what is direct assignment transaction

Submission Guidelines

Securitization and Direct Assignment Transactions in the Indian Economy

[ Vineet Ojha is Manager – IFRS & Valuation Services at Vinod Kothari Consultants Pvt Ltd]

The current financial year has witnessed a sharp surge and a life time high in the volume of securitization and direct assignment transactions in the Indian economy. Consequent to the funding problems that non-banking finance companies (NBFC) and housing finance companies (HFCs) have been facing over the last few months, direct assignments of retail portfolios have picked up considerable pace, with volumes touching an all-time high of Rs. 1.44 lakh crore during the nine-month period (April-December) of financial year 2019 (FY 19). Of this, around Rs. 73,000 crore was raised by NBFCs and HFCs through sell-down of their retail and small and medium enterprises (SME) loan portfolio to various investors (primarily banks). Investor appetite, particularly from public sector banks and private banks, is high at present, considering investors are not exposed to entity-level credit risk, and are seen taking exposure to the underlying pool of retail and SME borrowers. Yields have gone up significantly with the changing market dynamics. The momentum in the securitization market is likely to remain strong in the current fiscal as it is emerging as an important tool for retail-focused NBFCs for raising funds at reasonable costs while simultaneously providing a hedge against asset-liability mismatches. A visual trend of the market over the years can be seen below:

Source: India Securitization Market: Booklet by VKCPL

Why the sudden surge?

Looking at the figure above, we can see a sharp surge in the direct assignment volumes in FY19. A majority of the issuances comes from the third quarter with around Rs. 73,000 crores. Although the major driver is the Infrastructure Leasing and Financial Services Limited (IL&FS) imbroglio, it is not the only reason for this development.

IL&FS crisis

Following the IL&FS crisis, the Reserve Bank of India (RBI) has time and again prompted banks to assist NBFCs to recover from the cash crunch. However, wary of the credit quality of the NBFCs and HFCs, the banks have shown more interest in the underlying loan portfolios than on the originator itself. Through direct assignment and securitization, these institutions get upfront cash payments against selling their loan assets. This helps these institutions during the cash crunch. Funds raised by NBFCs and HFCs through this route helped the financiers meet sizeable repayment obligations of the sector in an otherwise difficult market.

RBI relaxes MHP norms for long tenure loans

Another reason that explains this sudden surge in the volume of direct assignment or securitization volumes is the relaxation of the minimum holding period (MHP) criteria for long-tenure loans by the RBI. This increased the quantum of assets eligible for securitization in the system. The motivation was the same is to encourage NBFCs and HFCs to securitize their assets to meet their liquidity requirements. More details about this can be found here.

Effects of Securitization

Primarily, priority sector lending (PSL) requirements were the primary drivers for securitization. The number of financial institutions participating in securitization were quite low. Now, for liquidity concerns, NBFCs and HFCs were forced to rely on securitization to meet their liquidity needs. This not only made them explore a new mode of funding, but also solved other problems like asset liability mismatches. In the nine months of FY19 and FY18, the share of non-PSL transactions has increased to 35 per cent compared to 24 per cent in FY17 and less than 20 per cent in the periods prior to that.

However, it is not a rosy picture all over. Due to the implementation of IFRS, upon de-recognition of a loan portfolio from the financial statements of the company, the seller shall have to recognize a gain on sale on the transaction. These gains disturb the stability of the profit trend in these financial institutions which would result in volatile earnings in their statements. The NBFCs have been trying to figure out solutions which would allow them to spread the gain on transfer over the life of the assets instead of booking it upfront.

The securitization market remained buoyant in the third quarter driven by the prevailing liquidity crisis following defaults by IL&FS and its subsidiaries. This surge is good for the Indian securitization market as India’s contribution to global securitization market, at about USD 12 billion, is barely recognized, for two reasons – firstly, India’s market has so far been largely irrelevant for the global investors, and secondly, bulk of the market has still been driven by PSL requirements. PSL-based securitizations obviously take place at rates which do not make independent economic sense. Now due to the surge in non-PSL based securitization, the rates at which the portfolios are sold are attractive to investors. This could attract global investors to the market.

Now that financial institutions have gained exposure to the securitization markets, they find that the transactions are attractive for sellers as well as investors. Our interaction with leading NBFCs reveals that there are immediate liquidity concerns. Banks are not willing to take on-balance sheet exposure on NBFCs; rather they are willing to take exposure on pools. Capital relief and portfolio liquidity are additional motivations for the originators (and other potential investors) to enter into securitization transactions.

– Vineet Ojha

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Master Circulars

1. 1 Asset Liability Management (ALM) System for NBFCs - Guidelines

It was decided to introduce an ALM System for the Non-Banking Financial Companies (NBFCs), as part of their overall system for effective risk management in their various portfolios. The abovementioned guidelines would be applicable to all the NBFCs irrespective of whether they are accepting / holding public deposits or not. However to begin with, NBFCs meeting the criteria of asset base of Rs.100 crore (whether accepting / holding public deposits or not) or holding public deposits of Rs. 20 crore or more (irrespective of their asset size) as per their audited balance sheet as of 31 March 2001 would be required to put in place the ALM System.

A system of half yearly reporting was put in place in this regard and the first Asset Liability Management return as on 30 September 2002 was to be submitted to RBI by only those NBFCs which are holding public deposits within a month of close of the relevant half year i.e., before 31 October 2002 and continue thereafter in similar manner. The half yearly returns would comprise of three parts:

(i) Statement of structural liquidity in format ALM;

(ii) Statement of short term dynamic liquidity in format ALM; and

(iii) Statement of Interest Rate Sensitivity in format ALM.

In the case of companies not holding public deposits, separate supervisory arrangements would be made and advised in due course of time.

2. 2 Nomination rules under Section 45QB of RBI Act for NBFC Deposits

In terms of Section 45QB of the RBI Act, the depositor/s of NBFCs may nominate, in the manner prescribed under the rules made by the Central Government under Section 45ZA of the Banking Regulation Act, 1949 (B.R.Act) one person to whom, in the event of death of the depositor/s, the amount of deposit may be returned by the NBFC. It has been decided in consultation with the Government of India, that the Banking Companies (Nomination) Rules, 1985 are the relevant rules made under Section 45ZA of the B. R. Act. A copy of the rules is enclosed. Accordingly, NBFCs may accept nominations made by the depositors in the form similar to that specified under the said rules.

3. 3 Safe Custody of Liquid Assets / Collection of Interest on SLR Securities

NBFCs including RNBCs are required to maintain liquid assets in the form of Government securities / guaranteed bonds as per the provisions of Section 45-IB of the RBI Act and lodge such securities in a Constituents' Subsidiary General Ledger (CSGL) Account with a scheduled commercial bank (SCB) / Stock Holding Corporation of India Ltd., (SHCIL) or in a demat account with a depository through a depository participant (DP) registered with Securities & Exchange Board of India (SEBI) or with a branch of SCB to the extent such securities are yet to be dematerialised.

In order to protect the interest of depositors, an exclusive CSGL or demat account to hold Government securities shall be maintained for securities held for the purpose of compliance with Section 45-IB of the RBI Act. This account should be operated only for purchase or sale of securities due to increase or decrease in the quantum of public deposits or withdrawal of securities for encashment on maturity or for repayment to depositors in special circumstances, and not be used to undertake repo or other transactions.

In case an NBFC (including RNBC) deals in the government securities in a manner other than that permitted above, another CSGL account may be opened for this purpose.

It is also observed that some of the NBFCs have either not dematerialised the government securities or have dematerialized but failed to report the same to the RBI. For this purpose the quarterly liquid asset return in the reporting formats of NBS 3 and NBS 3A has been amended to include the information about the demat accounts, which will ensure that the information in this regard is not omitted by NBFCs.

It may be possible that there may be a few Government securities / Government guaranteed bonds that have not been dematerialized and are held in physical form which for the purpose of collection of interest are withdrawn from the safe custody with their designated bankers and re-deposited with the banks after collection of interest. To avoid the process of withdrawal and re-depositing the same it has now been decided that NBFCs / RNBCs shall authorize the designated banks as agents for collection of interest on due dates on these securities held in physical form and lodged for safe custody. NBFCs / RNBCs may approach their designated banker and exercise a Power of Attorney in favour of the designated bank to enable it to collect interest on the securities / guaranteed bonds held in physical form on the due date.

4. 4 Non- Reckoning Fixed Deposits with Banks as Financial Assets

It was clarified, that the Reserve Bank issues a Certificate of Registration for the specific purpose of conducting NBFI activities. Investments in fixed deposits cannot be treated as financial assets and receipt of interest income on fixed deposits with banks cannot be treated as income from financial assets as these are not covered under the activities mentioned in the definition of “financial Institution” in Section 45I(c) of the RBI Act 1934. Besides, bank deposits constitute near money and can be used only for temporary parking of idle funds, and/or in the above cases, till commencement of NBFI business.

In addition, the NBFC which is in receipt of a CoR from the Bank must necessarily commence NBFC business within six months of obtaining CoR. If the business of NBFC is not commenced by the company within the period of six months from the date of issue of CoR, the CoR will stand withdrawn automatically. Further, there can be no change in ownership of the NBFC prior to commencement of business and regularization of its CoR.

5. 5 Operative instructions relating to relaxation / modification in Ready Forward Contracts, Settlement of Government Securities Transactions and Sale of securities allotted in Primary Issues

All NBFCs / RNBCs are instructed to follow the guidelines on transactions in Government Securities as given in the circular IDMD.PDRS.05/10.02.01/2003-04 dated March 29, 2004 and IDMD.PDRS.4777 , 4779 & 4783/10.02.01/2004-05 all dated May 11, 2005 as amended from time to time. In cases of doubt they may refer to IDMD.

6. 6 FIMMDA Reporting Platform for Corporate Bond Transactions

SEBI has permitted FIMMDA to set up its reporting platform for corporate bonds. It has also been mandated to aggregate the trades reported on its platform as well as those reported on BSE and NSE with appropriate value addition. All NBFCs would be required to report their secondary market transactions in corporate bonds done in OTC market, on FIMMDA's reporting platform with effect from September 1, 2007. Detailed operational guidelines in this regard would be issued by FIMMDA. In the meanwhile, the NBFCs may approach FIMMDA directly for participating in the mock reporting sessions.

7. Need for public notice before Closure of the Branch / Office by any NBFC

7 NBFCs should give at least three months public notice prior to the date of closure of any of its branches / offices in, at least, one leading national news paper and a leading local (covering the place of branch / office) vernacular language newspaper indicating therein the purpose and arrangements being made to service the depositors etc.

8. Cover for public deposits - creation of floating charge on Liquid Assets by deposit taking NBFCs

NBFCs raise funds for their operations from various sources like public deposits, bank borrowings, inter-corporate deposits, secured / unsecured debentures, etc.

8 In order to ensure protection of depositors interest, NBFCs should ensure that at all times there is full cover available for public deposits accepted by them. While calculating this cover the value of all debentures (secured and unsecured) and outside liabilities other than the aggregate liabilities to depositors may be deducted from the total assets. Further, the assets should be evaluated at their book value or realizable / market value whichever is lower for this purpose. It shall be incumbent upon the NBFC concerned to inform the Regional Office of the Reserve Bank in case the asset cover calculated as above falls short of the liability on account of public deposits. NBFCs accepting / holding public deposits were directed to create a floating charge on the statutory liquid assets invested in terms of Section 45-IB of the RBI Act, 1934, in favour of their depositors. Such charge should be duly registered in accordance with the requirements of the Companies Act, 1956.

9 In view of the practical difficulties expressed by the NBFCs in creating charge on the statutory liquid assets in favour of large number of depositors, it was subsequently decided that NBFCs accepting / holding public deposits may create the floating charge on the statutory liquid assets maintained in terms of Section 45-IB of the RBI Act, 1934 and notifications issued by the Bank from time to time, in favour of their depositors through the mechanism of 'Trust Deed'.

9. Unsolicited Commercial Communications - National Do Not Call Registry

10 It is an emerging practice in India to engage agents / outsource business operations for the purpose of soliciting or promoting any commercial transactions using telecommunication mode. There is a need to protect the right to privacy of the members of public and to curb the complaints relating to unsolicited commercial communications being received by customers / non-customers, as part of best business practices.

Telecom Regulatory Authority of India (TRAI) has framed the Telecom Unsolicited Commercial Communications (UCC) Regulations for curbing UCC. Further, the Department of Telecommunications (DoT) has issued relevant guidelines for telemarketers along with the registration procedure on June 6, 2007. These guidelines have made it mandatory for telemarketers to register themselves with DoT or any other agency authorized by DoT and also specified that the telemarketers shall comply with the Guidelines and Orders / Directions issued by DoT and Orders / Directions / Regulations issued by Telecom Regulatory Authority of India (TRAI) on Unsolicited Commercial Communications(UCC). The detailed procedure in this regard is also available on TRAI's website ( www.trai.gov.in ).

NBFCs are therefore advised

(i) not to engage Telemarketers (DSAs / DMAs) who do not have any valid registration certificate from DoT, Govt of India, as telemarketers; 11 NBFCs should engage only those telemarketers who are registered in terms of the guidelines issued by TRAI, from time to time, for all their promotional/ telemarketing activities.

(ii) to furnish the list of Telemarketers (DSAs/DMAs) engaged by them along with the registered telephone numbers being used by them for making telemarketing calls to TRAI; and

(iii) to ensure that all agents presently engaged by them register themselves with DoT as telemarketers.

10. 12 Investment through Alternative Investment Funds - Clarification on Calculation of NOF of an NBFC

It was observed in certain cases that an NBFC while arriving at the NOF figure as in terms of Section 45 IA of the RBI Act, 1934, did not reckon its investment in group companies on the ground that investments in the group companies were made by the Venture Capital Fund (VCF) sponsored by the NBFC, although, in term, the contribution to the funds held by the VCF had come primarily from the NBFC itself.

A VCF or any such Alternative Investment Fund (AIF) 13 means a pool of capital by investors and the investment made by such an AIF is done on behalf of the investors. Accordingly, it is clarified that while arriving at the NOF figure, investment made by an NBFC in entities of the same group concerns shall be treated alike, whether the investment is made directly or through an AIF / VCF, and when the funds in the VCF have come from the NBFC to the extent of 50% or more; or where the beneficial owner, in the case of Trusts is the NBFC, if 50% of the funds in the Trusts are from the concerned NBFC. For this purpose, "beneficial ownership" would mean holding the power to make or influence decisions in the Trust and being the recipient of benefits arising out of the activities of the Trust. In other words, in arriving at the NOF, the substance would take precedence over form. NBFCs were advised to keep this principle in mind, always, while calculating their NOF.

