Partial credit enhancement scheme gets off to a flying start

Abhirup Ghosh

The Government of India, with an intent to infuse liquidity in the financial sector, in the Union Budget, 2019, proposed to provide partial credit guarantee for sale of high quality assets of good NBFCs/ HFCs to public sector banks. Subsequently, on 10th August 2019, the FinMin launched the scheme[1].

Initially, there were various ambiguities in the scheme, however, later on, the same were clarified by the Government and the Reserve Bank of India. The start had to be slow and it took almost a month to figure things out and keep the systems in place, meanwhile an industry forum was also organised by the Indian Securitisation Foundation and Edelweiss Group to deliberate on the various issues surrounding the matter. However, close to the end of the second quarter, the product gained traction and reported volume of close Rs. 17,000 crores have already been done, with another Rs. 15,000 crores worth deals in the pipeline.

This has come as a relief for all the financial sector entities, as the banks are now keen to look at NBFC assets, considering that – a) the pool of loans are of good quality[2], b) additionally, the GOI will provide a first loss guarantee on the pool of assets. AA rating is itself treated as a good rating and with an additional sovereign guarantee over that, the transaction technically becomes risk free in the hands of the purchasing bank.

As per market sources, majority of the transactions are being priced in the range of 9%-10%.  Considering the level of stress the financial sector is going through, the transactions are being priced decently.

Some ambiguities still linger on

Though the transactions are being processed seamlessly, however, some ambiguities with respect to accounting treatment of the transaction are still worrying the financial institutions. The transaction being a mix of securitisation and direct assignment transaction throws new challenges. One of the key issues in case of any direct assignment/ securitisation transaction is whether the transaction would result in de-recognition of financial assets from the books of the originator. The de-recognition principles are laid down in Para 3.2 of Ind AS 109. These principles allow an entity to remove financial assets from its books either based on substantial transfer of risks and rewards, or based on a surrender of control. If the risks and rewards are substantially retained, de-recognition is denied. While the conditions of assessing whether there has been a substantial transfer of risks and rewards are subjective, there is substantial amount of global guidance on the subject.

Since Indian securitisation transactions involve credit enhancements normally to the extent of AAA-ratings, and sweep all residual excess spread, most of the securitisation transactions as currently done fail to transfer risks and rewards in the pool of assets, and consequently, do not lead to de-recognition of financial assets. However, in case of direct assignment transactions, the transfer of assets presumably leads to pari passu transfer of risks and rewards in the assets. Therefore, the same leads to de-recognition of assets transferred by the originator to the buyer.

In case of transfers under this Scheme, the assets must be rated as high as AA, which is impossible to achieve unless there is a tranching of pool done. This signifies that the first loss support to the pool would come from the originator or from a third party. There is certainly a strong element of risk retention by the originator. Correspondingly, the excess spread is also retained by the originator. However, whether the same would be regarded as “substantially all the risks and rewards” in the pool is still questionable. The very need for a sovereign guarantee signifies that there is a left over risk which requires to be covered by the Government guarantee..

Therefore, the transaction seems to be splitting the overall risks of the pool into 3 pieces – partially, retention by the originator, partially going to the GoI, and the remaining or super-senior part, going to the bank. It may be noted that if there is a significant transfer of risks, then it may not be separately necessary to establish a transfer of rewards as well, as risks and rewards are concomitant.

This, however, is subject to interpretation and there is a strong likelihood of different opinions in this regard. One shall have to wait for the finalisation of quarterly accounts of the major financial institutions to understand the direction in which the industry is inclined to.

The other ambiguity that continues is regarding the guarantee commission. On the apparent reading of the scheme, it seems that guarantee commission to be paid to the GOI, has to paid annually, however, another school of thought believes that the guarantee commission will have to be paid only once during the lifetime of the transaction. A clarification in this regard from the GOI will be very helpful.

Impact on other structured finance transactions

Interestingly, this scheme has, so far, not hampered the otherwise booming securitisation industry. The first half of the FY 2020 has reported recorded approximately Rs 1 lakh crores worth transactions, which is 48% year on year growth.


[2] As per the Scheme, the pool should be highly rated. It should be rated at least AA even before the government guarantee.

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