs/companies to the extent permitted under the Master Directions. It is clarified that the transferee should neither be a person disqualified under the IBC 4 nor, in cases of loan exposures where frauds have been identified, belong to an existing promoter group 5 of the borrower or its subsidiary / associate / related party 6 (domestic as well as overseas).
• Minimum Holding Period (MHP) : As the expression suggests, the MHP refers to a threshold period for which the transferor should hold the loan exposures, along with its risks and rewards, before the economic interest in respect thereto is transferred. The intent of having a MHP is to ensure that the loan has been seasoned in the books of the originator (or the transferor) for a certain specified time period. The MHP for loans with tenor upto 2 years and more than 2 years, as per the Master Directions, have been capped at 3 months and 6 months, respectively.

The holding period for the Transferor, in case of secured exposures, is to be computed from the date of registration of the underlying security interests; unless, of course, the loan is unsecured in which case the MHP runs from the date of first repayment under such unsecured exposure. However, in case of project loans, the foregoing months of MHP is required to be calculated from the date of commencement of commercial operations of the project being financed. Besides, the loans acquired by the Transferor itself are required to have a MHP of atleast 6 months from the date of acquisition of the loan on the books of the Transferor, irrespective of the tenor of the loan exposures.

It would be of significance to note that the MHP criteria prescribed under the Master Directions do not apply for loans transferred by an arranging bank under a syndication arrangement.

• Permitted Transferees : These include (i) Scheduled Commercial Banks, (ii) NBFCs (including HFCs), (iii) All India Financial Institutions and (iv) Small Finance Banks. The significance of carving out the foregoing financial sector entities from Clause 3 of the Master Directions lies in the fact that the transferor is permitted to transfer its loans (which are not in default) to permitted transferees only through novation, assignment, or loan participation. For the stressed exposures, the transfer is mandated only to such permitted transferees and ARCs and singularly through assignment or novation of such loan exposures.

Underlying Elements

The finer nuances of the Master Directions would certainly surface once the provisions have been widely given effect to by the stakeholders; however, as it stands, the framework undoubtedly promises to streamline the procedures and requirements for the stakeholders considering transfer of their loan exposures – standard as well as stressed. Some fundamental provisions of the Master Directions have been summarized as below:

• Overarching Transfer conditions : Quite categorically, the Master Directions stresses on the necessity of delineation of Transferor's 'risks and rewards' associated with the loan exposures to the extent of the transfer. In fact, it is stated that not only should the transferee have the unrestrained and unconditional entitlement to transfer or dispose of the loans to the extent of economic interest acquired by it, but also in the event of any economic interest in the loan exposure is retained by the transferor, the loan transfer agreement should demarcate the distribution of the principal and interest income from the transferred loan between the transferor and the transferee. The Master Directions also caution against any modification of terms of the underlying financing agreement and require that any change, in course of such transfer, should withstand the test of not being categorised as 'Restructuring' under the Prudential Framework. It would be significant to take note that the transfer of loan exposures under the Master Directions not only should be without recourse to the Transferor, but also the transferor or transferee should not be constrained to obtain consent from the transferee/ transferor, as the case may be, in the event of resolution or recovery in respect of the beneficial economic interest retained by or transferred to the respective entity. In addition to the foregoing, the Master Directions also prescribe for the enumerated conditions applicable to all transfers of loan exposures:
• The Transferor shall have no obligation to re-acquire or fund the re-payment of the loans or any part of it or substitute loans held by the Transferee or provide additional loans at any time;
• If the security interest is held by the Transferor in trust with the Transferee as the beneficiaries, the Transferee shall ensure that a mutually agreed and binding mechanism for timely invocation of such security interest is put in place;
• Any rescheduling, restructuring or re-negotiation of the terms of the underlying agreement attempted by Permitted Transferee, after the transfer of assets to the transferee, shall be as per the Prudential Framework;
• The Clause 3 entities, regardless of whether they are transferors or otherwise, should not offer credit enhancements or liquidity facilities in any form in the case of loan transfers.