11. 14 Accounting for taxes on income - Accounting Standard 22 - Treatment of deferred tax assets (DTA) and deferred tax liabilities (DTL) for computation of capital

As creation of DTA or DTL would give rise to certain issues impacting the balance sheet of the company, it is clarified that the regulatory treatment to be given to these issues are as under:

- The balance in DTL account will not be eligible for inclusion in Tier I or Tier II capital for capital adequacy purpose as it is not an eligible item of capital.

- DTA will be treated as an intangible asset and should be deducted from Tier I Capital.

- NBFCs may keep the above clarifications in mind for all regulatory requirements including computation of CRAR and ensure compliance with effect from the accounting year ending March 31, 2009.

In this connection it is further clarified that

DTL created by debit to opening balance of Revenue Reserves or to Profit and Loss Account for the current year should be included under 'others' of "Other Liabilities and Provisions."

DTA created by credit to opening balance of Revenue Reserves or to Profit and Loss account for the current year should be included under item 'others' of "Other Assets."

Intangible assets and losses in the current period and those brought forward from previous periods should be deducted from Tier I capital.

DTA computed as under should be deducted from Tier I capital:

(i) DTA associated with accumulated losses; and

(ii) The DTA (excluding DTA associated with accumulated losses) net of DTL. Where the DTL is in excess of the DTA (excluding DTA associated with accumulated losses), the excess shall neither be adjusted against item (i) nor added to Tier I capital."

12. 15 Introduction of Interest Rate Futures – NBFCs

NBFCs can participate in the designated interest rate futures exchanges recognized by SEBI, as clients, subject to RBI / SEBI guidelines in the matter, for the purpose of hedging their underlying exposures. NBFCs participating in IRF exchanges may submit the data in this regard half yearly, in the prescribed format, to the Regional office of the Department of Non-Banking Supervision in whose jurisdiction their company is registered, within a period of one month from the close of the half year.

13. 16 Finance for Housing Projects - Incorporating clause in the terms and conditions to disclose in pamphlets / brochures / advertisements, information regarding mortgage of property to the NBFC

While granting finance to housing / development projects, NBFCs also should stipulate as a part of the terms and conditions that :

(i) the builder / developer / owner / company would disclose in the Pamphlets / Brochures / advertisements etc., the name(s) of the entity to which the property is mortgaged.

(ii) the builder / developer / owner / company should indicate in the pamphlets / brochures, that they would provide No Objection Certificate (NOC) / permission of the mortgagee entity for sale of flats / property, if required.

NBFCs should ensure compliance with the above stipulations and funds should not be released unless the builder / developer / owner / company fulfills the above requirements.

14. 17 Loan facilities to the physically / visually challenged by NBFCs

NBFCs shall not discriminate in extending products and facilities including loan facilities to the physically / visually challenged applicants on grounds of disability. NBFCs were also instructed to advise their branches to render all possible assistance to such persons for availing of the various business facilities. 18 NBFCs should include a suitable module containing the rights of persons with disabilities guaranteed to them by the law and international conventions, in all the training programmes conducted for their employees at all levels. Further, NBFCs may ensure redressal of grievances of persons with disabilities under the Grievance Redressal Mechanism already set up by them.

15. 19 Participation in Currency Futures

All NBFCs excluding RNBCs are allowed to participate in the designated currency futures exchanges recognized by SEBI as clients, subject to RBI (Foreign Exchange Department) guidelines in the matter, only for the purpose of hedging their underlying forex exposures. NBFCs were advised to make appropriate regarding transactions undertaken in the Balance sheet.

16. 20 Submission of data to Credit Information Companies - Format of data to be submitted by Credit Institutions

In terms of Section 2(f)(ii) of the Credit Information Companies (Regulation) Act, 2005, a non-banking financial company as defined under clause (f) of Section 45-I of the Reserve Bank of India Act, 1934 has also been included as "credit institution". Further, the Credit Information Companies (Regulation) Act provides that every credit institution in existence shall become a member of at least one credit information company. Thus all NBFCs being credit institutions are required to become a member of at least one credit information company as per the statute.

In this regard, in terms of sub-sections (1) and (2) of Section 17 of the Credit Information Companies (Regulation) Act, 2005, a credit information company may require its members to furnish credit information as it may deem necessary in accordance with the provisions of the Act and every such credit institution has to provide the required information to that credit information company. Further, in terms of Regulation 10(a)(ii) of the Credit Information Companies Regulations, 2006, every credit institution shall:

(a) keep the credit information maintained by it, updated regularly on a monthly basis or at such shorter intervals as may be mutually agreed upon between the credit institution and the credit information company; and

(b) take all such steps which may be necessary to ensure that the credit information furnished by it, is update, accurate and complete.

It was therefore, advised that NBFCs which had become member / members of any new credit information company / companies may provide them the current data in the existing format. Such NBFCs were also advised to provide historical data in order to enable the new credit information companies to validate their software and develop a robust database. 21 However, NBFCs which are registered with the Bank as Core Investment Companies, Primary Dealers and those purely into investment activities without any customer interface are exempt from the applicability of these instructions.

16.1 22 Data Format for Furnishing of Credit Information to Credit Information Companies (CICs) and other Regulatory Measures

A committee to Recommend Data Format for Furnishing of Credit Information to Credit Information Companies (Chairman: Shri AdityaPuri) was constituted by the Reserve Bank of India (RBI). The Report of the Committee was placed on RBI’s website on March 22, 2014 inviting comments on the recommendations of the Committee. Subsequently, the Bank issued the Circular DBOD.No.CID.BC.127/20.16.056/2013-14 dated June 27, 2014 laying down instructions regarding the following:

i) Creating Awareness about Credit Information Report (CIR); ii) Usage of CIR in all Lending Decisions and Account Opening; iii) Populating Commercial Data Records in Databases of all CICs; iv) Standardisation of Data Format; v) Constitution of a Technical Working Group; vi) Process of Rectification of Rejected Data; vii) Determining Data Quality Index, viii) Calibration of Credit Score and Standardising Format of CIR. ix) Best practices for Banks/FIs.

16.2 Membership of Credit Information Companies (CICs)

23 Presently, four CICs, viz. Credit Information Bureau (India) Limited, Equifax Credit Information Services Private Limited, Experian Credit Information Company of India Private Limited and CRIF High Mark Credit Information Services Private Limited have been granted Certificate of Registration by RBI. In terms of Section 15 of the Credit Information Companies (Regulation) Act, 2005 (CICRA), every Credit Institution shall become member of at least one CIC. Further, Section 17 of CICRA stipulates that a CIC may seek and obtain credit information from its members (Credit Institution / CIC) only. As a result, when a Specified User, as defined in CICRA and Credit Information Companies Regulations, 2006, obtains credit information on a particular borrower/client from a CIC, it gets only such information that has been provided to the CIC by its members. This does not include credit history related to those non-member Credit Institutions with which the borrower/client has/had a current or a past exposure. To overcome this problem of incomplete/inaccurate credit information, pros and cons of certain possible alternatives have been discussed in the Report of the Committee to Recommend Data Format for Furnishing of Credit information to Credit Information Companies (Chairman: Shri Aditya Puri) constituted by the Reserve Bank of India (RBI). The report of the committee can be accessed on the following URL: http://rbi.org.in/scripts/PublicationReportDetails.aspx?UrlPage=&ID=763 .

These alternatives along with suggestions/comments obtained from IBA and the CICs have been examined by RBI. It has been decided that the best option would be to mandate all Credit Institutions to become members of all CICs and moderate the membership and annual fees suitably. These instructions would be reviewed in due course.

17. 24 Implementation of Green Initiative of the Government

As part of the ‘Green Initiative’ of the Government, the Government of India had suggested that steps be taken by entities in financial sector, including NBFCs to help better utilisation of their resources and also better delivery of services. NBFCs were therefore, requested to take proactive steps in this regard by increasing the use of electronic payment systems, elimination of post-dated cheques and gradual phase-out of cheques in their day to day business transactions which would result in more cost-effective transactions and faster and accurate settlements.

18. 25 Attempt to defraud using fake bank guarantee-modus operandi

In view of reports of instances of frauds involving fake Bank Guarantee with forged signature etc in certain bank branches, NBFCs were advised to take notice of the names of the beneficiaries /representative of beneficiaries and applicants of BGs in order to exercise due caution while handling cases involving the firms/individuals cited in the circular.

19. 26 Credit Default Swaps – NBFCs as Users

NBFCs shall only participate in CDS market as users. As users, they would be permitted to buy credit protection only to hedge their credit risk on corporate bonds they hold. They are not permitted to sell protection and hence not permitted to enter into short positions in the CDS contracts. However, they are permitted to exit their bought CDS positions by unwinding them with the original counterparty or by assigning them in favour of buyer of the underlying bond.

Apart from complying with all the provisions above, NBFCs were advised that, as users, they shall also be required to ensure that the guidelines enclosed including operational requirements for CDS are fulfilled by them.

20. 27 Revisions to the Guidelines on Securitisation Transactions

I. Detailed Guidelines on Securitisation of Standard Assets were issued to NBFCs vide Circular DBOD.NO.BP.BC.60/21.04.048/2005-06 dated February 01, 2006 .

In order to prevent unhealthy practices surrounding securitization viz. origination of loans for the sole purpose of securitization and in order to align the interest of the originator with that of the investors and with a view to redistribute credit risk to a wide spectrum of investors, it was felt necessary that originators should retain a portion of each securitization originated and ensure more effective screening of loans. In addition, a minimum period of retention of loans prior to securitization was also considered desirable, to give comfort to the investors regarding the due diligence exercised by the originator. Keeping in view the above objectives, revised guidelines were issued in this regard to banks and NBFCs also ( Annex-1 ). The guidelines also include, inter alia, bilateral sale of assets, accounting of profits and disclosures.

II. 28 Reset of Credit Enhancement

a) Detailed Guidelines on reset of credit enhancement were issued to banks vide circular DBOD.No.BP.BC-25/21.04.177/2013-14, dated July 1, 2013 . The guidelines cover in detail the manner in which such reset could be carried out subject to the conditions prescribed therein. The applicability of these instructions have been extended to securitization transactions undertaken by NBFCs as well.

b) In respect of the transactions already entered into in terms of circular dated DNBS.PD.No.301/3.10.01/2012-13, dated August 21, 2012 , reset can be carried out subject to the consent of all investors of outstanding securities. In respect of the transactions entered into prior to August 2012 guidelines, the stipulation pertaining to MRR will also have to be complied with in addition to other conditions for reset of CE mentioned in para a) above.

21. 29 Standardisation and Enhancement of Security Features in Cheque Forms - Migrating to CTS 2010 Standards

All NBFCs were advised about the "CTS-2010 standard“ which is a set of benchmarks towards achieving standardisation of cheques issued by banks across the country and include provision of mandatory minimum security features on cheque forms like quality of paper, watermark, bank's logo in invisible ink, void pantograph, etc., and standardisation of field placements on cheques. NBFCs were advised that "CTS-2010 standard“ were to be implemented by December 31, 2012 and those NBFCs who accept post –dated cheques from their customers for future EMI payments were required to ensure the replacement of Non–CTS-2010 standard compliant cheques with CTS-2010 standard compliant cheques before December 31, 2012. However, 30 taking into consideration the representations from NBFCs, it was decided to extend the time up to March 31, 2013 to ensure withdrawal of Non-CTS 2010 Standard compliant cheques and replace them with CTS-2010 Standard compliant cheques. However, NBFCs were advised to note that the residual Non-CTS-2010 Standard compliant cheques that get presented in the clearing system beyond the extended period, will continue to be accepted for the clearing but will be cleared at less frequent intervals.

22. 31 Migration of Post-dated cheques (PDC)/Equated Monthly Installment (EMI) Cheques to Electronic Clearing Service (Debit)

Reference is invited to circular issued by our Department of Payment and Settlement System ( DPSS.CO.CHD.No.133/04.07.05/2013-14 dated July 16, 2013 ) wherein it has been indicated that cheques not complying with CTS-2010 Standard will be cleared at less frequent intervals with effect from January 1, 2014 (thrice a week up to April 30, 2014, twice a week up to October 31, 2014 and weekly once from November 1, 2014 onwards).

To avoid delays in realization of non-CTS-2010 cheques, all NBFCs were advised

a) to migrate towards accepting only CTS-2010 standard cheques

b) Not to accept fresh / additional Post Dated Cheques (PDC) / Equated Monthly Installment (EMI) cheques (either in old format or new CTS-2010 format) in locations where the facility of ECS / RECS (Debit) is available. The existing PDCs / EMI cheques in such locations may be converted into ECS / RECS (Debit) by obtaining fresh ECS (Debit) mandates. This exercise were to be completed by December 31, 2013.

Considering the protection available under Section 25 of the Payment and Settlement Systems Act, 2007 which accords the same rights and remedies to the payee (beneficiary) against dishonor of electronic funds transfer instructions under insufficiency of funds as are available under Section 138 of the Negotiable Instruments Act, 1881, it was advised that there is no need for NBFCs to take additional cheques, if any, from customers in addition to ECS (Debit) mandates. Cheques complying with CTS-2010 standard formats shall alone be obtained in locations, where the facility of ECS/RECS is not available.

23. 32 Readiness of major service providers to migrate from IPv4 to IPv6

Government of India had envisaged providing “Broadband on Demand” by 2015 in the recently unveiled National Telecom Policy (NTP) – 2012 emphasizing the role of Internet as catalyst for socio-economic development of a country which serves as an effective medium of various citizen centric services in today’s information economy.

Department of Telecommunication under the Ministry of Communication and Information Technology, Government of India has undertaken the initiative of migration from IPv4 to IPv6. Since migration to IPv6 is an eventuality that has to be accepted and manage proactively, NBFCs/RNBCs were advised to initiate necessary action by constituting a special team to complete the migration by December 2012.

24. 33 Checklist for NBFCs, Non Banking Financial Company-Micro Finance Institutions (NBFC-MFIs), Non Banking Financial Company-Factoring Institutions (NBFC-Factors) and Core Investment Companies (CICs)

Five checklists with respect to Application for seeking Certificate of Registration from the Reserve Bank have been uploaded in the RBI website, a) documents required for registration as NBFCs b) documents required for registration of NBFC-MFI – New Companies and c) documents required for registration of NBFC-MFI (Existing NBFCs) d) documents required for registration of NBFC – Factors and e) documents required for registration as CIC-ND-SI. ( Annex 2 )

Checklists mentioned are indicative and not exhaustive. Bank can, if necessary, call for any further documents to satisfy themselves on the eligibility for obtaining registration as NBFC. In the event of the Bank calling for further documents in addition to those mentioned in the checklist, the applicant company must respond within a stipulated time of one month failing which the application/request for conversion along with all the documents will be returned to the company for submission afresh with the required information/documents.

