Comparison on Draft Framework for sale of loans with existing guidelines and task force recommendations

On 8th June, 2020, RBI issued the Draft Comprehensive Framework for Sale of loan exposures for public comments. This draft framework has brought about major changes in the regulatory framework governing direct assignment. One of the major changes is that the framework has removed MRR requirements in case of DA transactions. The framework covers both Sale of Standard Assets as well as stressed assets in separate chapter. We shall be coming up with a separate detailed analysis of sale of stressed assets under the draft framework.
In continuation of our earlier brief write-up titled Originated to transfer – new RBI regime on loan sales permits risk transfer, here we bring a point by point comparative along with our comments on the changes. Further, we have covered the Draft Directions on sale of loans in a Presentation on Draft Directions Sale of Loans.

ParticularsDraft framework for sale of loansExisiting guidelinesReport of the Task Force on the Development of Secondary Market for Corporate Loans
For the Assignor
Meaning of standard assets“Stressed assets” mean assets that are classified as NPA or as special mention account, and generally includes accounts which are in default as well as where lenders have given concessions for economic or legal reasons relating to the borrower’s financial difficulty.

[Thus, what is not covered under stressed assets would fall under the meaning of standard assets.]

Earlier guidelines applied to ‘Standard Assets’, which would normally include even SMA accounts not crossing 90 DPD.
Standard Assets under the draft Directions shall exclude the assets which are even a single day past due
Legal separataionPara 9 provides that sale of loan shall result in legal separation of the assets from the transferor

The meaning of the word transfer has been defined to include loan participations which in turn includes risk participation

Ture Sale criteria provided that the ‘sale’ in any form including direct sale, assignment or any other form of transfer of asset shall result in legal separation of the assets from the transferorTask Force recommends the following forms of transfer mechanisms in the proposed secondary market for corporate loans to transfer the loan from the seller to the buyer-
1) Assignment
2) Novation
Loan transfer is much wider term- this included all kinds of transfers. the scope of transfer may be very wide including risk participation, loan participation, transfer includes transfer of legal risk.

However, sale of loan is a restricted term. As per this definition, transfers other than by way of sale of loan shall not require legal separation of the asset.

Accordingly, entities may purely trade in risk on unfunded participation basis.

ApplicabilityApplicable to all loan sales, including sale of loans to special purpose entities for the purpose of securitisation, undertaken subsequent to the issue of these directions.Applicable specifically to direct assignment transactions
Sale of NPAs was dealt with separately
In case of securitisation, both the draft guidelines shall become applicable.
1. At the time of transfer of loans pool to SPV- (guidelines on sale of loans become applicable)
2. At the time of issue of PTCs etc. (guidelines on securitisation)
Eligible Assets-Single/ pool of standard assets-Single/ pool of standard assets
Ineligible assetsi) Revolving credit facilities
ii) Assets with bullet repayment of both principal and interest. (this doesnt include assets with bullet repayment of either principal or interest)
i) Revolving credit facilities
ii) Assets purchased from other entities
iii) Assets with bullet repayment of both principal and interest
Assets purchased from other entities can now be transferred.

Further, it has been clarified that the bar is not on bullet loans in which either of the components viz interest or principal is serviced regularly.

Transactions not covered under the frameworka. transfer of loan accounts at the request/instance of borrower;
b. inter-bank participations;
c. trading in bonds;
d. sale of entire portfolio of assets consequent upon a decision to exit the line of business completely;
e. sale of stressed assets;
f. consortium and syndication arrangements; and
g. any other arrangement/transactions, specifically exempted by the RBI
-Transfer of loan accounts of borrowers, 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
-Consortium and syndication arrangements
-Any other arrangement / transactions, specifically exempted by the RBI
Interbank participations were not excluded in the earlier guidelines.

Separate guidelines for sale of stressed assets has been provided in the new guidelines.