In case the transfer of loan exposures which are not compliant with the requirements mentioned in the Master Directions, the onus is on the Transferee to maintain capital charge equal to the actual exposure acquired and the Transferor is required to treat the transferred loan in its entirety, as if it was not transferred at all in the first place, and the consideration received by it shall be recognised as an advance.

• Board-approved Policy : The Transferors are mandated to put in place a comprehensive Board-approved policy for transfer and acquisition of loan exposures under the Master Directions. These guidelines must, inter alia , lay down the minimum quantitative and qualitative standards relating to due diligence, valuation, requisite IT systems for capture, storage and management of data, risk management, periodic Board level oversight, etc. Further, the policy must also ensure the independence of functioning and reporting responsibilities of the units and personnel involved in the transfer/acquisition of loans from that of personnel involved in originating the loans.
• Transfer of Standard Assets : The transfer of loan exposures classified as 'standard' can be undertaken through the mechanisms of assignment or novation or a loan participation. The transfer of such loan exposures should be only on a cash basis to be received at the time of transfer of loans; besides, the requirement of the transfer consideration being arrived at in a transparent manner on an arm's length basis. The Master Directions require the Transferees to monitor, on an ongoing basis and in a timely manner, the performance information on the loans acquired, including through conducting periodic stress tests and sensitivity analyses, and take appropriate action required, if any. Further, the Transferor's retention of economic interest, if any, in the loans transferred should be supported by legally valid documentation supported by a legal opinion.

The requirements of Chapter III of the Master Directions are, however, not applicable to certain identified loan transfers, as below:

• transfer of loan accounts of borrowers by a lender to other lenders, at the request/instance of borrower;
• inter-bank participations as per the RBI's circulars;
• sale of entire portfolio of loans consequent upon a decision to exit the line of business completely;
• sale of stressed loans; and
• any other arrangement/transactions, specifically exempted by the RBI.
• Minimum Risk Retention : The Master Directions are explicit in their requirement of the requisite due diligence in respect of the loans exposures and mention that the said exercise cannot be outsourced or delegated by the Transferee. In order to ensure a systemic departure from the conventional practice of placing solitary reliance on the due diligence of the originator (or the Transferor), the Master Directions mandate the Transferee to undertake the due diligence of the loan exposures through its own staff, at the level of each loan, and as per the same policies as would have been done had the Transferee been the originator of the loan. In case the due diligence of entire portfolio is undertaken by the Transferee, the requirement of a minimum retention requirement (MRR) of the Transferor can be dispensed with.

However, in case of loans proposed to be acquired as a portfolio, if a transferee is unable to perform due diligence at the individual loan level for the entire portfolio, the Transferor shall retain at least 10% of economic interest in the transferred loans as MRR. In such a case as well, the Transferee is required to undertake due diligence at the individual loan level for not less than one-third (1/3 rd ) of the portfolio by value and number of loans in the portfolio. As per the Master Directions, in case of multiple Transferees, the MRR would still be on the entire amount of transferred loan, even if any one of the transferee is unable to perform the due diligence at an individual level.

• Transfer of Stressed Assets : Chapter IV of the Master Directions deals specifically with the transfer of stressed loan exposures to ARCs and other Permitted Transferees. It is specifically stated that the mechanism for transfer of such stressed accounts can be consummated only through assignment or novation. Besides the requirement of a Board-approved policy for transfer as well as acquisition of stressed loan exposures and the parameters thereof, the Master Directions mandate such transfers to ARCs and other Permitted Transferees only. Importantly, the Transferor is necessarily required to undertake an auction through a ' Swiss Challenge method ' both in cases where (i) the aggregate loan exposure to be transferred is Rs. 100 crore or more after bilateral negotiations; and even under (ii) a transfer pursuant to the Resolution Plan approved in terms of the Prudential Framework (irrespective of the monetary threshold).

