RBI Notification

Overview of RBI’s Framework for Transfer of Loan Exposures

The framework for the transfer of loan exposures by the bank is enumerated under RBI (Transfer of Loan Exposures) Directions 2021. It provides a comprehensive framework for facilitating the sale, transfer, and acquisition of the loan standard and stressed assets in the secondary market. Based on the task force’s recommendations on the Development of a Secondary market from Corporate Loans, it was decided to segregate the direct assignment transactions from the securitisation guidelines. The transfer of loan exposures means that the banks can transfer their assets to ARCs to realise their standard and stressed assets so that the bank’s credit exposure can be maintained. The present article will briefly discuss the important provision for the transfer of loan assets in the secondary market by lenders.

What Are The Types Of Entities To Whom The Directions Are Applicable?

The framework for the transfer of loan exposures shall apply to the following entities:

• Scheduled Commercial banks
• Regional Rural Bank
• All co-operative banks, including urban, state and central
• All India Financial institutions
• Small financial banks
• NBFC and HCF (Housing Finance Companies)

Further, it is specifically mentioned that the lender shall not undertake any loan transfers or acquisition except for the purposes mentioned in the directions. Moreover, the directions are applicable for all transfers of loans, including the sale of loans through loan participation and novation or assignment.

What Are The General Requirements For Loan Transfers?

The general requirements for lenders under the framework for the transfer of loan exposures are:

• The lender must put in place a comprehensive board policy for the acquisition & transfer of loan exposures. The board policy may lay down the minimum qualitative and quantitative standards for valuation, due diligence and IT systems. The policy shall further ensure independence of functioning and reporting responsibilities.
• The transfer of the loan shall result in the transfer of economic interest without any change in the underlying terms and conditions of the loan contract.
• The legal ownership shall remain with the transferor even after the transfer of economic interest to the transferee.
• The lenders are not eligible to offer any credit enhancements or liquidity facilities in case of loan transfer.
• The lender cannot re-acquire the loan exposure that has been transferred by the entity previously.
• The loan transferor shall result in immediate separation of the transferor from the risks associated with the loans.
• The transferee shall have the unfettered right to transfer or dispose of the loans free from any constraint.
• The transferor shall have no right to re-acquire or fund the repayment or substitute loans held by the transferee.  
• In case the transferor holds the security interest in trust with the transferee, the transferee shall ensure that a binding agreement has been adequately documented for the timely invocation of such security interest.
• The transferor shall ensure that the right of the obligors is contravened in loan transfers.
• Any restructuring, rescheduling, or re-negotiation agreements shall be as per the provision of the RBI prudential Framework for the resolution of Stressed Assets.
• The transferor must notify RBI (Department of Supervision) of all the instances wherein it has replaced all the loans transferred to a transferee or paid damages that may arise due to any representation or warranties.
• The transferee must ensure that the transferor strictly adhere to the Minimum Holding criteria in domestic transactions.
• The acquisition or transfer of loan exposures by overseas branches of Indian banks shall comply with the requirements mentioned in the circular and without any derogation under the provisions of FEMA, 1999.
• The transferee shall maintain the capital charge equal to the acquired exposure with respect to the exposure that does not meet the requirements under the guidelines.

Can The Transferor Act As A Servicing Facility Provider?

The framework for the transfer of loan exposures permits the transferee to engage a servicing facility provider to service the acquired exposures. For this purpose, the transferee can appoint the transferor to serve the acquired exposures. If the lender or the transferor acts as a servicing facility provider for the transferee, in that case, it shall ensure that the following conditions are fulfilled:

• The written agreement shall contain the nature, purpose, and extent of the facility and all the required standards.
• The facility is provided on market terms & conditions and an arm’s length basis.
• Payment of fees or any other income arising from the position shall not be subject to any deferral or waiver.
• The duration of the facility shall be limited to the following:
  • Till Underlying loans are amortised
  • All claims of the transferee’s economic interest in the underlying loans are paid out.
  • The obligation of the lender is terminated
• The lender should not have recourse beyond the contractual obligations.
• The transferee can select another party to provide the servicing facility.
• The lender is under no obligation to remit the funds to the transferee until it has received the fund generated from the underlying loans.
• The lender may receive the cash flow generated on the underlying loans and shall avoid mixing it with its cash flow.

What Are The General Requirements For Loan Transfers Which Are Not In Default? 