Loans for agricultural activitiesLoans to individuals for agricultutal purposes (PSL loans) where both interest and principal are due only on maturity and and trade receivables with tenor up to 12 months discounted/purchased
by lenders- eligible for sale through assignment when borrower/ drawee has paid last 2 loans within 90 days of due date
No such provision under exisiting guidelines. This is same as the draft Securitisation Guidelines.
MHPIn addition to the MHP requirements provided under exisiting guidelines, cases where the repayment is at more than quarterly intervals, loans can be transferred after repayment of at-least two instalments

Loans purchased by the transferor from other entities shall not be sold before completion of twelve months from the date on which the loan was taken to the books of the transferor

MHP was applicable to various loans depending upon the tenor and repayment frequency.The existing MHP and MRR prescriptions were stipulated in 2012 and need to be reviewed in the current scenario.

RBI may consider reduction in MHP duration.

Specified MHP rquirements for loans with repayment intervals longer than a quarter

Allowed transfer of loans purchased from other entities- accordinly specified MHP requirements for the same.

0No minimum requirement-Assets with original maturity of 24 months or less- 5%
-Assets with original maturity of more than 24 months as well as loans with bullet repayments- 10%
RBI may consider relaxing the MRR of 100% during the MHP so as to enable the originating banks to offer sizeable portion of the loan for sale in the secondary market. Further, RBI may consider waiving the MRR beyond the MHP. This relaxation will not impact the existing loans that have run beyond the MHP and would be relevant in the context of new loans.
This is a new change. Under the existing framework, even direct assignments required MRR. This could kill the market for securitisation to a great extent.

This removal of MRR is in line with the recommendations made by the Task Force on Development of Secondary Market of Corporate Loans.

Credit EnhancementCredit enhancement of any form or liquidity facilities- not allowed. Further, transfer at contingent price is also not allowed.Credit enhancement of any form or liquidity facilities- not allowed
Investments in Interest Only Strip representing the Excess Interest Spread / Future Margin IncomeNo mentionNot allowed
Recommendations from the Report of the Task Force on the Development of Secondary Market for Corporate LoansIn order to validate the retention by the transferor, a legal opinion shall be requiredIn order to validate the maintenance of MRR by the originator, a legal opinion shall be required
Booking of ProfitIn addition to the requirements in exisiting guidelines, any loss, profit or premium realised from the sale, should be accounted accordingly and reflected in the Profit & Loss account for the accounting period during which the sale is completed.

Profits / premium shall be deducted from CET 1 (in case of banks only) capital or net owned funds for meeting regulatory capital adequacy requirements till the maturity of such assets.

The amount of profit in cash on direct sale of loans shall be held under an accounting head named “Cash Profit on Loan Transfer Transactions Pending Recognition” maintained on transaction basis. The same shall be amortised over the life of the transaction.
The requirement to book upfront profit and amortise it over a period of time still exists.

Additionally, the capital shall be reduced by the amount of profit.

This is a departure from the Ind AS 109, which deals with de-recognition of financial assets at length.

Asset classification (in case of retail loans)The transferor may maintain a consolidated account of the amount representing the retained interest.

In such case, the consolidated amount receivable against the retained interest and its periodicity should be clearly established, and the overdue status of the retained interest should be determined with reference to repayment of such amount.

-The originator is required to maintain a consolidated account of the amount representing MRR. The consolidated amount receivable in amortisation of the MRR and its periodicity shall be established. Asset classification shall be done with reference to the amortisation of MRR

The originator may also maintain borrower-wise separate accounts and carry out asset classification for the retained portion on the basis of repayment on each of such accounts

The originating bank may continue to maintain borrower-wise accounts for the proportionate amounts retained in respect of those accounts. The overdue status of the individual loan accounts should be determined with reference to repayment received in each account and accordingly asset classification and provisioning shall be made.
Asset classification (in case of other than retail loans)The transferor should maintain borrower-wise accounts for the interest retained in respect of assigned loans.

The overdue status of the retained interest in individual loan accounts should be determined with reference to repayment received in each account.