The transfer of such stressed loan exposures, as per the Master Directions, should be bereft of any operational, legal or any other type of risks relating to the transferred loans including additional funding or commitments to the borrower / transferee. In fact, it is specifically required for the transferor to ensure that no transfer of a stressed loan is made at a contingent price whereby in the event of shortfall in the realization of the agreed price, the Transferor would have to bear a part of the shortfall.

In addition, the Transferor is required transfer the stressed loans to transferee(s) other than ARCs only on cash basis and the entire transfer consideration should be received not later than at the time of transfer of loans. The stressed exposure can be taken out of the books of the Transferor only on receipt of the entire transfer consideration.

Quite significantly, the Master Directions prescribed that if the Transferee of such stressed loan exposure (except ARCs) have no existing exposure to the borrower whose stressed loan account is acquired, the acquired stressed loan shall be classified as "Standard" by the transferee. However, in case the Transferee has an existing exposure to such borrower, the asset classification of the acquired exposure shall be the same as the existing asset classification of the borrower with the Transferee, irrespective of whether such acquisition is pursuant to the transferee being a successful resolution applicant under the IBC.

Further, the Master Directions require the Transferee to hold the acquired stressed loans in their books for a period of at least 6 months before transferring to other lenders; however, such holding period is not applicable in case the transfer of stressed loan exposure is to an ARC or is pursuant to a resolution plan approved in terms of the Prudential Framework.

As regards the mandate of undertaking the 'Swiss Challenge method' is concerned, the Master Directions require the lenders put in place a Board-approved policy which should, interalia , specify the minimum mark-up over the base-bid required for the challenger bid to be considered by the lender(s), which in any case, shall not be less than 5% and shall not be more than 15%. However, for transfer of stressed exposure under the Prudential Framework, the minimum mark-up over the base-bid required for the challenger bid is to be decided with the approval of signatories to the ICA representing 75% by value of total outstanding credit facilities and 60% of signatories by number.

Additionally, the Master Directions provide for sharing of surplus between the ARC and the Transferor, in case of specific stressed loans; though, the clarity in respect of such specific stressed loans is not mentioned. The repurchase of stressed loan exposures is also stipulated from the ARCs in cases where the resolution plan has been successfully implemented

• Accounting : In the event the transfer of loan exposures results in loss or profit, which is realised, the same should be accounted for and, accordingly, reflected in the P&L account of the Transferor for the accounting period during which the Transfer is consummated. However, the unrealised profits (if any) arising out of such Transfers, shall be deducted from the Common Equity Tier 1 (CET 1) capital or net owned funds of the Transferor for meeting regulatory capital adequacy requirements till the maturity of such transferred exposures. The Master Directions prescribe maintenance of borrower-specific accounts both by the Transferor as well as the Transferee of the retained and transferred loan exposures, respectively. It has been further clarified that the extant requirements of RBI for 'income recognition, asset classification, and provisioning' shall, accordingly, be ensured by the transferor and the transferee with respect to their respective shares of holding in the underlying loan exposures.

Though it would be quite nascent to present an analysis of the Master Directions even before it has been actually implemented, yet there are indeed some crucial aspects which underline the significance of the Master Directions issued by RBI which can be summarized as follows:

