The Reserve Bank of India (RBI) issued guidelines on February 01, 2006, in relation to securitisation of standard assets by banks, All India Term-Lending and Refinancing Institutions and non-banking financial companies (NBFCs). Securitisation was defined as the process by which assets are sold to bankruptcy remote special purpose vehicle (SPV) in return for immediate cash flow, wherein the cash flows from the underlying pool of assets are used to service the securities issued by the SPV. The criteria for ‘true sale’ as well as the policy on provision of credit enhancement facilities, liquidity facilities and accounting treatment of such transactions was also set out. The guidelines did not separately deal with direct assignment of assets.
Thereafter, the RBI introduced revised guidelines in May, 2012, for scheduled commercial banks and All India Term-Lending and Refinancing Institutions in order to develop an orderly and healthy securitisation market. The revised guidelines were made applicable to NBFCs in August, 2012. The guidelines were organised in sections, the first section contained provisions relating to securitisation of assets and the second section dealt with stipulations regarding transfer of standard assets through direct assignment of cash flows.
In 2019, RBI set up a Task Force on the Development of Secondary Market for Corporate Loans, which issued its report on September 03, 2019. The Task Force was established inter alia to make recommendations to facilitate rapid development of the secondary market.
Separately, the RBI also set up a committee on Development of Housing Finance Securitisation Market in India to consider the best practices in residential and commercial mortgages in international jurisdictions and to develop the market. The committee reviewed the existing provisions of mortgage backed securitisation in India, including the regulations in place and provided specific recommendations to the RBI.
On June 08, 2020, the RBI released two drafts, namely, a framework for securitisation of standard assets (Draft Securitisation Framework) and a framework for sale of loan exposures (Draft Sale Framework). The Draft Securitisation Framework and Draft Sale Framework when introduced in final form will replace the guidelines issued in 2012 by the RBI. The RBI has sought comments from the public by June 30, 2020.
The purpose of the proposed revisions is to specify criteria to inter alia bring securitisation in line with Basel III requirements and to deepen the secondary loan trading market. Some of the amendments to the securitisation guidelines were overdue, in view of the revisions introduced under Basel III. The RBI has also taken into account the recommendations of the abovementioned committees.
A brief summary of some of the key revisions introduced by the RBI under the Draft Securitisation Framework are as follows:
Credit Tranched issuances – Revised Definition of Securitisation
Under the Draft Securitisation Framework, ‘securitisation’ has been defined as:
‘the set of transactions or scheme wherein credit risk associated with eligible exposures is tranched and where payments in the set of transactions or scheme depend upon the performance of the specified underlying exposures as opposed to being derived from an obligation of the originator and the subordination of tranches determines the distribution of losses during the life of the set of transactions or scheme; Provided that the pool may contain one or more exposures eligible to be securitised;’
The transactions that do not fall within the contours of the above definition, that is, the transactions where the credit risk associated with eligible exposures is not tranched, will not be entitled to capital relief provided for securitisation exposures in Chapter VI of the Draft Securitisation Framework.
Tranching enables distribution of risk among investors. Senior tranches typically have a lesser risk of default compared to junior and residual tranches, which, as per the terms, will bear the loss of any default. Such securities can be placed with investors with distinctive risk return requirements. One assumes that this will help develop a market for such products.
Single Asset Securitisation
An interesting development in the Draft Securitisation Framework is the permissibility of securitisation of single assets, which was not permissible under the 2012 guidelines. Single asset loans can also be credit tranched. The revision is an important development as longer tenor loans can now be securitised in whole or in part. Further, single loans, which are on the books of banks or NBFC, as the case may be, can be securitised and such credit tranched securities can be issued to eligible investors. The obligations, if any, with respect to such loans may have to continue with the existing lender unless specifically approved by the borrower. Previously, single asset securitisation was not permissible since it did not involve any credit tranching and redistribution of risk.
RBI has also permitted securitisation of bullet payment loans, provided either the interest or principal is paid in installments.
Traditional Securitisation and Simple, Transparent and Compatible (STC) structures
The Draft Securitisation Framework has introduced Simple, Transparent and Comparable (STC) securitisations. A traditional securitization, which additionally satisfies the criteria set out in Annexure 1, will fall within the scope of the STC framework.