25. 34 Raising Money through Private Placement by NBFCs-Debentures etc.

NBFCs raise money by issuing capital/debt securities including debentures by way of public issue or private placement. In the case of public issue of such securities, institutions and retail investors can participate. Private placement, on the other hand, may involve institutional investors. It has however been observed that NBFCs have lately been raising resources from the retail public on a large scale, through private placement, especially by issue of debentures.

As certain adverse features have come to the notice of the Reserve Bank in private placements by certain NBFCs, it has been decided to put in place a minimum set of guidelines (given in Annex-3 ) for compliance by all NBFCs 35 except Primary Dealers. The Guidelines require NBFCs to space out such issuances and also aim to bring NBFCs at par with other financial entities as far as private placement is concerned by restricting the maximum number of subscribers to forty nine (currently the ceiling of investors stipulated by the Companies Act 1956 for private placement is not applicable for NBFCs). It may be noted that all other extant guidelines on private placement remain unchanged. The provisions of these guidelines would however override other instructions in this regard, wherever contradictory.

26. 36 Filing of records of mortgages with the Central Registry

All NBFCs were advised to file and register the records of equitable mortgages created in their favour on or after 31st March 2011 with the Central Registry and also register the records with the Central Registry as and when equitable mortgages are created in their favour. 37 In continuation of the above, NBFCs were further advised to register all types of mortgages with CERSAI.

27. 38 Early Recognition of Financial Distress, Prompt Steps for Resolution and Fair Recovery for Lenders: Framework for Revitalizing Distressed Assets in the Economy

The RBI issued Framework for Revitalizing Distressed Assets in the Economy (Framework) on January 30, 2014. The framework covered in the guidelines, has outlined a corrective action plan that will incentivize early identification of problem account, timely restructuring of accounts which are considered to be viable, and taking prompt steps by lenders for recovery or sale of unviable accounts. In the background of the above, to the extent it is applicable to NBFCs; guidelines will be effective from April 1, 2014; as given in Annex-4 .

28 39 Rounding off transactions to the Nearest Rupee by NBFCs

NBFCs were advised that all transactions, including payment of interest on deposits/ charging of interest on advances, should be rounded off to the nearest rupee, i.e. fractions of 50 paise and above shall be rounded off to the next higher rupee and fractions of less than 50 paise should be ignored. Further, NBFCs were also advised to ensure that cheques/ drafts issued by clients containing fractions of a rupee should not be rejected by them.

Revisions to the Guidelines on Securitisation Transactions

Guidelines on Securitisation of Standard Assets

1 Requirements to be met by the orginating NBFCs

1.1 Assets Eligible for Securitisation

In a single securitisation transaction, the underlying assets should represent the debt obligations of a homogeneous pool of obligors 1 . Subject to this condition, all on-balance sheet standard assets 2 except the following, will be eligible for securitisation by the originators :

i) Revolving credit facilities (e.g., Credit Card receivables)

ii) Assets purchased from other entities

iii) Securitisation exposures (e.g. Mortgage-backed / asset-backed securities)

iv) Loans with bullet repayment of both principal and interest 3 .

1.2 Minimum Holding Period (MHP)

1.2.1 Originating NBFCs can securitise loans only after these have been held by them for a minimum period in their books. The criteria governing determination of MHP for assets listed below reflect the need to ensure that :

* the project implementation risk is not passed on to the investors, and

* a minimum recovery performance is demonstrated prior to securitisation to ensure better underwriting standards

1.2.2 NBFCs can securitise loans only after a MHP counted from the date of full disbursement of loans for an activity / purpose; acquisition of asset (i.e., car, residential house etc.) by the borrower or the date of completion of a project, as the case may be. MHP would be defined with reference to the number of instalments to be paid prior to securitisation. MHP applicable to various loans depending upon the tenor and repayment frequency is given in the following table 4 .

1.2.3 The MHP will be applicable to individual loans in the pool of securitised loans. MHP will not be applicable to loans referred to in foot note 3 of para 1.1.

1.3 Minimum Retention Requirement (MRR)

The originating NBFCs should adhere to the MRR detailed in the Table below while securitising loans :

1.3.2 MRR will have to be maintained by the entity which securitises the loans. In other words, it cannot be maintained by other entities which are treated as 'originator' in terms of para 5(vi) of the circular dated February 1, 2006 containing Guidelines on Securitisation of Standard Assets.

1.3.3 The MRR should represent the principal cash flows. Therefore, NBFCs' investment in the Interest Only Strip representing the Excess Interest Spread / Future Margin Income, whether or not subordinated, will not be counted towards the MRR.

1.3.4 The level of or selling the retained interest commitment by originators i.e., MRR should not be reduced either through hedging of credit risk. The MRR as a percentage of unamortised principal should be maintained on an ongoing basis except for reduction of retained exposure due to proportionate repayment or through the absorption of losses. The form of MRR should not change during the life of securitisation.

1.3.5 For complying with the MRR under these guidelines NBFCs should ensure that proper documentation in accordance with law is made.

1.4 Limit on Total Retained Exposures

1.4.1 At present, total investment by the originator in the securities issued by the SPV through underwriting or otherwise is limited to 20% of the total securitised instruments issued. It has been decided that the total exposure of NBFCs to the loans securitised in the following forms should not exceed 20% of the total securitised instruments issued :

- Investments in equity / subordinate / senior tranches of securities issued by the SPV including through underwriting commitments

- Credit enhancements including cash and other forms of collaterals including overcollateralisation, but excluding the credit enhancing interest only strip

- Liquidity support.

1.4.2 If an NBFC exceeds the above limit, the excess amount would be risk weighted at 667% 5 .

1.4.3 The 20% limit on exposures will not be deemed to have been breached if it is exceeded due to amortisation of securitisation instruments issued.

1.5 Booking of Profit Upfront

1.5.1 In terms of para 20.1 of circular DBOD.No.BP.BC.60/21.04.048/2005-06 dated February 1, 2006 , any profit / premium arising on account of securitisation of loans should be amortised over the life of the securities issued or to be issued by the SPV. These instructions were inter alia intended to discourage 'originate-to-distribute' model. Now that these concerns are sought to be addressed to some extent by MRR, MHP and other measures being proposed in these guidelines, it has been decided to allow higher recognition of cash profits during a year based on amortisation of principal and losses incurred as well as specific provision requirements on the securitisation exposures as explained below :

The amount of profit received in cash may be held under an accounting head styled as "Cash Profit on Loan Transfer Transactions Pending Recognition" maintained on individual transaction basis. The amortisation of cash profit arising out of securitisation transaction will be done at the end of every financial year and calculated as under :

Profit to be amortised = Max{L, [(X*(Y/Z))], [(X/n)]}

X = amount of unamortised cash profit lying in the account 'Cash Profit on Loan Transfer Transactions Pending Recognition' at the beginning of the year

Y = amount of principal amortised during the year

Z = amount of unamortised principal at the beginning of the year

L = Loss 6 (marked to market losses incurred on the portfolio + specific provisions, if any, made against the exposures to the particular securitisation transaction + direct write-off) excluding loss incurred on credit enhancing interest only strip 7

n = residual maturity of the securitisation transaction

1.5.2 The above method of amortisation of profit can be applied to outstanding securitisation transactions as well. However, the method can be applied only with respect to the outstanding amortisable profit and un-amortised principal outstanding as on the date of issuance of this circular.

1.5.3 At times, the originating NBFCs retain contractual right to receive some of the interest amount due on the transferred assets. This interest receivable by the originating NBFC represents a liability of the SPV and its present value is capitalised by the originating NBFC as an Interest Only Strip (I / O Strip), which is an on-balance sheet asset. Normally, a NBFC would recognise an unrealised gain in its Profit and Loss account on capitalisation of future interest receivable by way of I / O Strip. However, consistent with the instructions contained in circular dated February 1, 2006 referred to above, NBFCs should not recognise the unrealised gains in Profit and Loss account; instead they should hold the unrealised profit under an accounting head styled as "Unrealised Gain on Loan Transfer Transactions". The balance in this account may be treated as a provision against potential losses incurred on the I / O Strip due to its serving as credit enhancement for the securitisation transaction 8 . The profit may be recognised in Profit and Loss Account only when Interest Only Strip is redeemed in cash. As NBFCs would not be booking gain on sale represented by I / O Strip upfront, it need not be deducted from Tier I capital. This method of accounting of Interest Only Strip can be applied to outstanding securitisation transactions as well.

1.6 Disclosures by the Originating NBFCs

1.6.1 Disclosures to be made in Servicer / Investor / Trustee Report

The above periodical disclosures should be made separately for each securitisation transaction, throughout its life, in the servicer report, investor report, trustee report, or any similar document published. The aforesaid disclosures can be made in the format given in Appendix 1 .

1.6.2 Disclosures to be made by the Originator in Notes to Annual Accounts

The Notes to Annual Accounts of the originating NBFCs should indicate the outstanding amount of securitised assets as per books of the SPVs sponsored by the NBFC and total amount of exposures retained by the NBFC as on the date of balance sheet to comply with the MRR. These figures should be based on the information duly certified by the SPV's auditors obtained by the originating NBFC from the SPV. These disclosures should be made in the format given in Appendix 2 .

1.7 Loan Origination Standards

The originating NBFCs should apply the same sound and well-defined criteria for credit underwriting to exposures to be securitised as they apply to exposures to be held on their book. To this end, the same processes for approving and, where relevant, amending, renewing and monitoring of credits should be applied by the originators.

1.8 Treatment of Securitised Assets not Meeting the Requirements Stipulated above

All instructions contained in this paragraph will be applicable only to the new transactions unless explicitly stated otherwise. If an originating NBFC fails to meet the requirement laid down in the paragraphs 1.1 to 1.7 above, it will have to maintain capital for the securitised assets as if these were not securitised. This capital would be in addition to the capital which the NBFC is required to maintain on its other existing exposures to the securitisation transaction.

2. Requirements to be met by NBFCs other than originators having Securitisation exposure

2.1 Standards for Due Diligence

2.1.1 NBFCs can invest in or assume exposure to a securitisation position only if the originator (other NBFCs / FIs / banks) has explicitly disclosed to the credit institution that it has adhered to MHP and MRR stipulated in these guidelines and will adhere to MRR guidelines on an ongoing basis.

2.1.2 Before investing, and as appropriate thereafter, NBFCs should be able to demonstrate for each of their individual securitisation positions, that they have a comprehensive and thorough understanding of risk profile of their proposed / existing investments in securitised positions. NBFCs will also have to demonstrate that for making such an assessment they have implemented formal policies and procedures appropriate for analysing and recording the following :

information disclosed by the originators regarding the MRR in the securitisation, on at least half yearly basis;

the risk characteristics of the individual securitisation position including all the structural features of the securitisation that can materially impact the performance of the investing NBFC's securitisation position (i.e., the seniority of the tranche, thickness of the subordinate tranches, its sensitivity to prepayment risk and credit enhancement resets, structure of repayment waterfalls, waterfall related triggers, the position of the tranche in sequential repayment of tranches (time-tranching), liquidity enhancements, availability of credit enhancements in the case of liquidity facilities, deal-specific definition of default, etc.);

the risk characteristics of the exposures underlying the securitization position (i.e., the credit quality, extent of diversification and homogeneity of the pool of loans, sensitivity of the repayment behavior of individual borrowers to factors other than their sources of income, volatility of the market values of the collaterals supporting the loans, cyclicality of the economic activities in which the underlying borrowers are engaged, etc.);

the reputation of the originators in terms of observance of credit appraisal and credit monitoring standards, adherence to MRR and MHP standards in earlier securitisations, and fairness in selecting exposures for securitisation;

loss experience in earlier securitisations of the originators in the relevant exposure classes underlying the securitisation position, incidence of any frauds committed by the underlying borrowers, truthfulness of the representations and warranties made by the originator;

the statements and disclosures made by the originators, or their agents or advisors, about their due diligence on the securitized exposures and, where applicable, on the quality of the collateral supporting the securitised exposures; and

where applicable, the methodologies and concepts on which the valuation of collateral supporting the securitised exposures is based and the policies adopted by the originator to ensure the independence of the valuer.

2.1.3 When the securitised instruments are subsequently purchased in the secondary market by an NBFC, it should, at that point in time, ensure that the originator has explicitly disclosed that it will retain a position that meets the MRR.

2.2 Stress Testing

2.3 Credit Monitoring

NBFCs need to monitor on an ongoing basis and in a timely manner, performance information on the exposures underlying their securitization positions and take appropriate action, if any, required. Action may include modification to exposure ceilings to certain type of asset class underlying securitisation transaction, modification to ceilings applicable to originators etc. For this purpose, NBFCs should establish formal procedures commensurate with the risk profile of their exposures in securitised positions as stipulated in para 2.1.2. Where relevant, this shall include the exposure type, the percentage of loans more than 30, 60, 90, 120 and 180 days past due, default rates, prepayment rates, loans in foreclosure, collateral type and occupancy and frequency distribution of credit scores or other measures of credit worthiness across underlying exposures, industry and geographical diversification, frequency distribution of loan to value ratios with bandwidths that facilitate adequate sensitivity analysis. NBFCs may inter alia make use of the disclosures made by the originators in the form given in Appendix 1 to monitor the securitisation exposures.

2.4 Treatment of Exposures not Meeting the Requirements Stipulated above

The investing NBFCs will assign a risk weight of 667% to the securitisation exposures where the requirements in the paragraphs 2.1 to 2.3 above are not met. While NBFCs should make serious efforts to comply with the guidelines contained in paragraphs 2.1 to 2.3, the higher risk weight of 667% will be applicable with effect from October 01, 2012. NBFCs should put in place necessary systems and procedures to implement the requirements in paragraphs 2.1 to 2.3 before October 31, 2012.

Guidelines on Transactions Involving Transfer of Assets through Direct Assignment of Cash Flows and the Underlying Securities

1. Requirements to be met by the Originating NBFCs

1.1 Assets Eligible for Transfer 9

1.1.1 Under these guidelines, NBFCs can transfer a single standard asset or a part of such asset or a portfolio of such assets to financial entities through an assignment deed with the exception of the following :

Revolving credit facilities (e.g., Credit Card receivables)

Assets purchased from other entities

Assets with bullet repayment of both principal and interest 10

1.1.2 However, these guidelines do not apply to :

Transfer of loan accounts of borrowers by an NBFC to other NBFCs / FIs / banks and vice versa, at the request / instance of borrower;

Trading in bonds;

Sale of entire portfolio of assets consequent upon a decision to exit the line of business completely. Such a decision should have the approval of Board of Directors of the NBFC;

Consortium and syndication arrangements.

