RBI’s Draft Securitization Framework: Key Introductions

Ashish M. Shaji

29 Jun, 2020

The Reserve Bank of India (RBI) released the draft securitization framework for Securitization of Standard Assets and asked for the public opinion on it. The guidelines were released after much deliberation with a view to meet the recommendations of the Committee on Development of Housing Finance Securitization Market in India and the Task Force on the Development of Secondary Market for Corporate Loans.

What is the purpose of the Draft Securitization Framework?

The primary purpose of the proposed revision is to lay down the criteria in order to bring securitization in line with Basel III requirements and to deepen the secondary loan trading market. The amendments to some of the securitization guidelines were overdue with regard to revisions introduced under Basel III.

What are the highlights of the RBI draft securitization framework?

• Revised definition of Securitization

As per the Draft Securitization Framework, securitization’s definition is-

“The set of transactions or scheme where credit risk with eligible exposures is tranched and where the payments in the set of transactions or scheme depend on the performance of the underlying exposures and the subordination of tranches determines the distribution of losses during the life of transactions or scheme; provided that the pool has one or more exposures eligible to be securitized.”

• Single Asset Securitization

The proposed securitization framework allows for the securitization of single assets. It was not permitted under the guidelines issued by the RBI in 2012. Single asset loans can also be credit tranched. This means that the longer tenor loans may be securitized either wholly or partially. Single loans can be securitized which are in the books of banks or NBFCs, and such credit tranched securities may be issued to eligible investors.

The Reserve Bank of India has also allowed the securitization of bullet payment loans provided that the interest or principal is paid in instalments.

• Traditional Securitization and Simple, Transparent and Compatible structures

The draft Securitization framework has also proposed for a Simple, Transparent and Compatible (STC) securitizations. Exposures to securitizations that are Simple, Transparent and Compatible, can be subject to alternative capital treatment. It also permits a lower risk weight for traditional securitizations transactions that meet the framework of STC.

• Replenishment

Replenishment means the process of using cash flows from securitized assets with a view to acquiring more eligible assets which shall continue for a pre-announced replenishment period after which the structure shall regress to amortization one.

RBI has allowed the replenishment structures where the period of replenishment must be identified upfront, and after the end of that period, the structure shall regress to amortization one.

Introduction of replenishment structures shall help shorter tenor loan deals and bring better returns to investors.

• Residential Mortgage-Backed Securities

Residential mortgage-backed securities mean the securities issued by the special purpose entity against the underlying exposures which are residential mortgages. The RBI has proposed certain relaxations for residential mortgage-backed securities on the basis of the recommendations from the Committee on Development of Housing Finance Securitization Market in India.

As per the draft, the minimum holding period for Residential mortgage-backed securities will be six months or six instalments, whichever is later. The MRR has been limited to 5% of the book value of the loans that are securitized. In case where the value of the exposures is more than 500 crore rupees, it is proposed that the issued securities must be listed mandatorily.

• Prohibitions and Exemptions

Although the new draft allows the securitization of assets purchased from other securities; resecuritisation exposures, synthetic securitization and securitization with revolving credit facilities as underlying remains to be prohibited. The rating of some of the pools will increase due to the existing portfolios being pooled with the purchased loans. The draft securitization framework continues to exempt the transactions involving the revolving credit facilities, loans with bullet payments of principal and interest and securitization exposures.

• Capital requirement for securitization exposures

The new draft provides for conditions that must be met by the lenders for maintenance of capital. It will be immediately applicable to the existing securitization exposures. It includes the following:

1. The underlying exposure of the issue of securities by the special purpose entity and the credit risk associated with it. In that case, it will be deemed to be transferred if-
   • There are minimum three tranches and that the risk-weighted exposure amounts of the mezzanine securitization position held by the originator do not exceed 50% of what is in the entire mezzanine securitization positions existing in the securitization;
   • And if the originator doesn’t hold more than 20% of the exposure values of the securitization positions that are first loss positions.
2. The transferred exposures would be legally isolated so that they will be away from the reach of the originator and its creditor.
3. No obligation on the originator of the securities issued by the SPE (Special Purpose Entity).
4. No provision under the securitization where there is a requirement of replenishment or replacement of the underlying exposure in case of deterioration in the underlying credit quality.

• Capital Measurement Approaches

As per the Basel III guidelines, two capital measurement approaches are proposed, namely–

 a) Securitization External Ratings Based Approach (SEC-ERBA) and
 b) Securitization Standardised Approach (SEC-SA).

The Draft Securitization Framework provides that banks may adopt any of the approaches mentioned above, whereas NBFCs shall only apply SEC-ERBA for calculating risk-weighted assets.

Conclusion