The framework for the transfer of loan exposures has provided the following general requirements for loan transfers which are not in default:

• The transferor can transfer a single loan or a part of such loan or a portfolio of such loan to the permitted transferees through assignment, novation or loan participation contract.
• In case of a change of lender of record under a loan agreement, both the transferor and transferee shall ensure that the existing loan agreement has suitable provisions for consent by the underlying borrower.
• If the transferor’s interest is retained, legally valid documents should support the loans. The transferor shall also keep on record the legal opinion in regard to the following:
  • Legal validity of the amount of economic interest retained by the transferor.
  • The transferor does not retain any risk or reward of the loan transferred to the transferee.
  • The arrangement does affect the rights and rewards of the transferee associated with the loan.
  • The arrangement does not result in the transferor becoming a trustee, agent or fiduciary of the transferee.
• There should be no difference in the criteria for credit underwriting to the loans transferred, retained, or held.
• The transfer shall take place on a cash basis and be received at the time of the loan transfer.
• The transferee cannot outsource any activity of due diligence. It shall be carried by as per the same policy as would have been done for originating any loan. Further, it shall be applicable at each level of the loan.
• The lenders shall monitor periodically on an ongoing basis and in a timely manner the performance information on the acquired loans, including by conducting periodic stress tests, sensitivity analysis and other appropriate steps. It may also include modification to exposures ceilings in respect of certain classes of assets, change in ceilings of transferor etc. The lender shall adopt such formal policies and procedures that are commensurate with the risk profile of the loans.
• The credit monitoring procedures shall include the information verification submitted by the concurrent & internal auditors of the servicing facility agent. Further, all the information shall be made available to the supervisors of RBI for verification.

What is Minimum Holding Period?

According to the framework of RBI on the transfer of loan exposures, the transferor is allowed to transfer loan exposures only after the Minimum Holding Period (MHP). The minimum holding period shall be evaluated from the date of the registration of underlying security interest with the CERSAI and it shall be:

1. 3 months for loans which have a tenure of up to 2 years.
2. 6 months for loans which have a tenure of more than 2 years.

Calculation of MHP where there is no security: The loans which do not have any security or cannot be registered with CERSAI, in that case the MHP shall be calculated from the first date of repayment of the loan.

Calculation of MHP where there is the transfer of project loans: the MHP for the transfer of project loans shall be calculated from the commencement date of commercial operations of the financed project.

Further, if loans are acquired from other entities in that case, the loans cannot be transferred before 6 months from the date on which the loan is taken in the books of accounts of the transferor.

What Are The Requirements For Capital Adequacy And Other Prudential Norms?

According to the framework of RBI on the transfer of loan exposures, the following requirements are enumerated for capital adequacy and other prudential norms:

• The profit or loss arising from the transfer of loan exposures shall be reflected in the P&L account of the transferor. However, the unrealised profits shall be deducted from net owned funds or CET 1 capital for meeting regulatory capital adequacy requirements.
• The transferor and transferee shall maintain borrower-wise accounts in case of transfer of a pool of loan exposures and retention of economic interest. Post such transfer of loan exposures, the capital adequacy treatment shall be made as per the instruction originated by the lenders.  
• The transferee may get the pool of loan exposures externally rated before acquiring so as to have a third-party opinion on the credit quality of the loan in addition to their own due diligence.
• The transferor and transferee shall apply asset classification, income recognition, provisioning and exposure norms on an individual obligor basis.
• The transferee shall put in place a mechanism to ensure the application of prudential norms on an individual obligor basis in case of acquiring a pool of loan exposures. The mechanism shall also include the details obtained from the serving facility provider. Such a mechanism shall be subject to adequate checks by the transferee’s internal, concurrent, and statutory auditors.
• In a case where the transferor makes representations and warranties, in that case, the transferor is not required to hold capital against such representations & warranties provided that the following conditions are fulfilled:

a. The representation or warranty is provided through a formal written agreement.

b. The representation or warranties shall refer to an existing state of facts that the transferor can verify.

c. The representation or warranty is not open-ended and does not relate to the future creditworthiness of the loans.

d. If the transferor requires to replace transferred loans on the grounds covered in the representation, in that case, the exercise of representation shall be:

1. Undertaken within 30 days of transferring the loans
2. Conducted on the same terms & conditions as the original transfer

• The transferor is required to pay the damage in case of breach of representation, provided that the agreement contains the following conditions:

a. the onus of proving the damage shall always remain with the party who alleges.

b. the party alleging the breach serves a notice to the transferor, which shall contain the basis for the claim.

c. damages are limited to the losses directly incurred.

What Are The Requirements For The Transfer Of Stressed Loans?