Any other arrangement / transactions, specifically exempted by the Reserve Bank of India.

1.3.1 The originating NBFCs should adhere to the MRR detailed in the Table below while transferring assets to other financial entities :

1.3.2 In the case of partial sale of assets, if the portion retained by the seller is more than the MRR required as per para 1.3.1 above, then out of the portion retained by the seller, the portion equivalent to 5% of the portion sold or 10% of the portion sold, as the case may be, would be treated as MRR. However, all exposures retained by the selling NBFC including MRR should rank pari-passu with the sold portion of the asset.

1.3.3 NBFCs should not offer credit enhancements in any form and liquidity facilities in the case of loan transfers through direct assignment of cash flows, as the investors in such cases are generally the institutional investors who should have the necessary expertise to appraise and assume the exposure after carrying out the required due diligence. NBFCs should also not retain any exposures through investment in the Interest Only Strip representing the Excess Interest Spread / Future Margin Income from the loans transferred. However, the originating NBFCs will have to satisfy the MRR requirements stipulated in para 1.3.1 above. NBFCs' retention of partial interest in the loans transferred to comply with the MRR indicated in para 1.3.1 should be supported by a legally valid documentation. At a minimum, a legal opinion regarding the following should also be kept on record by the originator :

legal validity of amount of interest retained by the originator;

such arrangement not interfering with assignee's rights and rewards associated with the loans to the extent transferred to it; and

the originator not retaining any risk and rewards associated with the loans to the extent transferred to the assignee.

1.3.4 MRR will have to be maintained by the entity which sells the loans. In other words, it cannot be maintained by other entities which are treated as 'originator' in terms of para 5(vi) of the circular dated February 1, 2006 containing guidelines on securitisation of standard assets.

1.3.5 The level of commitment by originators i.e., MRR should not be reduced either through hedging of credit risk or selling the retained interest. The MRR as a percentage of unamortised principal should be maintained on an ongoing basis except for reduction of retained exposure due to proportionate repayment or through the absorption of losses. The form of MRR should not change during the life of transaction.

1.3.6 For complying with the MRR under these guidelines, NBFCs should ensure that proper documentation in accordance with law is made.

1.4 Booking of Profit Upfront

1.4.1 The amount of profit in cash on direct sale of loans may be held under an accounting head styled as "Cash Profit on Loan Transfer Transactions Pending Recognition" maintained on individual transaction basis and amortised over the life of the transaction. The amortisation of cash profit arising out of loan assignment transaction will be done at the end of every financial year and calculated as under :

Profit to be amortised = Max {L, [(X*(Y/Z)], [(X/n)]}

L = Loss (specific provisions to be made on retained exposures for credit losses plus direct write-off plus any other losses, if any) 11 incurred on the portfolio

1.4.2 Accounting, Asset Classification and provisioning norms for MRR

The asset classification and provisioning rules in respect of the exposure representing the MRR would be as under :

The originating NBFC may maintain a consolidated account of the amount representing MRR if the loans transferred are retail loans. In such a case, the consolidated amount receivable in amortisation of the MRR and its periodicity should be clearly established and the overdue status of the MRR should be determined with reference to repayment of such amount. Alternatively, the originating NBFC may continue to maintain borrower-wise accounts for the proportionate amounts retained in respect of those accounts. In such a case, the overdue status of the individual loan accounts should be determined with reference to repayment received in each account.

In the case of transfer of a pool of loans other than retail loans, the originator should maintain borrower-wise accounts for the proportionate amounts retained in respect of each loan. In such a case, the overdue status of the individual loan accounts should be determined with reference to repayment received in each account.

If the originating NBFC acts as a servicing agent of the assignee bank / NBFC for the loans transferred, it would know the overdue status of loans transferred which should form the basis of classification of the entire MRR / individual loans representing MRR as NPA in the books of the originating NBFC, depending upon the method of accounting followed as explained in para (a) and (b) above.

1.5 Disclosures by the Originating NBFCs

Same as in para 1.6 of Section A.

1.6 Loan Origination Standards

Same as in para 1.7 of Section A.

1.7 Treatment of Assets sold not Meeting the Requirements stipulated above

All instructions contained in this paragraph except in para 1.4.2 will be applicable only to the new transactions undertaken on or after the date of this circular. Instructions in para 1.4.2 will be applicable to both existing and new transactions 12 . If an originating NBFC fails to meet the requirement laid down in paragraphs 1.1 to 1.6 above, it will have to maintain capital for the assets sold as if these were still on the books of the NBFC (originating NBFC).

2. Requirements to be met by the Purchasing NBFCs

2.1 Restrictions on Purchase of loans

NBFCs can purchase loans from other NBFCs / FIs / banks in India only if the seller has explicitly disclosed to the purchasing NBFCs that it will adhere to the MRR indicated in para 1.3 on an ongoing basis. In addition, for domestic transactions, purchasing NBFCs should also ensure that the originating institution has strictly adhered to the MHP criteria prescribed in the guidelines in respect of loans purchased by them.

2.2 Standards for Due Diligence

2.2.1 NBFCs should have the necessary expertise and resources in terms of skilled manpower and systems to carry out the due diligence of the loans / portfolios of loans before purchasing them. In this regard the purchasing NBFCs should adhere to the following guidelines :

NBFCs with the approval of their Board of Directors, should formulate policies regarding the process of due diligence which needs to be exercised by the NBFCs' own officers to satisfy about the Know Your Customer requirements and credit quality of the underlying assets. Such policies should inter alia lay down the methodology to evaluate credit quality of underlying loans, the information requirements etc.

The due diligence of the purchased loans cannot be outsourced by the NBFC and should be carried out by its own officers with the same rigour as would have been applied while sanctioning new loans by the NBFC.

If an NBFC wishes to outsource certain activities like collection of information and documents etc., then NBFCs would continue to retain full responsibility in regard to selection of loans for purchase and compliance with Know Your Customer requirements.

2.2.2 Before purchasing individual loans or portfolio of loans, and as appropriate thereafter, NBFCs should be able to demonstrate that they have a comprehensive and thorough understanding of and have implemented formal policies and procedures commensurate with the risk profile of the loans purchased analysing and recording :

information disclosed by the originators regarding the MRR, on an ongoing basis;

the risk characteristics of the exposures constituting the portfolio purchased (i.e., the credit quality, extent of diversification and homogeneity of the pool of loans, sensitivity of the repayment behavior of individual borrowers to factors other than their sources of income, volatility of the market values of the collaterals supporting the loans, cyclicality of the economic activities in which the underlying borrowers are engaged, etc.);

the reputation of the originators in terms of observance of credit appraisal and credit monitoring standards, adherence to MRR and MHP standards in earlier transfer of portfolios and fairness in selecting exposures for transfer;

loss experience in earlier transfer of loans / portfolios by the originators in the relevant exposure classes underlying and incidence of any frauds committed by the underlying borrowers, truthfulness of the representations and warranties made by the originator;

the statements and disclosures made by the originators, or their agents or advisors, about their due diligence on the assigned exposures and, where applicable, on the quality of the collateral supporting the loans transferred; and

where applicable, the methodologies and concepts on which the valuation of loans transferred is based and the policies adopted by the originator to ensure the independence of the valuer.

2.3 Stress Testing

NBFCs should regularly perform their own stress tests appropriate to the portfolios of loans purchased by them. For this purpose, various factors which may be considered include, but are not limited to, rise in default rates in the underlying portfolios in a situation of economic downturn and rise in pre-payment rates due to fall in rate of interest or rise in income levels of the borrowers leading to early redemption of exposures.

2.4 Credit monitoring

2.4.1 The purchasing NBFCs need to monitor on an ongoing basis and in timely manner performance information on the loans purchased and take appropriate action required, if any. Action may include modification to exposure ceilings to certain type of asset classes, modification to ceilings applicable to originators etc. For this purpose, NBFCs should establish formal procedures appropriate and commensurate with the risk profile of the purchased loans. Such procedures should be as rigorous as that followed by the NBFC for portfolios of similar loans directly originated by it. In particular, such procedures must facilitate timely detection of signs of weaknesses in individual accounts and identification of non-performing borrowers as per RBI guidelines as soon as loans are 180 days past due. The information collected should include the exposure type, the percentage of loans more than 30, 60, 90, 120 and 180 days past due, default rates, prepayment rates, loans in foreclosure, collateral type and occupancy, and frequency distribution of credit scores or other measures of credit worthiness across underlying exposures, industry and geographical diversification, frequency distribution of loan to value ratios with band widths that facilitate adequate sensitivity analysis. Such information, if not collected directly by the NBFC and obtained from the servicing agent, should be certified by the authorized officials of the servicing agent. NBFCs may inter alia make use of the disclosures made by the originators in the form given in Appendix 1 to monitor the exposures.

2.4.2 Depending upon the size of the portfolio, credit monitoring procedures may include verification of the information submitted by the bank / NBFC's concurrent and internal auditors. The servicing agreement should provide for such verifications by the auditors of the purchasing NBFC. All relevant information and audit reports should be available for verification by the Inspecting Officials of RBI during the Annual Financial Inspections of the purchasing NBFCs.

2.5 True Sale Criteria 13

2.5.1 The 'sale' (this term would hereinafter include direct sale, assignment and any other form of transfer of asset, but does not include bills rediscounted, outright transfer of loan accounts to other financial entities at the instance of the borrower and sale of bonds other than those in the nature of advance) should result in immediate legal separation of the 'selling NBFC' 14 (this term hereinafter would include direct selling NBFC, assigning NBFC and the NBFC transferring assets through any other mode), from the assets 15 which are sold. The assets should stand completely isolated from the selling NBFC, after its transfer to the buyer, i.e., put beyond the selling NBFC's as well as its creditors' reach, even in the event of bankruptcy of the selling / assigning / transferring NBFC.

2.5.2 The selling NBFC should effectively transfer all risks / rewards and rights / obligations pertaining to the asset and shall not hold any beneficial interest in the asset after its sale except those specifically permitted under these guidelines. The buyer should have the unfettered right to pledge, sell, transfer or exchange or otherwise dispose of the assets free of any restraining condition. The selling NBFC shall not have any economic interest in the assets after its sale and the buyer shall have no recourse to the selling NBFC for any expenses or losses except those specifically permitted under these guidelines.

2.5.3 There shall be no obligation on the selling NBFC to re-purchase or fund the repayment of the asset or any part of it or substitute assets held by the buyer or provide additional assets to the buyer at any time except those arising out of breach of warranties or representations made at the time of sale. The selling NBFC should be able to demonstrate that a notice to this effect has been given to the buyer and that the buyer has acknowledged the absence of such obligation.

2.5.4 The selling NBFC should be able to demonstrate that it has taken all reasonable precautions to ensure that it is not obliged, nor will feel impelled, to support any losses suffered by the buyer.

2.5.5 The sale shall be only on cash basis and the consideration shall be received not later than at the time of transfer of assets. The sale consideration should be market-based and arrived at in a transparent manner on an arm's length basis.

2.5.6 If the seller of loans acts as the servicing agent for the loans, it would not detract from the 'true sale' nature of the transaction, provided such service obligations do not entail any residual credit risk on the sold assets or any additional liability for them beyond the contractual performance obligations in respect of such services.

2.5.7 An opinion from the selling NBFC's Legal Counsel should be kept on record signifying that : (i) all rights, titles, interests and benefits in the assets have been transferred to the buyer; (ii) selling NBFC is not liable to the buyer in any way with regard to these assets other than the servicing obligations as indicated in para 2.5.6 above; and (iii) creditors of the selling NBFC do not have any right in any way with regard to these assets even in case of bankruptcy of the selling NBFC.

2.5.8 Any re-schedulement, restructuring or re-negotiation of the terms of the underlying agreement/s effected after the transfer of assets to the buyer, shall be binding on the buyer and not on the selling NBFC except to the extent of MRR.

2.5.9 The transfer of assets from selling NBFC must not contravene the terms and conditions of any underlying agreement governing the assets and all necessary consents from obligors (including from third parties, where necessary) should have been obtained.

2.5.10 In case the selling NBFC also provides servicing of assets after the sale under a separate servicing agreement for fee, and the payments / repayments from the borrowers are routed through it, it shall be under no obligation to remit funds to the buyer unless and until these are received from the borrowers.

2.6 Representations and Warranties

An originator that sells assets to other financial entities may make representations and warranties concerning those assets. Where the following conditions are met the seller will not be required to hold capital against such representations and warranties.

Any representation or warranty is provided only by way of a formal written agreement.

The seller undertakes appropriate due diligence before providing or accepting any representation or warranty.

The representation or warranty refers to an existing state of facts that is capable of being verified by the seller at the time the assets are sold.

The representation or warranty is not open-ended and, in particular, does not relate to the future creditworthiness of the loans / underlying borrowers.

The exercise of a representation or warranty, requiring an originator to replace asset (or any parts of them) sold, on grounds covered in the representation or warranty, must be : * undertaken within 120 days of the transfer of assets; and * conducted on the same terms and conditions as the original sale.

A seller that is required to pay damages for breach of representation or warranty can do so provided the agreement to pay damages meets the following conditions : * the onus of proof for breach of representation or warranty remains at all times with the party so alleging; * the party alleging the breach serves a written Notice of Claim on the seller, specifying the basis for the claim; and * damages are limited to losses directly incurred as a result of the breach

A seller should notify RBI (Department of Non-Banking Supervision) of all instance where it has agreed to replace assets sold to another financial entity or pay damages arising out of any representation or warranty.

2.7 Re-purchase of Assets

In order to limit the extent of effective control of transferred assets by the seller in the case of direct assignment transactions, NBFCs should not have any re-purchase agreement including through "clean-up calls" on the transferred assets.

2.8 Applicability of Capital Adequacy and other Prudential Norms

2.8.1 The capital adequacy treatment for direct purchase of loans will be as per the rules applicable to loans directly originated by the NBFCs. Investment in tranches of securitized loans will attract capital adequacy and other prudential norms as applicable to securitization transactions. NBFCs may, if they so desire, have the pools of loans rated before purchasing so as to have a third party view of the credit quality of the pool in addition to their own due diligence. However, such rating cannot substitute for the due diligence that the purchasing NBFC is required to perform in terms of para 2.2 of this Section.