• Identification and Resolution of Stressed Exposures : Though quite a premature assessment, yet it is felt that the framework under Master Directions could facilitate the development of a robust distressed asset ecosystem and speed-up the resolution of various stressed exposures, which could be driven by the ensuing characteristics of the Master Directions:
• Early Identification and Resolution of Stressed Exposures : The framework has expanded the definition of stressed exposures ('stressed loans') to include both non-performing assets (NPAs) and special mention accounts (SMAs). Also, the deregulation of the price discovery process will enable faster and more efficient pricing of exposures – especially when coupled with a wider range of eligible investors.
• Enhanced Viability of Stressed Asset Takeover Structures :More importantly, the Master Directions allow investors in stressed assets to classify the exposure as standard, although subject to any other exposure to the same entity on the investor's books not being sub-standard on the date of the acquisition of the asset. This could significantly lower capital charge and provisioning requirements for the acquirer/investor of the stressed assets. Given that most stressed assets are restructured as well – often including a complete management overhaul, the rationalisation of the capital charge and provisions could make such assets more attractive to prospective acquirers.
• Impetus to Long-Term Funding structures : The Indian credit markets have for long been bereft of avenues for mobilising capital through long-term debt instruments. As a result, liability structures for corporate borrowers in sectors such as power generation and roads front load cash outflows during the project life. This, at least in part, reflects the non-availability of long-dated liabilities for the financial sector. Therefore, an ecosystem which allows lenders to off-load long-dated exposures after a certain time period with reasonable foresightedness could enable borrowers to raise long-term debt instruments from the financial system in a cost-efficient manner.
• Independent Credit Evaluations Could Prove Critical : The Master Directions mentions that transferees may have the loan pools rated before acquisition so as to have a third-party view of their credit quality in addition to their own due diligence; though, the latter is a mandatory requirement and cannot substitute for the due diligence that the transferee(s) are required to perform. Also, in case of transfer of stressed assets, it becomes critical to ensure that the valuation of the exposure and associated risk capital allocation are based on an assessment of the asset to meet its contractual debt obligations. Even restructured accounts have subsequently come under stress in some cases due to fundamental weaknesses in the business profile, heightened management risk/weak governance structures and unsustainable debt levels even after restructuring. Though not prescribed as a mandatory requirement under the Master Directions, yet a third-party evaluation by a credit rating agency could provide an added layer of assessment and valuations for such exposures along with subsequent capital charge and provisioning norms could be linked to the outcome of such evaluation.

1. Registered with the Reserve Bank of India under Section 3 of the Securitisation and Reconstruction of Financial Assets and Enforcement of Security Interest Act, 2002

2. Sub-section (20) of Section 2 of the Companies Act, 2013

3. Sub-section (17) of Section 3 of the Insolvency and Bankruptcy Code, 2016

4. Section 29A of the Insolvency and Bankruptcy Code, 2016

5. As defined under SEBI (ICDR) Regulations, 2018

6. As defined under the Insolvency and Bankruptcy Code, 2016

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

Finance and Banking

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Intricacies of the Draft Framework on Sale of Loans

-Kanakprabha Jethani ([email protected])

The draft framework for ‘Sale of Loan Exposures’ [1] (‘Draft’) issued by the Reserve Bank of India (RBI) recently provides a detailed framework for sale of all kinds of loan exposures viz. standard, stressed and NPLs. The RBI invited comments and suggestions from the stakeholders on the Draft and has raised a few specific questions for discussion in the Draft.

Presently, there are two separate guidelines, one for sale of standard assets (Direct Assignment guidelines) and one for sale of stressed assets and NPLs (Master Circular on Prudential norms on Income Recognition, Asset Classification and Provisioning pertaining to Advances [2] )

While we have already prepared a comparative [3] and a detailed analysis [4] for sale of standard loans, we hereby provide an analysis of guidelines relating to sale of stressed assets and NPLs.

Understanding the Existing Framework

The existing framework for sale of loan exposures is posed in bits and pieces. The framework may broadly be understood in the following manner:

What does the Draft behold?

The Draft proposes a consolidated framework to govern sale of loan exposures and is a combination of certain existing guidelines and some newly introduced ones. Let us delve into key changes introduced in the Draft one by one.

Applicability

While the existing guidelines were specifically applicable to NBFCs, banks and other financial institutions, the applicability of the Draft is extended to SFBs and All India Financial Institutions (AIFIs) such as NABARD, NHB, SIDBI, EXIM Bank etc.

The existing guidelines were applicable to sale of loans by a financial entity to another. However, this did not prohibit sale of loans to non-financial entities. The only difference was that the rights under SARFAESI and other laws were impacted.

The Draft guidelines specifically state that the sale of sale of loans may be made by the entities mentioned above as sellers to any regulated entity, which is allowed by its statutory or regulatory framework to buy such loans.