Originator is required to maintain borrower-wise accounts for the proportionate amounts retained in respect of each loan. Asset classification shall be done in accordance with the overdue status of such individual loan accounts
Treatment of assets not meeting the requirementsIn case the originator does not meet the requirements specified above, it shall be required to maintain capital corresponding to the entire portfolio size rather than for the MRR portion only
For Assingee
Restrictions on purchaseAssignee can puchase only when the originator explicitly dicloses that it shall maintain MRR
There is no MRR under the draft Directions.
Stress TestingAssignee is required to carry out stress testing of the portfolio on a regualr basisAssignee is required to carry out stress testing of the portfolio on a regualr basis
True sale criteria-Legal Separataion
-Originator/transferor shall not be allowed to repurchase
– Not obliged to lossess incurred to the transfereee
-Security interest shall be duly registered in the name of transferee
-legal opinion
-Restructuring of terms shall not be binding on the originator
– such arrangement shall not interfere with transferee’s rights and rewards
associated with the loans to the extent transferred to it
– such arrangement shall not result in the transferor becoming an agent,
trustee, or fiduciary of the transferee, apart from servicing facilities extended
by the transferor, if any, post such transfer
– Legal separation
– Transfer of all risks and rewards
– No obligation on the originator to repurchase/fund the purchase of assets sold
-Opinion from legal counsel
-Sale shall be on cash basisi only
– Restructuring of terms shall not be binding on the originator
-In case orinator is servicer, payment to the assignee shall be contingent upon receipt of the same from the borrower
Re-purchaseNot allowedNot allowed
Asset Classification and provisioningAs applicable to the loans originated by the originator

Loan account based and not portfolio based

As applicable to the loans originated by the originator

Loan account based and not portfolio based

The purchasing banks shall maintain borrower-wise accounts for the proportionate amounts purchased in respect of those accounts. The overdue status of the individual loan accounts should be determined with reference to repayment received in each account and accordingly asset classification and provisioning shall be made.
Capital AdequacyAs per the rules applicable to loans directly originated by the lendersAs per the rules applicable to loans directly originated by the lendersThe capital adequacy treatment for purchase of loans will be as per the rules applicable to loans directly originated by the banks.
Recording of purchased assetsThe requirement is applicable only on banks/AIFIsThe purchased loans shall be carried at acquisition cost unless it is more than the face value, in which case the premium paid shall be amortised based on straight line method or effective interest rate method

In case the acquisition cost is higer than face value, the premium should be amortised on straight line method basis or effective interest rate method

Although IndAS is not currently applicable to other entiites, this shall result in conflict once the same beocmes applicable
Treatment of exposures not meeting the requirementsRisk weight of 1250%Risk weight of 667%The capital adequacy treatment for purchase of loans will be as per the rules applicable to loans directly originated by the banks.
Purchase of ECB loansCan be purchased from eligible lenders. Haircuts or losses on transfer shall be accounted for by the transferor onlyThe RBI vide circular dated July 30, 2019 has permitted banks to sell, through assignment, certain loans (availed domestically for capital expenditure in manufacturing and infrastructure sector if classified as Special Mention Account (SMA)-2 or NPA, under any one time settlement with lenders) to eligible ECB lenders provided, the resultant external commercial borrowing complies with all-in-cost, minimum average maturity period and other relevant norms of the ECB framework.FPIs and ECB lenders may be permitted to purchase distressed loans across sectors directly from banks.
This is a new insertion.

However, the ECB shall remain ECB after such transfer. Accordingly, transfer to a domestic entity shall result in the ECB becoming a domestic loan.

Hence, a transfer between branches of 2 Indian Banks abroad shall come under this.

Transferor as a service provider– Execute a written agreement
– Service to be provided at arm’s legth basis
– Servicing Fee shall not be subject to deferral/waiver
– Limited duration of facility
– No non-contingent or unconditional liability to pay to the transferee
– Hold the recipets in trust for transferee. shall not co-mingle the funds
– Should not result in additional credit risk on the transferor
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