2.8.2 In purchase of pools of both retail and non-retail loans, income recognition, asset classification, provisioning and exposure norms for the purchasing NBFC will be applicable based on individual obligors and not based on portfolio. NBFCs should not apply the asset classification, income recognition and provisioning norms at portfolio level, as such treatment is likely to weaken the credit supervision due to its inability to detect and address weaknesses in individual accounts in a timely manner. If the purchasing NBFC is not maintaining the individual obligor-wise accounts for the portfolio of loans purchased, it should have an alternative mechanism to ensure application of prudential norms on individual obligor basis, especially the classification of the amounts corresponding to the obligors which need to be treated as NPAs as per existing prudential norms. One such mechanism could be to seek monthly statements containing account-wise details from the servicing agent to facilitate classification of the portfolio into different asset classification categories. Such details should be certified by the authorized officials of the servicing agent. NBFC's concurrent auditors, internal auditors and statutory auditors should also conduct checks of these portfolios with reference to the basic records maintained by the servicing agent. The servicing agreement should provide for such verifications by the auditors of the purchasing NBFC. All relevant information and audit reports should be available for verification by the Inspecting Officials of RBI during the Annual Financial Inspections of the purchasing NBFCs.

2.8.3 The purchased loans will be carried at acquisition cost unless it is more than the face value, in which case the premium paid should be amortised based on straight line method or effective interest rate method, as considered appropriate by the individual NBFCs. The outstanding / unamortised premium need not be deducted from capital. The discount / premium on the purchased loans can be accounted for on portfolio basis or allocated to individual exposures proportionately.

2.9 Treatment of Exposures not Meeting the Requirements Stipulated Above

The investing NBFCs will assign a risk weight of 667% to the assignment exposures where the requirements in paragraphs 2.1 to 2.8 above are not met. While NBFCs should make serious efforts to comply with the guidelines contained in paragraphs 2.1 to 2.4, the higher risk weight of 667% for non-compliance of these paragraphs will be applicable with effect from October 01, 2012. NBFCs should put in place necessary systems and procedures to implement the requirements in paragraphs 2.1 to 2.4 before October 31, 2012.

Securitisation Activities / Exposures not permitted

1. At present, NBFCs in India are not permitted to undertake the securitisation activities or assume securitisation exposures as mentioned below.

1.1 Re-securitisation of Assets

A re-securitisation exposure is a securitisation exposure in which the risk associated with an underlying pool of exposures is tranched and at least one of the underlying exposures is a securitisation exposure. In addition, an exposure to one or more resecuritisation exposures is a re-securitisation exposure. This definition of resecuritised exposure will capture collateralised debt obligations (CDOs) of asset backed securities, including, for example, a CDO backed by residential mortgage backed securities (RMBS).

1.2 Synthetic Securitisations

A synthetic securitisation is a structure with at least two different stratified risk positions or tranches that reflect different degrees of credit risk where credit risk of an underlying pool of exposures is transferred, in whole or in part, through the use of funded (e.g. credit-linked notes) or unfunded (e.g. credit default swaps) credit derivatives or guarantees that serve to hedge the credit risk of the portfolio. Accordingly, the investors' potential risk is dependent upon the performance of the underlying pool.

1.3 Securitisation with Revolving Structures (with or without early amortisation features)

These involve exposures where the borrower is permitted to vary the drawn amount and repayments within an agreed limit under a line of credit (e.g. credit card receivables and cash credit facilities).Typically, revolving structures will have nonamortising assets such as credit card receivables, trade receivables, dealer floorplan loans and some leases that would support non-amortising structures, unless these are designed to include early amortisation features. Early amortisation means repayment of securities before their normal contractual maturity. At the time of early amortisation there are three potential amortisationmechanics : (i) Controlled amortisation; (ii) Rapid or non-controlled amortisation; and (iii) Controlled followed by a subsequent (after the completion of the controlled period) non-controlled amortisation phase.

2. The appropriateness and suitability of transactions prohibited in the above guidelines would be revisited in due course.

Appendix - 1

Format for Disclosure Requirements in offer documents, servicer report, investor report, etc. 16

Name / Identification No. of securitisation transaction 17

Disclosures to be made in Notes to Accounts by NBFCs

1 The single asset securitisations do not involve any credit tranching and redistribution of risk, and therefore, are not consistent with the economic objectives of securitisation.

2 In these guidelines the term loans / assets have been used to refer to loans, advances and bonds which are in the nature of advances

3 Trade receivables with tenor up to 12 months discounted / purchased by NBFCs from their borrowers will be eligible for securitisation. However, only those loans / receivables will be eligible for securitisation where a drawee of the bill has fully repaid the entire amount of last two loans / receivables within 180 days of the due date.

4 Where the repayment is at more than quarterly intervals, loans can be securitised after repayment of at-least two instalments.

5 The minimum CRAR requirement for NBFCs is 15%. Hence risk weight has been capped at 667% so as to ensure that the capital charge does not exceed the exposure value.

6 The losses, including marked-to-market losses, incurred by NBFCs, specific provisions, if any, and direct write-offs to be made on the MRR and any other exposures to the securitisation transaction (other than credit enhancing interest only strip) should be charged to Profit and Loss account. However, the amortisation formula would ensure that these debits to Profit and Loss account are offset to the extent there is balance in "Cash Profit on Loan Transfer Transactions Pending Recognition Account". NBFCs should also hold capital against securitisation exposures in terms of extant guidelines of RBI without taking into account balance in "Cash Profit on Loan Transfer Transactions Pending Recognition Account".

7 For accounting of losses in respect of credit enhancing interest only strip, please see para 1.5.3.

8 The I / O Strips may be amortising or non-amortising. In the case of amortising I / O strips, an NBFC would periodically receive in cash, only the amount which is left after absorbing losses, if any, supported by the I / O strip. On receipt, this amount may be credited to Profit and Loss account and the amount equivalent to the amortisation due may be written-off against the "Unrealised Gain on Loan Transfer Transactions" A/c bringing down the book value of the I / O strip in the NBFC's books. In the case of a non-amortising I / O Strip, as and when the NBFC receives intimation of charging-off of losses by the SPV against the I / O strip, it may write-off equivalent amount against "Unrealised Gain on Loan Transfer Transactions" A/c and bring down the book value of the I / O strip in the NBFC's books. The amount received in final redemption value of the I / O Strip received in cash may be taken to Profit and Loss account.

9 In these guidelines, transfer would mean transfer of assets through direct sale, assignment and any other form of transfer of assets. The generic term used for transfers would be sale and purchase.

10 Trade receivables with tenor up to 12 months discounted / purchased by NBFCs from their borrowers will be eligible for direct transfer through assignment. However, only those loans / receivables will be eligible for such transfer where a drawee of the bill has fully repaid the entire amount of last two loans / receivables within 180 days of the due date.

11 The specific provisions to be made as well as direct write-offs and other losses, if any, on the retained exposures should be charged to Profit and Loss account. In addition NBFCs should hold capital against the exposure retained as part of MRR as required in terms of extant guidelines of RBI without taking into account balance in "Cash Profit on Loan Transfer Transactions Pending Recognition" account. NBFCs will also be required to separately maintain 'standard asset' provisions on MRR as per existing instructions which should not be charged to the "Cash Profit on Loan Transfer Transactions Pending Recognition" A/c.

12 For existing transactions para 1.4.2 would apply to credit enhancements or any other type of retained exposures.

13 For true sale criteria for securitisation transaction, please refer to Guidelines on Securitisation of Standard Assets DBOD.NO.BP.BC.60/21.04.048/2005-06 dated February 01, 2006 as amended from time to time.

14 In this para, the term 'selling NBFC' will include other financial entities selling loans to NBFCs

15 In case of sale of a part of an asset, true sale criteria will apply to the part of the asset sold

16 This appendix will also be applicable to direct transfer of loans. For that purpose the words 'securitised assets'/'asset securitised' may be interpreted to mean 'loans directly transferred / assigned'. NBFCs should disclose / report the information in respect of securitisation and direct transfers separately.

17 These disclosures should be made separately for each securitisation transaction throughout the life of the transaction

18 This item is not relevant for direct transfer of loans, as there will be no credit enhancement, liquidity support and tranching.

19 Only the SPVs relating to outstanding securitisation transactions may be reported here

A. Guidelines on Private Placement by NBFCs:

1. Definitions:

"Preferential Allotment" or "Private placement" means 40 non-public offering of NCDs by NBFCs to such number of select subscribers and such subscription amounts, as may be specified by the Reserve Bank from time to time.

"Public issue" means an invitation by an NBFC to public to subscribe to the securities offered through a prospectus.

A Non-Banking Financial Company (NBFC) means an NBFC as defined in Section 45 I (f) read with Section 45 I (c) of the RBI Act, 1934.

2. Regulations

i. The offer document for private placement should be issued within a maximum period of 6 months from the date of the Board Resolution authorizing the issue. The offer document should include the names and designations of the officials who are authorised to issue the offer document. The Board Resolution and the offer document must contain information on purpose for which the resources are being raised.

ii. The offer document may be printed or typed "For Private Circulation Only". General information including the address of the registered office of the NBFC, date of opening / closing of the issue etc. shall be clearly mentioned in the offer document.

iii. An NBFC shall only issue debentures for deployment of funds on its own balance sheet and not to facilitate resource requests of group entities/ parent company / associates. 41 However this clause shall not be applicable to Core Investment Companies.

iv. Private placement by all NBFCs shall be restricted to not more than 49 investors, identified upfront by the NBFC.

v. The minimum subscription amount for a single investor shall be Rs. 25 lakh and in multiples of Rs.10 lakh thereafter.

vi. 42 NBFCs, were advised to put in place before the close of business on September 30, 2013, a Board approved policy for resource planning which, inter-alia, should cover the planning horizon and the periodicity of private placement.

vii. An NBFC shall not extend loans against the security of its own debentures (issued either by way of private placement or public issue).

viii. AII other extant instructions with regard to private placement remain unchanged.

ix. The provisions of the Guidelines shall override other instructions wherever contradictory.

B. Security cover for debentures (by private placement or public issue):

NBFCs shall ensure that at all points of time the debentures issued, including short term NCDs, are fully secured. Therefore in case, at the stage of issue, the security cover is insufficient /not created, the issue proceeds shall be placed under escrow until creation of security, which in any case should be within one month from the date of issue. 43 However this clause shall not be applicable to subordinated debt, as defined under paragraph 2(1)(xvii) of the Non-Banking Financial (Non-Deposit Accepting or Holding Companies Prudential Norms (Reserve Bank) Directions, 2007.

C. Amendment to Directions:

(i) Para 2(xii)(f) and (i) of the Non-Banking Financial Companies Acceptance of Public Deposits (Reserve Bank) Directions, 1998 has been amended to clarify that only those debentures that are either compulsorily convertible into equity or fully secured would be exempted from the definition of public deposits. Hybrid / subordinated debt with a maturity not less than sixty months would continue to be exempted from the definition of public deposits provided there is no option for recall by the issuer within the period.

44 Early Recognition of Financial Distress, Prompt Steps for Resolution and Fair Recovery for Lenders : Framework for Revitalising Distressed Assets in the Economy

Corrective Action Plan to arrest increasing NPAs

1.1 Early Recognition of Stress and Reporting to Central Repository of Information on Large Credits (CRILC)

2.1.1 Before a loan account turns into an NPA, NBFCs will be required to identify incipient stress in the account by creating a sub-asset category viz. 'Special Mention Accounts' (SMA) with the three sub-categories as given in the table below :

1.1.2 The Reserve Bank of India has set up a Central Repository of Information on Large Credits (CRILC) to collect, store, and disseminate credit data to lenders as advised by the Bank in its Circular dated February 13, 2014 issued by the Department of Banking Supervision. All systemically important non-banking financial companies (NBFC-ND-SI), NBFCs-D and all NBFC-Factors, (Notified NBFCs, for short) shall be required to report the relevant credit information on a quarterly basis in the enclosed formats given in Annex II to CRILC once the XBRL reporting mechanism is established. Till then they shall forward the information to PCGM, Department of Banking Supervision, Reserve Bank of India, World Trade Centre, Mumbai - 400 005 in hard copy. The data includes credit information on all the borrowers having aggregate fund-based and non-fund based exposure of Rs.50 million and above with them and the SMA status of the borrower. The Notified NBFCs shall be ready with the correct PAN details of their borrowers having fund based and / or non-fund based exposure of Rs.50 million and above duly authenticated from Income Tax records.

1.1.3 Individual notified NBFCs shall closely monitor the accounts reported as SMA-1 or SMA-0 as these are the early warning signs of weaknesses in the account. They should take up the issue with the borrower with a view to rectifying the deficiencies at the earliest. However, as soon as an account is reported as SMA-2 by one or more lending banks / notified NBFCs, this will trigger the mandatory formation of a Joint Lenders' Forum (JLF) and formulation of Corrective Action Plan (CAP) 2 as envisioned in Para 2.3 of the Framework. Notified NBFCs must put in place a proper Management Information and Reporting System so that any account having principal or interest overdue for more than 60 days gets reported as SMA-2 on the 61st day itself in the format given in Annex III, in hard copy to PCGM, Department of Banking Supervision, Reserve Bank of India, World Trade Centre, Mumbai - 400 005. NBFCs shall endeavour to put in place an XBRL reporting framework at the earliest.

1.2 Accelerated Provisioning

1.2.1 In cases where NBFCs fail to report SMA status of the accounts to CRILC or resort to methods with the intent to conceal the actual status of the accounts or evergreen the account, NBFCs will be subjected to accelerated provisioning for these accounts and / or other supervisory actions as deemed appropriate by RBI. The current provisioning requirement and the revised accelerated provisioning in respect of such non performing accounts are as under :

1.2.2 Further, any of the lenders who have agreed to the restructuring decision under the CAP by JLF and is a signatory to the Inter Creditor Agreement (ICA) and Debtor Creditor Agreement (DCA), but changes their stance later on, or delays / refuses to implement the package, will also be subjected to accelerated provisioning requirement as indicated above, on their exposure to this borrower i.e., if it is classified as an NPA. If the account is standard in those lenders' books, the provisioning requirement would be 5%. Further, any such backtracking by a lender might attract negative supervisory view during Supervisory Review and Evaluation Process.

1.2.3 Presently, asset classification is based on record of recovery at individual NBFCs and provisioning is based on asset classification status at the level of each NBFCs. However, if lenders fail to convene the JLF or fail to agree upon a common CAP within the stipulated time frame, the account will be subjected to accelerated provisioning as indicated above, if it is classified as an NPA. If the account is standard in those lenders' books, the provisioning requirement would be 5%.

