The RBI introduced securitisation of standard assets (SSA) in 2006 and revised the guidelines in 2012 and 2021. However, India does not have an active securitisation market for several reasons. First, banks and financial institutions (FIs) do not like to securitise high-quality standard assets.
Second, India’s special purpose entities (SPEs)/asset reconstruction companies (ARCs) are reluctant to acquire standard assets that are likely to become NPAs (non-performing assets) quickly, such as special mention accounts, unless a deep haircut is allowed.
Third, both asset acquirers (SPEs/ARCs) and asset managers (asset management companies (AMCs)) should be under unified regulation. In India, while SPEs/ARCs are regulated by the RBI, AMCs are registered with SEBI.
Fourth, market discipline is yet to develop in India to have a retail investor base for credit derivatives, who can actively trade such instruments in the secondary market.
Discussion Paper
The RBI recently came out with a Discussion Paper on the Securitisation of Stressed Asset Framework (SSAF) and sought public comments on several issues by end-February 2023. The objectives of SSAF are not well-defined. If the purpose of SSAF is to develop a vibrant securitisation market, it is most unlikely to pick up.
Except for generating some business for rating agencies and resolution managers (RMs), SSAF would face severe valuation problems like SSA leading to hidden risks and financial instability. As the secondary market for the securitised market in India is underdeveloped, SPEs/ARCs have to hold the securitised NPAs till all possibilities of recovery are exhausted. If the purpose of SSAF is the resolution of NPAs, it is better to strengthen resolution mechanisms by modifying the the Insolvency and Bankruptcy Code (IBC), 2016 and SARFAESI Act, 2002.
The securitisation of standard assets is currently not allowed for revolving credit, restructured loans and advances, loans with refinance exposures, short-term loans with residual maturity of less than one year, loans with bullet payments etc., which may also be applicable to the securitisation of NPAs.
The underlying pool of NPAs that are eligible for securitisation can be grouped under two categories — retail loans (mortgages, unsecured personal loans and small loans to MSMEs) and corporate loans. Shifting NPAs from one balance sheet to another through securitisation is not a good resolution mechanism. If banks cannot amicably restructure the loans how can the SPEs do it? Ultimately, if NPAs reach the dead-end through liquidation, the existing IBC/SARFAESI Act may be preferred over the securitisation of NPAs.
Retail investor base
In the absence of a retail investor base in India, the SPEs are the initial and final investors, who may exercise due diligence about the valuation of NPAs through RMs for a fee. If RMs are engaged by SPEs, undervaluation of NPAs is inevitable, which banks/FIs may reject. If RMs are engaged by banks/FIs, overvaluation of NPAs would dissuade the SPEs to accept the deal.
If both originator and acquirer maintain an arm’s length relationship with RMs, who would finance the due diligence exercise? If RMs have access to finance from a third party for the evaluation of NPAs, a collusion of either originator or acquirer with RMs cannot be ruled out. For risk sharing, if a minimum retention ratio for RMs is prescribed, they would be tempted to undervalue NPAs to benefit from the deal. The regulatory framework relating to SPEs and RMs is difficult to formulate.
Three categories
The underlying pool of NPAs under asset-backed securitisation is visualised under three categories — senior tranche (AAA-rated), mezzanine tranche (AA to BB-rated), and junior tranche (not rated). Banks/FIs may like to retain most of the senior tranche assets as the quality of available collaterals is good and may be adequate to recover the loan. Therefore, securitisation in this category may be limited.
Unless haircuts are deep for the other two tranches, SPEs may find them unattractive. Moreover, credit enhancement, if allowed, may not be available in these two categories and therefore SSAF may remain a non-starter. Issues relating to capital charge/write-up/risk weight may not pose problems as originators are well-regulated.
After the Global Financial Crisis, the BIS tightened regulations, including the securitisation of assets, to avoid the recurrence of regulatory failures leading to the financial crisis. Although the Basel Committee on Banking Supervision (BCBS) issued guidelines on the securitisation of NPAs in November 2020, which became effective from January 1, 2023, the capital requirement and risk weights for exposures to NPA securitisation are stringent.
If regulation is stringent, innovations may not proceed further; if light-touch regulation is prescribed it may lead to financial instability. The recent trend has been to preserve financial stability rather than promote innovations that are potentially disruptive.
There are several loose ends, which the RBI has posed as questions in the Discussion Paper and sought comments from the stakeholders. Unless those issues are addressed upfront, there is a high probability of misuse, which may lead to undue litigations and overburden the grievances redress system.
The writer, a former Head of the Monetary Policy Department of RBI, is currently RBI Chair Professor at Utkal University. The views are personal