Securitisation of stressed assets: RBI releases paper on regulatory purview

As per the current guidelines, Securitisation is allowed only in the case of standard assets while lenders have to largely rely on Asset Reconstruction Companies (ARCs) for bad assets. Based on market feedback, stakeholder consultations, and the recommendations of the Task Force on Development of Secondary Market for Corporate Loans, RBI decided to introduce a framework for securitisation of stressed assets in addition to the ARC route, similar to the framework for securitisation of standard assets, as part of its Statement on Developmental and Regulatory Policies released on September 30, 2022.

Accordingly, the Central Bank (RBI) on Wednesday (25^th January) released a discussion paper on securitisation of stressed assets. It said the framework on securitisation of stressed assets (SSA) can be extended to standard assets with a certain ceiling.

The Discussion paper broadly covers nine relevant areas of the framework including asset universe, asset eligibility, minimum risk retention, the regulatory framework for special purpose entity and resolution manager, access to finance for resolution manager, capital treatment, due diligence, credit enhancement, and valuation. It draws upon similar frameworks introduced in other jurisdictions while trying to keep it structurally aligned with the framework for securitisation of standard assets.

The paper has earlier mooted a set of questions for discussions, starting with whether the framework should apply only for loans recognised as Non-Performing Assets (NPAs) or it should include loans that are in categories like special mention accounts or tagged as standard assets.

The participants in the discussion paper considered the following points.

1. Whether the framework for Stressed Assets Framework should be limited only to NPAs, or should it include standard assets too, up to a certain threshold?
2. Which type of assets should be eligible for Securitisation of Stressed Assets?
3. Term loans only with the same asset universe as it is there in Securitisation of Standard Assets;
4. Big ticket loans above a certain aggregate threshold (e.g. Rs. 100 crores);
5. Small ticket loans such as commercial/residential mortgages, loans to MSMEs, and unsecured retail assets with floor-on pool specifications such as a minimum number of loans/ticket size/cumulative loan amount, etc.

3. Whether form and quantum of Minimum Retention Ratio (MRR) is required to be prescribed regulatorily for SSAF? If so;

a) Should the MRR stipulation be same as for SSA or different in terms of quantum/form?

b) Who shall fulfill MRR requirement – Resolution Manager, originator, both, or other parties too?

4. Does the idea of an independent Resolution Manager Lead to any prudential, economic, or any other conflict/arbitrage?

5. Should the framework completely prohibit any kind of relationship of the originator with the Resolution Manager post transfer of stressed assets or an arm’s length relationship may be permitted for a certain period (say, 3 months post transfer) to ensure a smooth transition and information exchange?

6. What would be the ideal regulatory framework for the SPE and the Resolution Manager under SSAF, considering inter alia the imperative of regulatory reporting?

7. What could be the possible corporate structures for the Resolution Manager within the ambit of the regulatory power of the RBI? Are there any foreseeable concerns if the Resolution Manager is required to be an NBFC/ARC registered with RBI?

8. Should the Resolution Managers be permitted to borrow from other lending institutions towards additional funding for the resolution of underlying assets? If so, what safeguards may be necessary?

9. Is the capital regime based on the External Ratings Based Approach (ERBA), subject to a minimum NRPPD and RW floor of 100 per cent, robust enough to capture the risks associated with the NPA securitisation exposures? How should the NRPPD be structured to balance the considerations – a uniform NRPPD of, say, 50 per cent, or a graded NRPPD?

 10: Should the framework propose a lower NRPPD (e.g. 30 per cent) for it to be ‘qualifying’ under the framework provided the assets are sold promptly (thereby improving their recoverability prospects)? What should be the pre-requisite/safeguard for such dispensation?

11. For the due diligence to be conducted by the investors/resolution manager will the framework under SSA broadly suffice or is there a need for major modification in the SSAF framework?

12. Which of the following options may be considered for permitting credit enhancement?

a) Credit Enhancements may be permitted for all tranches; the capital requirement will be based on an external credit rating framework for all Regulated Entities (Res) extending Credit Enhancement (CE)

b) Credit Enhancement may only be permitted for senior tranches. In either of the options, the originator cannot provide CE

c) Credit Enhancements are not allowed.

13. Does the proposed valuation regime capture the risk, associated with the securitisation notes with stressed assets as underlying, sufficiently? Does the proposed arrangement present any challenges from operational, accounting, or any other perspective?

According to the participants in the discussion paper, investors are exposed to the risk that the workout of the resolution exercise may not generate sufficient recoveries to cover the net value of the transferred underlying assets.

The discussion paper said the main difference between the securitization of stressed assets and the standard assets is related to the lower degree of certainty of cash flows from the underlying pool in the case of stressed assets. The participants also discussed the inclusion of retail and large corporate loans under the SSA framework. Some participants were in favour of including retail assets as they have predictable cash flows, reducing the complexities involved in structuring such transactions.

Members of the public could suggest alternatives to the proposed regime and they have been asked to submit their comments by mail or e-mail by February 28, 2023, to Credit Risk Group, Department of Regulation, Central Office of Reserve Bank of India.