1.3 "Non-Co-operative borrowers"

1.3.1 All Notified NBFCs shall identify "non-co-operative borrowers". A "non-co-operative borrower" is defined as one who does not provide necessary information required by a lender to assess its financial health even after 2 reminders; or denies access to securities etc. as per terms of sanction or does not comply with other terms of loan agreements within stipulated period; or is hostile / indifferent / in denial mode to negotiate with the NBFC on repayment issues; or plays for time by giving false impression that some solution is on horizon; or resorts to vexatious tactics such as litigation to thwart timely resolution of the interest of the lender/s. The borrowers will be given 30 days' notice to clarify their stand before their names are reported as non-cooperative borrowers.

1.3.2 With a view to discouraging borrowers / defaulters from being unreasonable and non-cooperative with lenders in their bonafide resolution / recovery efforts, NBFCs may classify such borrowers as non-cooperative borrowers, after giving them due notice if satisfactory clarifications are not furnished. Notified NBFCs will be required to report classification of such borrowers to CRILC. Further, NBFCs will be required to make higher / accelerated provisioning in respect of new loans / exposures to such borrowers as also new loans / exposures to any other company promoted by such promoters / directors or to a company on whose board any of the promoter / directors of this non-cooperative borrower is a director. The provisioning applicable in such cases will be at the rate of 5% if it is a standard account and accelerated provisioning, if it is an NPA. This is a prudential measure since the expected losses on exposures to such non-cooperative borrowers are likely to be higher.

2. Board Oversight

2.1 The Board of Directors of NBFCs will take all necessary steps to arrest the deteriorating asset quality in their books and should focus on improving the credit risk management system. Early recognition of problems in asset quality and which resolution envisaged in the Framework requires the lenders to be proactive and make use of CRILC as soon as it becomes functional.

2.2 Boards should ensure that a policy is put in place for timely provision of credit information to and access to credit information from CRILC, prompt formation of JLFs, monitoring the progress of JLFs and periodical review of the above policy.

3. Credit Risk Management

3.1 Notified NBFCs should carry out their independent and objective credit appraisal in all cases of lending and must not depend on credit appraisal reports prepared by outside consultants, especially the in-house consultants of the borrowing entity. They should carry out sensitivity tests / scenario analysis, especially for infrastructure projects, which should, inter alia, include project delays and cost overruns. This will aid in taking a view on viability of the project at the time of deciding Corrective Action Plan (CAP). NBFCs should ascertain the source and quality of equity capital brought in by the promoters / shareholders. Multiple leveraging, especially, in infrastructure projects, is a matter of concern as it effectively camouflages the financial ratios such as Debt / Equity ratio, leading to adverse selection of the borrowers. Therefore, NBFCs should ensure at the time of credit appraisal that debt of the parent company is not infused as equity capital of the subsidiary / SPV.

3.2 While carrying out the credit appraisal, notified NBFCs should verify as to whether the names of any of the directors of the companies appear in the list of defaulters by way of reference to DIN / PAN etc. Further, in case of any doubt arising on account of identical names, NBFCs should use independent sources for confirmation of the identity of directors rather than seeking declaration from the borrowing company.

3.3 In addition to the above, notified NBFCs are advised that with a view to ensuring proper end-use of funds and preventing diversion / siphoning of funds by the borrowers, NBFCs could consider engaging their own auditors for such specific certification purpose without relying on certification given by borrower's auditors. However, this cannot substitute NBFC's basic minimum own diligence in the matter.

5. Purchase / Sale of Non-Performing Financial Assets to Other Banks / FIs / NBFCs

5.1 DBOD Circular on Guidelines on Sale / Purchase of Non-Performing Financial Assets' (also applicable to NBFCs) as consolidated and updated in DBOD Master Circular 'Prudential Norms on Income Recognition, Asset Classification and Provisioning pertaining to Advances', inter-alia, prescribes the following :

A non-performing asset in the books of a bank shall be eligible for sale to other banks only if it has remained a non-performing asset for at least two years in the books of the selling bank. A non-performing financial asset should be held by the purchasing bank in its books at least for a period of 15 months before it is sold to other banks

5.2 In partial modification to the above, it is advised that NBFCs will be permitted to sell their NPAs to other banks / FIs / NBFCs (excluding SCs / RCs) without any initial holding period. However, the non-performing financial asset should be held by the purchasing bank / FI / NBFC in its books at least for a period of 12 months before it is sold to other banks / financial institutions / NBFCs (excluding SCs / RCs). The extant prudential norms on asset classification of such assets in the books of purchasing banks / FIs / NBFCs will remain unchanged.

List of Circulars

1 Details in DNBS(PD).CC.No.15/02.01/2000-2001 dated June 27, 2001

2 Details in DNBS.(PD).CC.No.27/02.05/2003-04 dated July 28, 2003

3 Details in DNBS. (PD).C.C.No.28/02.02/2002-03 dated July 31 ,2003 , DNBS.(PD).CC.No.37/02.02/2003-04 dated May 17, 2004 ]

4 Details in DNBS(PD)CC.No.259/03.02.59/2011-12 dated March 15, 2012

5 Details in DNBS.(PD).C.C.No.38/02.02/2003-04 dated June 11, 2004 , DNBS. (PD).CC.No.49/02.02/2004-05 dated June 9, 2005

6 Details in DNBS.PD/C.C.No.105/03.10.001/2007-08@ dated July 31, 2007]@ Actual Circular Number should be DNBS.PD/C.C.No.96/03.10.001/2007-08

7 Details in DNBS.(PD).CC.No.11/02.01/99-2000 dated November 15, 1999

8 Details in DNBS. (PD).C.C.No.47/02.01/2004-05 dated February 07, 2005

9 Details in DNBS. (PD).C.C.No.87/03.02.004/2006-07 dated January 4, 2007

10 Details in DNBS.PD/C.C No.109/03.10.001/2007-08 dated November 26, 2007

11 Inserted vide DNBS (PD) CC No. 353/ 03.10.042 / 2013-14 dated July 26, 2013

12 Inserted vide DNBS (PD) CC.No.373/03.10.01/2013-14 dated April 7, 2014

13 As defined in 'Securities and Exchange Board of India (Alternative Investment Funds) Regulations, 2012'

14 Details in DNBS. (PD).C.C.No.124/03.05.002/2008-09 dated July 31, 2008 and DNBS.PD/CC.No.142/03.05.002/2008-09 dated June 9, 2009

15 Details are in DNBS.PD.CC.No.161/3.10.01/2009-10 dated September 18, 2009

16 Details are in DNBS(PD) C.C.No.174/03.10.001/2009-10 dated May 6, 2010

17 Inserted vide DNBS.CC.PD.No.191/03.10.01/2010-11 dated July 27, 2010

18 Inserted vide DNBS.(PD).CC.No.195/03.10.001/2010-11 dated August 09, 2010

19 Inserted vide DNBS.(PD).CC.No.195/03.10.001/2010-11 dated August 09, 2010

20 Inserted vide DNBS.(PD).CC.No.200/03.10.001/2010-11 dated September 17, 2010

21 Inserted vide DNBR.(PD).CC.No.015/03.10.001/2014-15 dated January 28, 2015

22 Inserted vide DNBS(PD).CC.No.407/03.10.01/2014-15 dated August 20, 2014

23 Inserted vide DNBR.(PD).CC.No.019/03.10.001/2014-15 dated February 06, 2015

24 Inserted vide DNBS(PD).CC.No.248/03.10.01/2011-12 dated October 28, 2011

25 Details in DNBS(PD).CC.No.245/03.10.42/2011-12 dated September 27, 2011

26 Details in DNBS.CC.PD.No.253/03.10.01/2011-12 dated December 26, 2011

27 Inserted vide DNBS. PD. No. 301/3.10.01/2012-13 dated 21.8.12

28 Inserted vide DNBS. PD. No. 372/3.10.01/2013-14 dated 24.3.14

29 Inserted vide DNBS.PD/CC.NO.308/03.10.001/2012-13 dated 6.11.12

30 Inserted vide DNBS.PD.CC.No.317/03.10.001/2012-13 dated 20.12.12

31 Inserted vide DNBS.PD/CC.No 359/03.10.001/2013-14 dated November 06, 2013

32 Inserted vide DNBS(Inf.).CC. No 309/24.01.022 /2012-13 dated 8.11.12

33 Inserted vide DNBS.CC.PD.No. 312 /03.10.01/2012-13 dated 7.12.13

34 Inserted vide DNBS(PD)CC.NO 330/03.10.01/2012-13 dated June 27, 2013

35 Inserted vide DNBS(PD)CCNo.349/03.10.001/2013-14 dated July 02, 2013

36 Inserted vide DNBS.(PD).CC.No 360/03.10.001/2013-14 dated November 12, 2013

37 Inserted vide DNBS.(PD).CC.No.371/03.05.02/2013-14 dated March 21, 2014

38 Inserted vide DNBS (PD) CC.No.371/03.05.02/2013-14 dated March 21, 2014

39 DNBS (PD) CC.No.377/03.10.001/2013-14 dated May 27, 2014 Foot Note: The reference to Companies Act, 1956 in the Master Circular will be changed as and when change is effected in the original circulars/notifications.

40 Inserted vide DNBS(PD) CC.No 349/03.10.001/2013-14 dated July 02, 2013

41 Inserted vide DNBS(PD) CC.No 349/03.10.001/2013-14 dated July 02, 2013

42 Inserted vide DNBS(PD) CC No. 349/03.10.001/2013-14 dated July 02, 2013

43 Inserted vide DNBS(PD)CC.No 349/03.10.001/2013-14 dated July 02, 2013

44 Inserted vide DNBS.(PD).CC.No.371/03.05.02/2013-14 dated March 21, 2014

An ISO/IEC 27001:2013 certified organisation

What is direct assignment (da).

Direct Assignment (DA) is a type of asset-backed securities (ABS) transaction. ABS are financial instruments similar to bonds, and contracts that represent a claim on cash flows from a pool of underlying assets. In the context of the lending business of the Banking industry, the ABS transaction that Direct Assignment functions upon is loan assets.

How does Direct Assignment Work in India?

The DA Business can be best understood by factoring in 3 main Stakeholders/Players

Originators (Original Owner of Loan Portfolio)

Buyers (Investors)

Reserve Bank of India (RBI)

A bank and NBFC representatives in suits, striking a direct assignment deal for a bank loan.

Originators

Originators typically NBFCs and Banks sell their loans or receivables to buyers, becoming co-lenders. The credit risk is now shouldered by the Originator and Co-Lender in proportion to the shares. The original owners or originators continue to service the loan on behalf of the Investors. The originator retains the right to manage the loans, collections and payments from borrowers and forward them to the investor. In doing so, originators gain by converting their illiquid loan asset products into cash or liquidity that empowers them to manage their operations, meet short-term obligations and also expand their business strategically. Originators are also paid maintenance fees by the investors for managing loan servicing activities on their behalf.

Investors/Buyers

Investors/Buyers are typically banks that benefit from purchasing these loan assets because it empowers them to not only grow/expand in Scale but also to meet their Priority Sector Obligations (PSL) requirements.

Taking Priority Sector Obligations as an example, PSL obligations guidelines are set by the RBI as lending targets for banks to fulfil as part of the initiatives taken for the Socio-economic development of the country. Banks purchase priority sector loans and thereby not only meet their lending targets but also benefit from mitigating risks and diversifying portfolios.

The RBI plays a vital role in regulating DA activities by setting strict guidelines and practices for efficient, ethical and legal conduct of business. At its core, below are some of the major requirements (not limited to), that are to be followed.

MRR or Minimum Retention Requirement specify that Originators must retain a minimum portion of loans or in other words a stake in securitized assets to ensure they can carry out due diligence of loans to be securitized

True Sale Criteria is a set of criteria in place for the originators to sell their loan portfolio to Investors in a manner that when met implies that the sale is genuine. In other words, the investor is well-informed by the originator of all associated risks and rewards.

Reporting and Disclosure Requirements include finer details such as the nature of assets, and deal terms that are provided to the Investors showcasing proof of compliance with RBI guidelines and proving transparency.

Prudential Norms are guidelines set by the RBI for Risk Management, capital adequacy and other financial parameters to ensure smooth conduct of the DA business.

Challenges with the Direct Assignment Business

At its core, challenges arise from manual processes used in loan management and the synchronization with originator systems for maintaining accurate information. While the former is an operational challenge the latter is an accounting & Transparency challenge.

Below, is an expansion of the same

Multiple formats from Originators

Dynamic Credit Policy

Compliance with Statutory Regulations

Due Diligence Process

MIS Reporting and Reconciliation

Auditable Processes

SIMSMART To Manage Direct Assignment Deals

SIMSMART is a fully automated system for tracking and managing the whole lifecycle of direct assignment negotiations from a buyer's or Investor's perspective. This solution ensures that Assignee's resources are used efficiently while also meeting statutory requirements.

SIMSMART provides a comprehensive solution to improve the efficiency of Direct Assignment loan management by addressing the challenges above. It supports standardized data formats, ensures seamless integration with multiple Originators, and eliminates manual data conversion errors. Through automated policy enforcement, the system enables dynamic credit policy management and adaptability to changing market conditions. SIMSMART ensures compliance with statutory regulations by providing a transparent audit trail that tracks all loan management activities for auditors. It automates task allocation, work status tracking, and report generation, reducing manual efforts and simplifying the due diligence process. The system also excels at providing automatic comprehensive MIS reports, expediting monthly pay-in data reconciliation, and simplifying accounting entry procedures, leading to time savings and lower mistake probability. SIMSMART also provides extensive auditing capabilities, ensuring that all processes are auditable and giving a clear activity trail for both internal and external audits.

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SimSol your trusted partner in B2B banking solutions, pioneering technology solutions in the lending business, invites you to experience the Future of Banking technology! We are an ISO/IEC 27001:2013 certified organisation and specialize in providing world-class solutions for the following and are committed to ensuring attractive ROI on the investments.