The general requirements for the transfer of stressed loans under the framework for the transfer of loan exposures are:

• Transferring a stressed loan shall be done only through novation or assignment. The loan participation is not allowed in stressed loans.
• There shall be board approved policy of every lender on the transfer or acquisition of stressed loans, which shall cover the following aspects:
  • Procedure and Norms for transfer or acquisition of stressed loans.
  • Reasonable valuation method to ensure that the realisable value of stressed assets and realisability of the underlying security interest is estimated reasonably.
  • C. Delegation of powers to other functionaries for deciding on transfer or acquisition
  • Objectives for acquiring stressed assets
  • Risk premium
• The board policy on the acquisition & transfer of loan exposures shall contain the following principles:
  • For transfer, the process of identification of stressed loans beyond the specified value shall be undertaken by the lender’s head officer or corporate office.
  • The board committee shall review all loans classified as NPA beyond the threshold amount at periodic intervals.
• The transferors should place clear policies in regard to the valuation of transfer of loan exposures proposed to be transferred. The policy shall determine the type of valuation used, the discount rate used by the transferor, cost of equity, cost of funds or opportunity cost etc. However, if the credit exposure is more than Rs 100 crore or more, the transferor is required to obtain two external valuation reports.
• The lender shall transfer stressed loans only to permitted transferees and ARCs.
• The manner of transfer shall be according to the board-approved policy of the transferor. The lender may also use e-platforms for transferring their loans.
• When the transfer is negotiated on a bilateral basis, such negotiations shall necessarily be followed by auction through Swiss Challenge method,in case if the aggregate exposure of lenders to the borrowers whose loan is being transferred is Rs 100 crore or more.
• The transferor shall not assume any operational, legal or other risks, including additional funding or commitment to the borrower after the transfer of stressed loans.
• If the transfer of stressed loans is under a resolution plan that results in the exit of all the lenders, in that case, the transfer is allowed to any class of entities, including corporate entities permitted to take loan exposures in terms of statutory provisions or under regulations issued by the financial regulators.
• The transferor must provide adequate time to a prospective acquisition for due diligence.
• There shall be no transfer at a contingent price which may lead the transferor to bear a part of the shortfall.
• The transferor is required to transfer the stressed loan only on a cash basis apart from the ARCs.
• The lender can treat the pool of stressed loans as a single asset in their books.
• The transferee will be responsible for reporting to the credit information companies with respect to acquired stressed loans.
• The lender acquiring the stressed loans shall at the time of acquisition make provision in its books for such loans as per the asset classification status.
• The lender shall hold the acquired stressed loans for 6 months in their books before transferring them to other lenders.

Can The Stressed Loans Be Transferred To ARCs?

As per the framework of RBI on the transfer of loan exposures, all the stressed loans in default in the books of the transferor are allowed to be transferred to ARCs. This shall include exposures identified as a fraud on the date of transfer, subject to the responsibilities of the transferor in regard to the reporting, monitoring, and filing of complaints with the law enforcement agencies are also transferred to the ARCs. The other general requirements for the transfer of stressed loans to ARCs will include the following:

• The transferor, in certain cases of a stressed loan, shares the surplus with ARC in the proportion agreed between them.
• The lenders shall debit the shortfall to the P & L account for the year in which there is a transfer of loan exposure if the stressed loan transferred to ARC is below Net book Value.  
• The lenders shall reverse the excess provision to the P & L account for the year in which there is a transfer of loan exposures if the stressed loan transferred to ARC is more than the Netbook Value.
• The investment in the SRs, PTCs or other securities issued by ARC shall be periodically valued by the estimated Net Asset Value declared by the ARC, depending on the recovery ratings received for such instruments.
• If the SRs or PTCs are not redeemed at the end of the resolution period, then they will be treated as a loss assets in the books of the lender.
• The norms for classification and valuation applicable to the investments in the Non- SLR shall apply to the investment by the lenders in debentures, bonds, SRs and PTCs.
• The lender is not prohibited from taking any over standard accounts from ARCs.

What Are The Disclosure And Reporting Requirements?

As per the framework of RBI on the transfer of loan exposures, the lender is required to make the following discoursers and reporting:

1. The lenders are required to disclose certain transactions in their financial statements under ‘Notes to Accounts’ on a quarterly basis beginning from the quarter and ending on 31^st December 2021:

a. Total amount of loans not in default,

b. Stressed loans transferred & acquired to and from other entities.

2. The transferors shall also disclose the number of excess provisions reversed to the P & L account at the time of the sale of stressed loans.

3. The transferor shall report each transaction of transfer of loan exposures to a report trading platform.

Conclusion

The RBI framework on the transfer of loan exposures provides that the transfer shall take place in accordance with the norms and requirements mentioned above. To provide a regulatory framework for the transfer of loan exposures transactions, the RBI has provided that the lender shall put in place such policies to ensure that the transfer takes place without any hindrance. The framework will also enable the excessive transfer of stressed loans, which will lead to an increase the credit exposure in the market. Further, it also increases the parties’ responsibilities for the loan transfer.  

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