Is capital relief allowed for on-balance sheet securitisations?

Timothy Lopes, Executive, Vinod Kothari Consultants

Non-Banking Financial Companies (NBFCs) have been actively involved in the securitisation market, being one of its major participants at the originating as well as investing front. One of the key motivation of a securitisation transaction is its ability to take the loans off the books of the originator, thereby extending capital relief.

Until the implementation of IFRS or Ind AS in the Indian financial sector, the de-recognition of financial assets from the books of financial institutions was pretty simple; however, with complex conditions for de-recognition under Ind AS 109, almost all securitisation transactions now fail to qualify for de-recognition.

This leads to the key question of whether capital relief will still be available, despite the transactions failing de-recognition test under Ind AS. Through this write-up we intend to explore and address this question.

Situation prior to Ind-AS

Prior to the implementation of Ind-AS, there was no accounting guidance with respect to de-recognition of the financial assets from the books of the financial institutions. However, it was a generally accepted accounting principle that if the transaction fulfilled the true sale condition, then the assets were eligible to go off the books.

The true sale condition came from the RBI Guidelines on Securitisation[1]. The off-balance sheet treatment of the assets led to capital relief for the financial institutions. However, the Guidelines requires knock off, to the extent of credit enhancement provided, from the capital (Tier 1 and Tier 2) of the financial institution.

Post Ind-AS scenario

One of the key highlights of the IFRS 9 or Ind AS 109 is the introduction of the de-recognition criteria for financial instruments. Under Ind AS, a financial asset can be put off the books, only when there is a transfer of substantially all risks and rewards arising out of the assets. This, however, is difficult to prove for the transactions that take place in India because most of the structures practiced in India have high level of first loss credit support from the originators, therefore, evidencing high level of risk retention in the hands of the originator.

As a result, the transactions fail to satisfy the de-recognition test and the financial assets do not go off the books of the financial institutions.

This raises another concern with respect to maintenance of regulatory capital, since the assets are not de-recognized as per accounting standards, although backed by a legal true sale opinion. The apprehension here is whether capital relief would still be available in case the assets are retained on the books as per accounting norms. Capital relief would mean not having to assign any risk weight to or maintain capital for these assets.

RBI guidance on implementation

In the absence of any clarity on the question of capital relief to be availed by NBFCs, the whole idea for securitization was getting frustrated. However, RBI has on March 13, 2020 issued guidance for NBFCs and Asset Reconstruction Companies for implementation of Ind-AS[2].

It has now been clarified by RBI that securitised assets not qualifying for de-recognition under Ind-AS due to credit enhancement given by the originating NBFC on such assets shall be risk weighted at zero percent. This implies that the originating NBFC will not be required to maintain any capital against the securitised portfolio of assets. However, the originator shall still be required to make 50% deduction from Tier 1 and 50% from Tier 2 capital.

The relevant extract of RBI notification states as follows-

vii) Securitised assets not qualifying for de-recognition under Ind AS due to credit enhancement given by the originating NBFC on such assets shall be risk weighted at zero percent. However, the NBFC shall reduce 50 per cent of the amount of credit enhancement given from Tier I capital and the balance from Tier II capital.

Accordingly, the fact that a transaction does not qualify for off-balance sheet treatment shall not be relevant for capital adequacy computation. As long as a securitisation transaction satisfies the conditions laid down in the relevant Securitsation Guidelines the fact that whether it has been de-recognised or not for accounting purposes will not make a difference.

Read our related write ups here –

Securitisation accounting under Ind-AS

Securitisation accounting: disconnects between RBI Guidelines and Ind-AS

Accounting for DA under Ind-AS



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