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Securitisation Transactions in India – Legal Validity

Pratish Kumar (Partner, Juris Corp)

Ankit Sinha (Principal Associate)

Garima Parakh (Associate)

1) Background

Securitisation was introduced in India as part of the wave of financial reforms in 1999 to expand the funding capacity of banks and non-banking financial companies ( “NBFCs” ). With a volume of INR 1.57 lakh crore in December 2019 [1] , securitisation is a popular resource-raising mechanism, especially amongst NBFCs and housing finance companies ( “HFCs” ). This is also common in banks for meeting the priority sector lending requirements. The steady upward trend in securitisation transactions, from INR 1.44 lakh crore in the nine months preceding the financial year 2019 to INR 1.57 lakh crore in the nine months preceding the financial year 2020, is also reflective of the severe liquidity crunch faced by NBFCs and HFCs in recent times. [2]

Redistribution of risk can be achieved by way of sale of certain assets by banks or financial institutions, in any of the following manners –

(a) Direct assignment : In a direct assignment transaction, assets owned by the originator bank or financial institution ( “Originator” ) are sold directly to the buyer(s). The said assets are reflected in the books of account of the buyer(s). A key principle in direct assignment transactions is that of true sale, which is required to be adhered to for a valid assignment of the standard assets. A direct assignment transaction is the most preferred mode of down selling standard assets. [3]

(c) Listed transactions : The Securities and Exchange Board of India( “SEBI” ) has notified the SEBI (Public Offer and Listing of Securitised Debt Instruments) Regulations, 2008 ( “SDI Regulations” ). These regulations, inter-alia specify disclosure requirements for public issuance and listing of securitised debt instruments ( “SDIs” ) (both publicly issued and privately placed) and obligations of the parties involved in the transaction. Under the SDI Regulations, a special-purpose distinct entity is a trust that acquires debt or receivables from funds mobilised by the entity, by issuing SDIs through one or more schemes. A certificate or instrument is issued to an Investor by the special purpose distinct entity, which possesses any debt or receivable, including mortgage debt assigned to such an entity by the Originator and the trustee. This certificate acknowledges the beneficial interest of the Investor in such debts or receivables.

Certain securitisation transactions which do not involve loan receivables (for example, lease receivables) are undertaken under the SDI Regulations. Securitisation of loan receivables may also be listed under the SDI Regulations. However, due to lack of an investor base, such transactions are not very common in India.

We have received many queries in relation to the legal validity of securitisation transactions. In specific, interested clients have raised questions as to whether Courts in India have upheld the validity of securitisation transactions (not Securitisation and Reconstruction of Financial Assets and Enforcement of Security Interest Act, 2002 related provisions). While we have seen very few case laws on securitisation transactions in India, it is noteworthy to mention that all such judicial pronouncements indicate that the Courts in India have recognized and upheld the structure of securitisation transactions, their legality and feasibility.

The underlying basis of securitisation transactions is assignment of actionable claims. This forms part of laws relating to transfer of property. In this article, we are not dealing with case laws relating to ‘actionable claims’ and have restricted it to those relating to securitisation transactions.

2) Case laws

Two landmark judgments, of the Hon’ble Supreme Court of India and Hon’ble High Court of Bombay recognise the role of Investors / buyers under securitisation and direct assignment transactions to be as creditors and further uphold the principles of true sale and bankruptcy remoteness.

(a) ICICI Bank Limited v. Official Liquidator of APS Star [6]

The core question before the Hon’ble Supreme Court of India was whether assignment of debt is a permissible activity under the Banking Regulation Act, 1949 ( “BR Act” ). In this case, ICICI Bank Limited ( “Assignor” ) had, by way of deeds of assignment, assigned certain non-performing loans, including that availed by APS Star Industries Ltd. ( “Debtor” ), to Kotak Mahindra Bank ( “Assignee” ). Winding-up proceedings were initiated against the Debtor, and the Assignee sought to substitute the Assignor in the winding-up petitions. The Hon’ble Supreme Court of India relied upon certain provisions of the BR Act and the Reserve Bank of India’s ( “RBI” ) Guidelines on Purchase / Sale of Non Performing Financial Assets Scope dated 13 th July 2005, to hold that banking companies can venture into new areas of business apart from their principle business of lending and accepting deposits, as long as they do not attract prohibitions and restrictions such as those contained in Sections 8 and 9 of the BR Act. In arriving at this conclusion, the Hon’ble Supreme Court of India relied upon Section 6(1)(a) read together with Section 6(1)(n) of the BR Act which permits banks to, inter se , deal in non-performing assets ( “NPAs” ). The Hon’ble Supreme Court of India concluded that, dealing in NPAs is a bona fide banking business and that assignment of NPAs is a well-recognised tool used in the interest of banking policy to resolve the issue of NPAs.

(b) Interim applications in the Dewan Housing Finance Corporation Limited (DHFL) cases

A series of applications were filed by the assignees of DHFL against an ad-interim order of the High Court of Bombay dated 10 th October 2019 ( “Order” ), which had restrained DHFL from making any payments to its creditors, unless made to all secured creditors on a pro-rata basis from its current and future receivables. The applications sought a modification to the Order to allow payments to be made to the plaintiffs under securitisation and assignment agreements entered into with DHFL. The Hon’ble High Court of Bombay while accepting the contentions put forth by the plaintiffs, modified the Order to allow payments to be made to banks under such agreements. In doing so, the Hon’ble High Court of Bombay recognised the aspect of bankruptcy remoteness of such securitisation and direct assignment transactions.

3) Securitisation Transactions: Legal Framework

(a) The guidelines pertaining to securitisation and direct assignment of standard assets were issued by the RBI on 1 st February 2006. These guidelines were subsequently revised by the RBI on receipt of comments from concerned stakeholders and issued on 7 th May 2012 (the “Guidelines” ). The Guidelines are organised in three Sections. Section A contains provisions relating to securitisation of assets. Section B contains stipulations regarding transfer of standard assets through direct assignment of cash flows. Section C enumerates the securitisation transactions which are currently not permissible in India.

(b) Section A of the Guidelines deals with requirements to be met by the originating bank and the assets eligible for securitisation. The said Section of the Guidelines states that in a single securitisation transaction, the underlying assets should represent the debt obligations of a homogeneous pool of obligors. Section A of the Guidelines also specify the assets that cannot be transferred.

(c) Section B of the Guidelines deals with the requirements to be met by the originating bank and the assets eligible to be transferred by way of direct assignment. The said Section of the Guidelines states that banks are permitted to transfer a single standard asset or a part of such asset or a portfolio of such assets to financial entities through an assignment deed. Section B of the Guidelines also specifies the assets which cannot be transferred. Specifically, assets purchased from other entities cannot be transferred by way of direct assignment.

(d) The Guidelines also stipulate the minimum holding period and minimum retention requirement to be satisfied under Sections A and B, respectively and the true sale criteria which in effect requires immediate legal separation of the selling bank from the assets that are sold.

(e) For securitisation under the SDI Regulations, please refer to paragraph 1) (c) above.

(f) As regards stamp duty laws, stamp duty is applicable on such transaction documents at the time of execution. Many States (for example, Maharashtra, Karnataka and the National Capital Territory of Delhi) have provided certain relaxations on payment of stamp duty re assignment of debt. The quantum of stamp duty may be ascertained once the place of execution is finalised.

(g) As regards registration of the transaction documents, the law in certain States (for example, the National Capital Territory of Delhi) require the document relating to the assignment of loan receivables to be mandatorily registered.

[1] ICRA, ‘ICRA: Securitisaton market on path to see all-time high issuance volume in FY2020 despite some headwinds’, press release dated 21 st January 2020.

[2] ICRA, ‘ICRA: Securitisaton market on path to see all-time high issuance volume in FY2020 despite some headwinds’, press release dated 21 st January 2020.

[3] Anand Shah et. al., ‘India: Securitisation 2020: Trends and Developments in India’, (Mondaq, 21 st January 2020) <https://www.mondaq.com/india/securitization-structured-finance/885822/securitisation-2020-trends-and-developments-in-india>

[4] RBI, ‘Report of the In-house Working Group on Asset Securitisation’, 29 th December 1999 <https://rbidocs.rbi.org.in/rdocs/PublicationReport/Pdfs/10788.pdf>

[5] Anand Shah et. al., ‘India: Securitisation 2020: Trends and Developments in India’, (Mondaq, 21 st January 2020) <https://www.mondaq.com/india/securitization-structured-finance/885822/securitisation-2020-trends-and-developments-in-india>

[6] Civil Appeal No.8393 of 2010.

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What is Securitization?

Securitization is a process where a pool of securities is bundled together and are given credit rating by an independent credit agency and then are sold to investors at a fixed coupon rate. Securitization, as the name suggests, involves the transformation of loans, which are a kind of illiquid assets into liquid assets. The underlying assets are generally secured loans such as home loans, automobile loans and unsecured loans like personal loans, etc.

It is a process by way of which an originator (bank) pools together its assets and then sells it to a Special Purpose Vehicle (SPV) – an entity specially created for the process of securitization which further sells it to investors.

To get a better understanding, consider the following example:

Suppose, a small bank ABC with an existing loan portfolio of 100 crores wants to raise a loan of 50 crores by monetizing its current assets.

The ABC bank will pool together 50 crores worth of loan which might contain thousands of loans and sells them to the SPV for cash.

The SPV then obtains credit ratings from an independent credit rating organization based on the future cash flow generated and the quality of the pooled amount.

Assuming the actual returns from the total loan book is 10%, and over the three years, due to the risk factor involved, the pooled amount is sold at 8.5%

The margin of 1.5% is used as maintenance charges by SPV and obligator(bank) who is responsible for collecting cash flows from the borrowers and transferring them to the investors.

Certificates are created worth 50 crores and are opened for investment. Once the issue is fully subscribed, the cash flows will be collected from the borrower and will be disbursed among the investors for three years.

The difference between what is charged from the borrowers (10.5%) and what is paid to the investors (8.5%) will be the servicing fee.

Parties in a Securitization Process:

Types of Securitised Products in India

Pass-Through Certificates (PTC's)

Pass-Through Certificates are similar to bonds, the difference being that they are issued against underlying securities. The payment to investors constitutes interest payments and principal payments received by the obligator on a pro-rata basis after deducting the servicing fee. However, in a Pay-Through Certificate, the principal and the interest amount is not transferred to the investor. Instead, the investors are issued new securities by SPV in return to this.

Direct Assignment

Direct Assignment involves buying a loan book at a fixed interest rate. Suppose a bank is interested in increasing his exposure to agricultural loan, to fulfill this, he will directly buy the pool of agrarian loan from an NBFC. Here, the terms are negotiable and can be customized in favor of both parties.

Why would banks be buyers?

As per the Reserve Bank of India, banks need to lend to the “priority sector” (Table 1), which includes the following categories:
Agriculture
Micro, Small and Medium Enterprises (MSME)
Export Credit
Social Infrastructure
Renewable Energy

Table 1: Priority Sector Lending Requirements

Banks do not necessarily want to be the originators of the loan while on the other hand, NBFC’s would like to sell their loans for the purpose of generating more cash and extending more credit. To fulfill the requirements of the RBI, banks go for buying NBFC's loans.

Commercial Banks can lend only at Marginal Cost of Funds based Lending Rate (MCLR) plus some spread where the MCLR is fixed (can be changed only at monthly reset dates) for each and every customer, and only the spread is variable. However, NBFC's can charge various rates from customer i.e., Prime Lending Rates (PLR) plus spread. Here, both PLR and Spread are variable. Thus, banks here can take advantage of higher interest rate margins earned by NBFC's.
When the RBI goes for slashing of lending rates, while banks have to pass on the interest rate benefits, NBFC’s can choose not to pass on the interest rate benefits to the borrowers. Thus, even though there is a cut in lending rates, the securitized pool sold to the banks will yield the same amount of returns.
There are some sectors, for example, Real Estate, where banks cannot lend directly due to restrictions imposed by the RBI. In such cases, banks can expand their portfolio and take exposure in such sectors through NBFC's.
Thus, through securitization, banks take advantage of Interest Rate Arbitrage and by earning some additional money through investing in NBFC’s.

How does the risk get shared?

Securitization is an easy way out for NBFC's, to transfer their pool of illiquid assets to banks in order to convert them into tradeable securities. However, to ensure that NBFC's do bear some risk even after the Securitization Process, the concept of Minimum Retention Ratio (MRR) was brought forward. This means if a part of the loan pool goes into default, the first blow will be borne by the originator(NBFC's)

The RBI guideline dated November 29, 2018, states that loans which have an original maturity of 5years or above which receive six monthly installments or two quarterly installments, the MRR requirements would be 20% of the book value of the loans being securitised/20% of the cash flows from the assets assigned.

Why are banks shying away from securitization? What exactly are the risks associated with lending to NBFC’s?

There are two risks associated with lending to NBFC’s

Consider a situation where ABC bank lends to XYZ, which is an NBFC. XYZ further gives it to a company, say PQR. If PQR defaults on payment, then XYZ would not receive payment who also would not be able to pay ABC. This is the solvency risk or the default risk or credit risk.

Let us now understand how NBFC’s face Liquidity Risk.

NBFC’s issue commercial papers or non-convertible debentures for short term (3 months-1 years) to raise money from various mutual funds, banks, etc. The raised money is then used to extend loans to borrowers for the long term (5 years). This means that NBFC's will return lenders their money within three months but will receive money from the borrower after five years.

Why do NBFC's resort to this practice?

Only because short-term loans are cheaper, and long-term loans are expensive, NBFC's take advantage of the situation and earn an interest rate margin.

Let us now understand how exactly this technique works well for NBFC's.

To make this system work well, NBFC's go for rollover. Say, for example, an NBFC owes payment to its lenders for commercial papers after three months. To ensure complete repayment without default, the NBFC will issue new commercial papers to another set of lenders. The raised money will then be used to repay the earlier lenders. This is the Rollover Strategy. This goes on and on to ensure liquidity.

However, what if NBFC fails to find this set of new lenders?

To repay its previous lenders, it will approach its borrower asking for repayment. But, the borrower won't be able to repay the NBFC since all of its money would be invested in his project. This situation gives rise to what is popularly known as the Liquidity Crisis.

The Liquidity Crisis in one NBFC creates a general perception that all NBFC’s are going to default on their payments, creating a kind of systematic risk i.e., when one party suffers, all the parties suffer. The IL&FS liquidity crisis is one suitable example in this context.

The recent liquidity crisis is going to impact the sentiments of particularly Mutual Funds since any default in interest, or principal payments would ultimately have to be borne by the investors. Thus, the only way to lift NBFC’s out of the crisis is securitization. Hence, it would not be wrong to call Securitization- The lifeline of the NBFC sector.

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Assignment of Accounts Receivable: Meaning, Considerations

Adam Hayes, Ph.D., CFA, is a financial writer with 15+ years Wall Street experience as a derivatives trader. Besides his extensive derivative trading expertise, Adam is an expert in economics and behavioral finance. Adam received his master's in economics from The New School for Social Research and his Ph.D. from the University of Wisconsin-Madison in sociology. He is a CFA charterholder as well as holding FINRA Series 7, 55 & 63 licenses. He currently researches and teaches economic sociology and the social studies of finance at the Hebrew University in Jerusalem.

Charlene Rhinehart is a CPA , CFE, chair of an Illinois CPA Society committee, and has a degree in accounting and finance from DePaul University.

Investopedia / Jiaqi Zhou

What Is Assignment of Accounts Receivable?

Assignment of accounts receivable is a lending agreement whereby the borrower assigns accounts receivable to the lending institution. In exchange for this assignment of accounts receivable, the borrower receives a loan for a percentage, which could be as high as 100%, of the accounts receivable.

