Securitisation helps provide banks and other lenders the capital they need to offer loans to borrowers who are expanding or growing their business, buying cars or homes, etc. Financial institutions like banks and NBFCs package a loan with similar loans via securitisation, and investors then purchase these as bonds. These payments are prioritised by risk called tranches and consider the timing of the payments. It allows short-term investors seeking immediate cash flow to repay the loan in the next few months or one year and long-term investors to plan their loan repayment a few to many years out.
In this guide, you will learn the meaning of securitisation and the significant changes proposed by RBI to its norms.
What Is Securitisation?
Securitisation is the process of grouping financial instruments together to create asset-backed security. The resulting security is sold to investors as a distinct unit. The assets are sold to a bankruptcy remote special purpose vehicle in return for an immediate cash payment.
Securitisation follows a 2 stage process –
- Stage 1 involves the sale of assets to a SPV (special purpose vehicle) in return for immediate cash payment, known as DA or Direct Assignment transaction.
- Stage 2 involves repackaging and selling the security interests representing claims on incoming cash flows from the assets to third-party investors by issuing debt securities called Pass Through Certificates.
Securitisation aims to pool illiquid financial assets, such as credit card debts, mortgages or accounts receivables, and create liquidity for the issuing firm. Securitisation helps create liquidity for financial institutions, and they can create new capital to be offered as loans to other consumers.
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What are the Major Changes Proposed by RBI in Securitisation Norms?
In the hopes of developing a robust market, RBI proposed some significant changes in securitisation norms. The revision in guidelines attempts to sync the regulatory framework with the Basel guidelines on securitisation that came into effect on January 1, 2018. Some of the salient features of the draft securitisation guidelines are given below:
- Transactions that result in multiple tranches of securities that reflect different credit risks are the only transactions that will be treated as securitisation transactions.
- Staying aligned with the Basel-III guidelines, Securitisation External Ratings Based Approach or SEC-ERBA and Securitisation Standardised Approach or SEC-SA are the two capital measurement approaches that have been proposed.
- A particular case of securitisation called STC or Simple, Transparent, and Comparable securitisations has been prescribed in the draft guidelines. It comes with clearly defined preferential capital treatment and criteria.
- To allow single asset securitisations, the definition of securitisation has been altered. As per the revised guidelines, securitisation of exposures purchased from other lenders will be allowed.
- The draft proposes a differential treatment for RMBS or Residential Mortgage Backed Securities compared to other securitisations in respect of prescriptions regarding MRR (minimum retention requirements), MHP (minimum holding period) and reset of credit enhancements.
The proposed guidelines apply to all banks, non-banking financial companies, and all-India financial institutions. Housing finance companies must also abide by the latest changes in securitisation norms.
What Is the Master Direction Issued by RBI for Securitisation of Standard Assets and Loan Transfer?
RBI issued a master direction on transferring loan exposures and securitising standard assets. The directions came after RBI considered public comments on the draft rules, which were issued on June 8, 2020. The objective is to transform the opaque and complex securitisation structures to promote financial stability.
The master direction will apply to all scheduled commercial banks in India. But the small finance banks, regional rural banks, all-India term financial institutions, and NBFCs will be excluded.
In the master direction, RBI specified the MRR or minimum retention requirement for different asset classes.
- For underlying loans with an original maturity of twenty-four months or less, the MRR will be 5% of the book value of the loans being securitised.
- Loans with bullet payments or original maturity of more than twenty-four months will have a 10% MRR of the book value of the loans being securitised.
- The MRR for the originator will be 5% of the book value of the loans being securitised in the case of residential mortgage-backed securities, regardless of the original maturity.
The direction added that the minimum ticket size for issuance of securitisation notes will be one crore.
Additionally, the central bank issued Reserve Bank of India (Transfer of Loan Exposure) Directions, 2021, which requires NBFCs, banks and other leading financial institutions to have a detailed board-approved policy pertaining to such transactions.
There are various reasons why lenders resort to loan transfers, and it can range from rebalancing their strategic sales or exposures to managing liquidity. Additional revenues for raising liquidity will be created if there’s a robust secondary market in loans.
The master direction prescribes a minimum holding period for different loan categories, and the loan will become eligible for transfer after this period.
According to the master direction, the lenders need to put in place a comprehensive Board-approved policy for acquiring and transferring loan exposures. The guidelines must lay down the qualitative and quantitative standards related to valuation, due diligence, requisite IT systems for storage, data capture and management, periodic Board level overnight, risk management, etc. Moreover, the master direction directs that loan transfers must immediately separate the transferor from the rewards and risks associated with loans to the extent that the economic interest has been transferred.
According to the master direction of RBI, the assets eligible for securitisation are as follows:
- Lenders, including overseas branches of Indian banks, will not undertake the securitisation activities or assume securitisation exposures as re-securitisation exposures, synthetic securitisation and structures in which short-term instruments are issued against loan-term assets.
- It has been cleared that securitisation of exposures held by overseas branches of Indian banks will not contravene any extant regulatory or legal framework provisions, including Foreign Exchange Management Act, 1999 and the regulations or rules thereunder.
- The originators of the exposures must satisfy the Minimum Holding period requirement according to Clause 39 of the Reserve Bank of India (Transfer of Loan Exposures) Directions, 2021.
Rating Criteria – Securitisation Transactions
A typical securitisation transaction structure is shown below.
The originator is the seller of the assets, and it can be a financial institution/bank/company that had originally lent to the underlying Borrower. The sale is made to a special purpose entity (SPE), and the SPE raises funds from investors by issuing PTCs, and the proceeds are paid to the originator.
The different types of securitisation transactions are as follows:
- Residential mortgage-backed securities
- Personal loans like Micro credit-backed securities
- Asset-Backed Securities, such as tractor loans and CVs
The rating criteria may differ but a general overview is explained below. The image shows the factors taken into consideration during the process.
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