Hence, any sale of loans, to entities whose regulatory/statutory framework does not allow such purchase, cannot be done. Further, sale of loan to entities whose regulatory/statutory framework allows such purchase, irrespective of whether such entity is a financial entity or not, shall be governed by the provisions of the Draft.

Nature of Assets

The Draft directions contain separate provisions for sale of standard assets, sale of stressed assets to ARCs and sale of NPAs. Under the existing framework, an asset was said to be standard, till it is classified as NPA i.e. after 90 DPD. The Draft defines stressed assets to include NPAs as well as SMA accounts. Thus, any 0+ DPD account becomes a stressed asset. Due to this, the provisions relating to sale of standard assets, which are broadly in line with the guidelines on DA, shall not apply on assets falling between 1 to 90 DPD.

Since the classification of the asset is strictly based on the number of days past due, it may raise various practical difficulties. For example, if the due date for repayment of a loan installment is January 1, 2020 and there is a grace period of 10 days. The loan is classified as SMA-0 on February 1, 2020 (irrespective of the fact that it is not even 30 days past the grace period) and now, the sale of such loan shall be as per the guidelines for sale of stressed assets.

Recourse against the Transferor/Originator

Under the existing guidelines, the sale to ARCs was allowed on a ‘with’ or ‘without’ recourse basis and sale of NPAs to parties other than ARCs was allowed on a non-recourse basis only. The Draft clearly states that any sale of loans shall be on a ‘without recourse’ basis only. While there will be no impact on sale of standard assets and sale NPAs to parties other than ARCs, the transactions of sale of stressed assets to ARCs shall certainly be affected.

Treatment of loans given for on-lending

The Draft contains specific provisions with respect to the loans that were granted by the originator for on-lending. Para 51 of the Draft states that “Lenders may also purchase stressed assets from other lenders even if such assets had been created out of funds lent by the transferee to the transferor subject to all the conditions specified in these directions.”

Let us take an example to understand this:

A is an NBFC, which has given out a loan amounting to Rs. 100 @ 5% p.a. to B, which is another NBFC. Now B, gives out loans of Rs. 20 each @ 7% p.a. to 5 individuals.

Now, A can purchase these 5 loans from B, when they become stressed i.e. 0+ DPD. Here, it is clearly visible that the risk undertaken by B has no risk at all. The funds for lending have been provided by A. B keeps the assets in its books only till they are standard. As soon as assets turn SMA-0, B will remove them from its books sell them off to A. Additionally, till the time assets were standard, B earned a spread of 2%.

Manner of Transfer

The Draft defines transfer as- “transfer” means a transfer of economic interest in loan exposures in the manner prescribed in these directions, and includes loan participations and transactions in which the loan exposure remains on the books of the transferor even after the said transaction.

Para 9 contradicts the definition, requiring a legal separation of the asset from the books of the transferor. Tis issue has been discussed at length in our write-up titled “Originated to transfer- new RBI regime on loan sales permits risk transfers. [8] ”

The Draft further specifies that the sale/transfer of loans may be done by way of assignment or novation. Presently, most of such transactions are effected through assignment only. The loan agreement usually contains a clause whereby the borrowers gives consent to the lender to sell the loan to a third party. In case such a clause is not there in the loan agreement, the sale of loan would require consent of all the parties to the agreement, including the borrower.  In this case, the transfer of loans will have to be effected through novation of the agreement.

The Draft simply clarifies that transfer may be done through either of the modes. We do not see any practical implication as such.

Asset Classification

The asset classification criteria has been divided into 2 categories:

• If the transferee has existing exposure to the same borrower: The asset classification shall be the same as that of the existing exposure in books of the transferee
• If the transferee does not have an existing exposure to the same borrower: The asset acquired shall be classified as standard and thereafter the classification shall be determined based on the record of recovery

If the existing exposure is not standard in the books, the asset classification of the acquired asset shall also be as per the existing exposure. This seems to be derived from the asset classification practices followed earlier to determine stress in the assets i.e. if the borrower is defaulting in one of the exposures, it is likely to delay/default in repayment of other exposures as well.