Exposures to securitisations that are STC-compliant can be subject to alternative capital treatment, detailed in clauses 112 to 114 or clauses 127 to 128 of the Draft Securitisation Framework. The Draft Securitisation Framework permits a lower risk weight for traditional securitisation transactions, which meet the STC framework.
Under the Draft Securitisation Framework, a traditional securitisation is a ‘structure where the cash flow from an underlying pool of exposures is used to service at least two different stratified risk positions or tranches, reflecting different degrees of credit risk, where payments to the investors depend upon the performance of the specified underlying exposures, as opposed to being derived from an obligation of the originator’.
The above is beneficial for banks.
RBI has specifically allowed replenishment structures wherein the replenishment period has to be identified upfront and following the end of such period, the structure reverts to an amortisation one.
Replenishment has been defined as the ‘process of using cash flows from securitised assets to acquire more eligible assets, which will continue for a pre-announced replenishment period, following which the securitisation structure reverts to an amortising one’. Securitisation, which features a replenishment period, is required to have provisions for appropriate early amortisation events and / or triggers for termination of the replenishment period.
Introducing replenishment structures will help package shorter tenor loan deals and ensure better return to investors.
Residential Mortgage Backed Securities
The RBI has also provided certain relaxations in relation to residential mortgage backed securities (RMBS) basis the recommendations of the Committee on Development of Housing Finance Securitisation Market in India. RMBS is defined as ‘securities issued by the special purpose entity against underlying exposures that are all residential mortgages’.
Under the Draft Securitisation Framework, the minimum holding period for RMBS will be six months or six instalments, whichever is later. The MRR for RMBS has been limited to 5% of the book value of the loans being securitised. If the value of the exposures underlying an RMBS is INR 500 crore or above, it is proposed that the securities issued must be mandatorily listed.
The revisions suggested, if given effect to, will enable HFCs and NBFCs with exposure to RMBS to package such portfolios and issue securities of different credit tranches and list them. Senior tranches can be issued to investors who are risk averse, while junior tranches can be issued to institutions who subscribe to such instruments. This will certainly provide the much-needed liquidity to HFCs and over time deepen the RMBS market and ensure that these products are available to a wider spectrum of investors.
Exemptions and Prohibitions
While the Draft Securitisation Framework now permits assets purchased from other entities to be securitised, resecuritisation exposures, synthetic securitisation and securitisation with revolving credit facilities as underlying continue to be prohibited. Pooling of purchased loans along with existing portfolios will increase the rating of certain kinds of pools.
Transactions involving revolving credit facilities, loans with bullet repayments of both principal and interest and securitisation exposures continue to be exempt from the applicability of the Draft Securitisation Framework.
Capital Requirement for securitisation exposures
The Draft Securitisation Framework provides for conditions required to be met by lenders for maintenance of capital. Such conditions will come into immediate effect and will apply to existing securitisation exposures as well. Conditions required to be met for de-recognition of the transferred asset by the originator include:
- significant credit risk associated with the underlying exposures of the securities issued by the special purpose entity (SPE) being transferred to third parties. Significant credit risk will be treated as transferred if (i) there are at least three tranches, risk weighted exposure amounts of the mezzanine securitisation positions held by the originator do not exceed 50% of the risk weighted exposure amounts of all mezzanine securitisation positions existing in this securitisation; and (ii) in cases where there are no mezzanine securitisation positions, the originator does not hold more than 20% of the exposure values of securitisation positions that are first loss positions;
- the transferred exposures are legally isolated from the originator and are put beyond the reach of the originator or its creditors;
- the securities issued by the SPE are not obligations of the originator;
- securitisation does not contain clauses that require the originator to replenish or replace the underlying exposures to improve the credit quality of the pool, in the event of deterioration in the underlying credit quality.
Capital Measurement Approaches
In line with the Basel III guidelines, two capital measurement approaches have been proposed: Securitisation External Ratings Based Approach (SEC-ERBA) and Securitisation Standardised Approach (SEC-SA).
The Draft Securitisation Framework further provides that banks can adopt either of the two approaches. NBFCs (including housing finance companies) shall only apply the Securitisation External Ratings Based approach for calculation of risk weighted assets.
The Draft Securitisation Framework recognises the challenges faced by the market in certain aspects and has sought to address the same. It also enables and clarifies the permissibility of certain structures that were uncertain earlier. If issued in final form, it will enable securitisation of certain loans that were earlier not permissible. There is movement towards developing a more robust and sophisticated market.