The borrower pays interest, a service charge on the loan, and the assigned receivables serve as collateral. If the borrower fails to repay the loan, the agreement allows the lender to collect the assigned receivables.

Key Takeaways

Assignment of accounts receivable is a method of debt financing whereby the lender takes over the borrowing company's receivables.
This form of alternative financing is often seen as less desirable, as it can be quite costly to the borrower, with APRs as high as 100% annualized.
Usually, new and rapidly growing firms or those that cannot find traditional financing elsewhere will seek this method.
Accounts receivable are considered to be liquid assets.
If a borrower doesn't repay their loan, the assignment of accounts agreement protects the lender.

Understanding Assignment of Accounts Receivable

With an assignment of accounts receivable, the borrower retains ownership of the assigned receivables and therefore retains the risk that some accounts receivable will not be repaid. In this case, the lending institution may demand payment directly from the borrower. This arrangement is called an "assignment of accounts receivable with recourse." Assignment of accounts receivable should not be confused with pledging or with accounts receivable financing .

An assignment of accounts receivable has been typically more expensive than other forms of borrowing. Often, companies that use it are unable to obtain less costly options. Sometimes it is used by companies that are growing rapidly or otherwise have too little cash on hand to fund their operations.

New startups in Fintech, like C2FO, are addressing this segment of the supply chain finance by creating marketplaces for account receivables. Liduidx is another Fintech company providing solutions through digitization of this process and connecting funding providers.

Financiers may be willing to structure accounts receivable financing agreements in different ways with various potential provisions.

Special Considerations

Accounts receivable (AR, or simply "receivables") refer to a firm's outstanding balances of invoices billed to customers that haven't been paid yet. Accounts receivables are reported on a company’s balance sheet as an asset, usually a current asset with invoice payments due within one year.

Accounts receivable are considered to be a relatively liquid asset . As such, these funds due are of potential value for lenders and financiers. Some companies may see their accounts receivable as a burden since they are expected to be paid but require collections and cannot be converted to cash immediately. As such, accounts receivable assignment may be attractive to certain firms.

The process of assignment of accounts receivable, along with other forms of financing, is often known as factoring, and the companies that focus on it may be called factoring companies. Factoring companies will usually focus substantially on the business of accounts receivable financing, but factoring, in general, a product of any financier.

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New Model of Co-Lending in financial sector

Scope expanded, risk participation contractual, borders with direct assignment drawn

-Team Financial Services ( [email protected] )

[This version dated 20th March, 2021]

Co-lending is coming together of entities in the financial sector – mostly, something that happens between banks and NBFCs, or larger banks and smaller banks. Financial interfaces between different financial entities may take the form of securitisation, direct assignment, co-lending, banking correspondents, loan referencing, etc.

While direct assignment and securitisation have been around for quite some time, co-lending was permitted by the RBI under its existing guidelines on ‘Co-origination of loans between banks and NBFC-SIs for granting loan to the priority sector’ [1] . As per the Statement on Developmental and Regulatory Policies issued by the RBI dated October 9, 2020, it was decided to expand the scope of co-lending, currently permitted only for NBFC-SIs, to all NBFCs. Accordingly, the RBI came, vide notification on co-lending by banks and NBFCs (Co-Lending Model/CLM) [2] dated November 5, 2020, with a new regulatory framework for co-lending, of course, in case of priority sector loans. The CLM supersedes the existing guidelines on co-origination.

There is no clarity, still, on whether the non-priority sector loans (PSL or Non-PSL) will also be covered by this regulatory discipline, or any discipline for that matter. In this write-up, we explore the key features of the co-lending regime, and also get into tricky questions such as applicability to non-PSL loans, the borderlines of distinction between direct assignments and co-lending, the sharing of risks and rewards, etc.

Applicability

The erstwhile Regulations for priority sector lending covered co-lending transactions of Banks and Systemically Important NBFCs. However, under the Co-Lending Model.The CLM covers all NBFCs (including HFCs) in its purview.

There is a whole breed of new-age fintech companies using innovative algo-based originations, and aggressively using the internet for originations, and these companies pass a substantial part of their lending to either larger NBFCs or to banks. Thus, the expanded ambit of the Co-Lending Model will increase the penetration and result into wider outreach, meet the objective of financial inclusion, and potentially, reduce the cost for the ultimate beneficiary of the loans. Smaller NBFCs have their own operational efficiencies and distribution capabilities; hence, this is a welcome move.

Further, the RBI has excluded foreign Banks, including wholly owned subsidiaries of foreign banks, having less than 20 branches, from the applicability of the CLM. Also, Small Finance Banks, Regional Rural Banks, Urban Cooperative Banks and Local Area Banks have been excluded from the applicability of CLM.

An interesting question that comes up here is whether such exclusion should be construed as a restriction on such entities from entering into co-lending transactions, or a relaxation from the applicability of the Co-Lending Model? It may be noted that the CLM a precondition for PSL treatment of the loans. This is clear from the title ‘ Co-Lending by Banks and NBFCs to Priority Sector’ . The intent is not to put a bar on existence of co-lending arrangements outside the CLM. That is to say, if the loan, originated by the principal co-lender, is a priority sector loan, then the participating co-lender will also be able to treat the participant’s share of the loan as a PSL, subject to adherence to the conditions specified in CLM. The implication of this is that where the loan does not meet the conditions of CLM, then the participating bank will not be able to accord a PSL status, even though the loan in question is a PSL loan.

With that rationale, in our view, there is no absolute prohibition in the excluded banking entities from being a co-lender. However, if the major motivation of the co-lending mechanism under the CLM is the PSL tag, that tag will not be available to the excluded banks, and hence, the very inspiration for falling under the arrangement may go away. This is also clear from the PSL Master Directions [3] which recognises c o-origination of loans by SCBs and NBFCs for lending to the priority sector and specifically excludes RRBs, UCBs, SFBs and LABs.

Applicability date and the fate of existing transactions

In the absence of any specified timelines, the CLM supersedes the existing co-lending guidelines with immediate effect. However, it specifies that outstanding loans in terms of the erstwhile guidelines would continue to be classified under priority sector till their repayment or maturity, whichever is earlier.

This would mean grandfathering of existing loans, and not existing lending arrangements. That is to say, if there are existing co-lending arrangements, but the loan in question has not yet originated, even existing co-lending arrangements will have to abide with the Co-Lending Model. Needless to say, any new co-lending arrangements will nevertheless have to abide by the Co-Lending Model.

As we note below, one of the very important features of the Co-Lending Model is that risk-sharing and loan-sharing do not have to follow the same proportion. Additionally, it is possible for the participating bank to have an explicit recourse against the originating co-lender. This feature was not available under the earlier framework. This alone may be a sufficient motivation for existing CLMs to be revised or redrawn.

Co-lending, Outsourcing and Direct Assignment – new borderlines of distinction

For the purpose of entering into co-lending transactions, banks and NBFCs will have to enter into a ‘Master Agreement’. Such agreement may require the bank either to mandatorily take the loans originated by the NBFC on its books or retain discretion as to taking the loans on its books.

Where the participating bank has a discretion as to taking its share of the loans originated by the originating partner, the transaction partakes the character of a direct assignment. Para 1(c) of the CLM says that ”… if the bank can exercise its discretion regarding taking into its books the loans originated by NBFC as per the Agreement, the arrangement will be akin to a direct assignment transaction. Accordingly, the taking over bank shall ensure compliance with all the requirements in terms of Guidelines on Transactions Involving Transfer of Assets through Direct Assignment of Cash Flows and the Underlying Securities….with the exception of Minimum H olding Period (MHP) which shall not be applicable in such transactions undertaken in terms of this CLM.

That would mean, a precondition for the arrangement being treated as a CLM is that the participating bank takes the loans originated by the originating partner without discretion exercisable on a cherry-picking basis.

Does this mean that irrespective of whether the loan originated by the originating partner fits into the credit screen of the bank or not, the bank will still have to take it, lying low? certainly, this is not the intent of the CLM This is what comes form clause 1(a)- ‘ …..the partner bank and NBFC shall have to put in place suitable mechanisms for ex-ante due diligence by the bank as the credit sanction process cannot be outsourced under the extant guidelines .’

Thus, even in case the bank gives a prior, irrevocable commitment to take its share of exposure, the same shall be subject to an ex-ante due diligence by the bank. Ex-ante obviously implies a prior As per the outsourcing guidelines for banks [4] , the credit sanction process cannot be outsourced. Accordingly, it must be ensured that the credit sanction process has not been outsourced completely and the bank retains the right to carry out the due diligence as per its internal policy. Notwithstanding the bank’s due diligence exercise, the co-lending NBFC shall also simultaneously carry out its own credit sanction process.

The conclusion one gets from the above is as follows:

The essence of co-lending arrangement is that the participating bank relies upon the lead role played by the originating bank. The originating bank is the one playing the fronting role, with customer interface. The credit screens, of course, are pre-agreed and it will naturally be incumbent upon the originating bank to abide by those. Hence, on a case by case basis or so-called “cherry picking” basis, the participating bank is not selecting or dis-selecting loans. If that is what is being done, the transaction amounts to a DA.
Subject to the above, the participating bank is expected to have its credit appraisal process still on. Where it finds deviations from the same, the participating bank may still decline to take its share.

It is important to note that if DA comes into play, the requirements such as MHP, MRR, true sale conditions will also have to be complied with. However, co-lending transactions do not have any MHP requirements, unlike in case of either DA or securitiastion. Of course co-lending transactions do have a risk retention stipulation, as the CLM require a 20% minimum share with the originating NBFC. Hence, the intent of the RBI is that co lending mechanism must not turn out to be a regulatory arbitrage to carry out what is virtually a DA, through the CLM.

(Almost) A new model of direct assignments: assignments without holding period

Para 1 c. of the Annex seems to be leading to a completely new model of direct assignments – direct assignments without a holding period, or so-called on-tap direct assignments. Reading para 1 c. suggests that while co-lending takes the form of a loan sharing at the very inception, the reference in para 1 c. is to loans which have already been originated by the NBFC, and the participating bank now cherry-picks some or more of those loans. The cherry-picking is evident in “if the bank can exercise its discretion regarding taking into its books the loans originated by NBFC”. However, unlike any other direct assignment, this assignment happens on what may be called a back-to-back arrangement, that is, without allowing for lapse of time to see the loan in hindsight.

In essence, there emerge 3 possibilities:

A non-discretionary loan sharing, which is the usual co-lending model, where the originating co-lender has a minimum 20% share.
A discretionary, on-tap assignment, where the originating assignor needs to have a minimum 20% share
A proper direct assignment, with minimum holding period, where the assignor needs to have a minimum 10% share.

The on-tap assignment referred to above seems to be subject to all the norms applicable to a direct assignment, other than the minimum holding period.

Interest Rates

The erstwhile guidelines require that the interest rate charged on the loans originated under the co-lending guidelines would be calculated as per Blended Interest Rate Calculations, that is to say the rate shall be calculated by assigning weights in proportion to risk exposure undertaken by each party, to the benchmark interest rate of the respective lender.

The current guidelines require that the interest rate shall be an all inclusive rate that is mutually agreed by the parties. However it shall be ensured that the interest rate charged is not excessive as the same would breach the provisions of fair practice code, which is to be compulsorily complied.

This change would provide flexibility to the lenders and also ensure that the cost incurred in tracing and disbursals to remote sectors as well as enhanced risk exposure is appropriately compensated.

Determining the roles

Under the erstwhile provisions, it was mandatory that the share of the co-lending NBFC shall be at least 20%. The same has been retained in the CLM as well, requiring NBFCs to retain a minimum of 20% share of the individual loans on their books.

Under the CLM, the co-lending NBFC shall be the single point of interface for the customers. Further, the grievance redressal function would also have to be carried out by the NBFC.

Operational Aspects

Escrow Account

For the purpose of disbursals, collections etc. an escrow account should be opened. The co-lending banks and NBFCs shall maintain each individual borrower’s account for their respective exposures. It is only for the purpose of avoiding commingling of funds, that an escrow mechanism is required to be placed. The bank and NBFC shall, while entering into the Master Agreement, lay down the rights and duties relating to the escrow account, manner of appropriation etc.

Creation of Security

The manner of creation of charge on the security provided for the loan shall be decided in the Master Agreement itself.

Each of the lenders shall record their respective exposures in their books. The asset classification and provisioning shall also be done for the respective part of the exposure. For this purpose, the monitoring of the accounts may either be done by both the co-lenders or may be outsourced to any one of them, as agreed in the Master Agreement. Usually, the function of monitoring remains with the NBFC (since, it has done the origination and deals with the customer.)

Non-PSL loans: whether the framework would apply in pari materia ?

The guidelines on CLM have been issued for co-lending of loans that qualify for the purpose of priority sector lending. This does not bar lenders from entering into co-lending transactions outside the purview of these guidelines. The only difference it would make is such loans would not be eligible to be classified as loans to the priority sector (which is the primary motive for banks to enter into co-lending transactions).

This seems to form a view that the guidelines would not at all be applicable in case of non-priority sector loans. However, for a transaction to be a co-lending transaction, there has to be adequate risk sharing between the co-lenders. Hence, the guidelines on CLM shall be applicable in pari-materia.

[1] https://www.rbi.org.in/Scripts/NotificationUser.aspx?Id=11376&Mode=0

[2] https://www.rbi.org.in/Scripts/NotificationUser.aspx?Id=11991&Mode=0

[3] https://www.rbi.org.in/Scripts/NotificationUser.aspx?Id=11959&Mode=0

[4] https://www.rbi.org.in/scripts/NotificationUser.aspx?Id=3148&Mode=0

Other related write-ups:

Co-lending arrangement between Banks and NBFCs for PSL

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What is an ACH transaction?

An ACH transaction is an electronic money transfer made between banks and credit unions across a network called the Automated Clearing House (ACH).

ACH is used for all kinds of money transfers, including direct deposit of paychecks and monthly debits for routine payments. Businesses often allow you to pay bills via ACH by providing your account number and bank routing number. Some online payment services also conduct transactions via ACH, including online bill payment services through banks and credit unions.

Are ACH payments faster than other payment types?

It’s possible for ACH payments to clear quickly, even on the same day they are entered, on business days during business hours. That might not mean a transaction you make through ACH is completed on the same day you enter it. Because of the way ACH transactions are processed and because the network must guard against fraud and money laundering, payments can take days to complete.

Your bank or credit union might have a limit on the amount you can transfer, and they might charge you a fee for each transaction. ACH transactions can “bounce,” or be returned for nonpayment, if there is not enough money in the account.

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COMMENTS

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