However, this shall increase the provisioning requirements for the transferee and thus, may be a demotivating factor for sale of stressed assets.

MHP requirements

The Draft extends MHP requirements to ARCs as well. The business of ARCs includes frequent selling and buying of loans and portfolios. Putting a holding requirement of 12 months may slow down the business.

On the other hand, this may ensure that ARCs put better recovery efforts, before selling the loans to other entities.

Reporting Requirements

The existing guidelines did not lay the responsibility of reporting to CIC on any of the parties. Thus, the same was determines by the agreement between the parties. Usually, in case of sale to ARCs, the reporting is done by the ARCs and in case of sale to banks/FIs, the reporting is done by the originator only (since originator usually acts as a servicer).

The Draft specifically lays the responsibility of reporting on the transferee. Reasonably, the servicer of the loans has entire information of the servicing of the loan, repayment patterns etc. and thus, is the most suitable party to do the reporting. Let us examine a few cases with regard to reporting:

Hence, the reporting obligation may be placed on the servicer or may be kept open for the parties to decide.

Realisation

The existing guidelines relating to sale of NPAs required the transferor to work out the NPV of the estimated cash flows associated with the realisable value of the assets net of the cost of realisation. At least 10% of the estimated cash flows should be realized in the first year and at least 5% in each half year thereafter, subject to full recovery within three years.

The above requirement is not there in the Draft, the reason for which is unknown.

The Draft provides that in case of sale to ARCs, if the ARC is not able to redeem the SRs/PTCs by the end of resolution period (obviously due to inadequate servicing of the loans) the liability against the same should be written off as loss.

Takeover of standard assets

The Draft allows all the regulated entities, other than the transferor, to take over the assets from ARCs, once they turn standard on successful implementation of resolution plan. Earlier only ARCs were allowed to buy assets from other ARCs. This is a welcome move as it will enable other financial entities to buy assets from ARCs.

The Draft has come with some interesting proposals and the RBI is yet to receive comments on the same from the industry. The representations from the industry and the response of the RBI on the same will formulate the new regime for securitisation.

Our other write-ups may be referred here:

http://vinodkothari.com/2020/06/draft-guidelines-on-securitisation-sale-of-loans-with-respect-to-rmbs-transactions/

http://vinodkothari.com/2020/06/presentation-on-draft-directions-on-securitisation-of-standard-assets/

http://vinodkothari.com/2020/06/presentation-on-draft-directions-on-sale-of-loans/

http://vinodkothari.com/2020/06/inherent-inconsistencies-in-quantitative-conditions-for-capital-relief/

http://vinodkothari.com/2020/06/comparison-of-the-draft-securitisation-framework-with-existing-guidelines-and-committee-recommendations/

http://vinodkothari.com/2020/06/originated-to-transfer-new-rbi-regime-on-loan-sales-permits-risk-transfers/

http://vinodkothari.com/2020/06/new-regime-for-securitisation-and-sale-of-financial-assets/

[1] https://www.rbi.org.in/Scripts/PublicationReportDetails.aspx?UrlPage=&ID=957

[2] https://www.rbi.org.in/Scripts/BS_ViewMasCirculardetails.aspx?id=9908#7

[3] http://vinodkothari.com/2020/06/originated-to-transfer-new-rbi-regime-on-loan-sales-permits-risk-transfers/

[4] http://vinodkothari.com/2020/06/comparison-on-draft-framework-for-sale-of-loans-with-existing-guidelines-and-task-force-recommendations/

[5] https://rbidocs.rbi.org.in/rdocs/notification/PDFs/45MD01092016B52D6E12D49F411DB63F67F2344A4E09.PDF

[6] https://www.rbi.org.in/Scripts/NotificationUser.aspx?Id=11580&Mode=0

[7] https://www.rbi.org.in/Scripts/NotificationUser.aspx?Id=10588&Mode=0

[8] http://vinodkothari.com/2020/06/originated-to-transfer-new-rbi-regime-on-loan-sales-permits-risk-transfers/

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