SOSTRA: The New shastra of liquidating Non-performing loans

-Team Finserv (finserv@vinodkothari.com)

“Only the few know the sweetness of the twisted apples” – Sherwood Anderson

If securitisation of stressed assets abbreviates as SOSTRA, here is the new shastra (tool) for NPA clean-up from the financial system. On January 11, 2024, while speaking at the Centre for Advanced Financial Learning (CAFRAL)^[1], then RBI Governor Shaktikanta Das announced that the RBI is in the process of formulating a framework for the securitisation of stressed assets based on the public comments received on the Discussion Paper on Securitisation of Stressed Assets Framework, released by the RBI on January, 2023.

Based on the comments received on the above mentioned discussion paper and as  proposed in the Statement on Developmental and Regulatory Policies dated April 09, 2025, the RBI has now released a draft framework for securitisation of non-performing assets. This is a major improvisation over the draft originally released in January 2023.

Some of the highlights of the new Draft Directions are:

• Banks as well as NBFCs may securitise pool of NPAs;
• The pool shall consist entirely of stressed loans, but upto 10% of the pool may be assets which are standard (that is, more than 1 but upto 89 DPD). That is, originators may add a deal-sweetener. However, re-performing loans (that is, those that earned the tag of an NPA due to past default history, which is not completely washed out) may be securitised;
• To ensure that the pool does not have a significant concentricity, the Herfindahl Index of the loan pool should be within 0.3;
• The originator may optionally engage the services of a resolution manager fulfilling such eligibility criteria as mentioned under the Draft Directions;
• The originator may retain upto 20% exposure in the pool (that is, first loss piece, plus 10%, not exceeding 20% in total);
• Securitisation notes acquired by the buyer will get a standard status to begin with, but will be subject to valuation and provisioning requirements. The provisioning requirement is based on a linear amortisation of 20% each year, and aims at splitting the total provision to the tranches in the ratio of risk weights. Highest provisioning will be taken by the equity tranche, and lowest by the senior tranche.
• The SPV needs to ensure that the investors are not related parties of the borrower or disqualified in terms of Section 29A of the Insolvency and Bankruptcy Code, 2016
• For the purpose of ticket size the Directions have referred to the SSA Directions hence the minimum ticket size for issuance of securitisation notes shall be Rs. 1 crore.

Team VKC notes: In the 2023 draft, team VKC submitted clause-wise comments to the RBI and also gave a presentation to the RBI’s team. Many of our recommendations have been accepted by the RBI.

In our view, the proposed draft Directions provide an effective solution to clean up the NPA clogs, particularly in case of retail loans.

The key highlights of the proposed framework are illustrated below:

Existing framework:

At present, in India, there exists a framework for securitisation of standard assets only which are regulated through the Master Direction – Reserve Bank of India (Securitisation of Standard Assets) Directions, 2021’ (‘SSA Directions’), which deals with standard asset securitisation. Under the SSA Directions, the definition of standard assets does not include non-performing loans, i.e., only those assets with a delinquency up to 89 days, would qualify for securitisation under the SSA directions.

On the other hand, in case of stressed loans, the TLE  framework has always been permissive. That is, stressed loans may be sold by way of bilateral transactions.

Now, the present draft directions, Reserve Bank of India (Securitisation of Stressed Assets) Directions, 2025 (‘Draft Directions’) has been issued to facilitate securitisation of assets with a delinquency of more than 89 days, i.e stressed loans. The RBI proposed to introduce a framework for the purpose of securitisation of stressed loans back in 2023. The RBI had published a discussion paper for public consultation titled  Discussion Paper on Securitisation of Stressed Assets Framework, whereunder the paper discussed the mechanism of securitisation of stressed assets. Vide the Statement on Developmental and Regulatory Policies the RBI announced its intention to come out with a draft framework for Securitisation of Stressed Assets and accordingly the draft framework for public consultation towards the same has been published on 09 April 2025, with comment period upto 12th May, 2025.

Comparative Analysis – SOSTRA, ARC and SSFs

Basis	SOSTRA	Asset Reconstruction Companies	Special Situation Funds
Global context	Securitisation of NPLs happens all over the world; in some cases (home loans in particular), with State support.	Globally, AMCs were envisaged, normally with a sunset, to tide over a crisis. Essentially for resolving systemic generation of NPLs	For driving investments into stressed loans, essentially with a view to the underlying collateral; mostly with significant upside opportunities
Indian context	Securitisation is currently allowed for standard assets only; draft Directions now permit securitisation of NPLs, including, within a limit of 10%, stressed but standard assets	27 ARCs exist; however, most of them focus on asset aggregation, IBC resolution etc. Relatively less active in retail loan space	Cumulative Data as at Dec 31, 2024: Commitments raised-2048 cr.; Funds Raised- 1531 cr; Investment made-1510 crComparatively less popular
Economic drivers	Unlocking the inherent value of NPLs, particularly those which are still giving regular cashflows. Pertinent in case of retail pools	Resolution abilities of the ARC, in particular, sec 8 and 13 of the SARFAESI Act, legal powers and IBC	Investment returns based on the underlying collateral
Minimum Ticket Size	For investment- min. ₹1 crore per investor  (similar to SSA Directions)	No statutory ticket size, but given limited number of investors, mostly aligned with the deal size.	Min. Investment by an Investor Rs 10 crores.
Nature of the investment	Credit-enhanced, mostly rated investment in securitisation notes, backed by cashflows expected from the pool of securitised loans. Distributions happen on a waterfall mechanism	Investment in security receipts; no credit enhancements. Distributions happen as and when collections are done.	Pooled investment by investors into a fund, which in turn buys multiple stressed loans. Subordination structures currently not permitted.
Skin-in-game for the originator	No originator risk retention stipulated; however, tranching/ credit-enhancement call for originator risk retention. Maximum originator retention 20%.	No minimum originator retention; ARC investment minimum 15% of originator’s share, or 2.5% of total SRs, w.e.h. SRs are pari passu – hence, subordination is not common/permitted	Direction acquisition of NPLs by the fund does not seem possible under the structure, except under Clause 58 of TLE Directions (resolution plans or JLF decision)
Potential Investors	Any investor, except related parties of the borrower or persons disqualified in terms of Section 29A of the IBC.	AIFs, FPIs, ARCs, all NBFCs (28th Feb 2025 notification), Banks (QBs)	HNIs and well-informed, sophisticated  investors
Diversification of pool	Securitisation requires pool diversification – Herfindahl Index to be within 0.3. Single loan or chunky loans cannot be securitised	Single loan or chunky loans may be securitised	Will mostly be applicable in case of corporate loans undergoing JLF/IBC mechanism
Types of assets that can  be acquired	NPAs- must be min. 90% Up to 10% can be stressed loans with 1 to 89 DPDFraud/red-flagged/wilful default accounts cannot be securitized.	All stressed loans which are in default for 1 DPD or more, NPAs,SRs of other ARCs, Fraud/wilful default accounts allowed (with conditions)	Stressed loans under clause 58 of TLE Directions, SRs of ARCs,Securities of distressed companies
MHP required on stressed assets	None	None in case of transfer to ARC	None in case of transfer to SSF;Further 6 month MHP is applicable on SSF
Enforcement of  security interest under  the SARFAESI Act	Possible to retain originator’s privity with the borrower; hence, originator’s original powers (if any) may continue.	Enforcement under SARFAESI – sec 13 Special powers under sec. 9In case original loan did not have the power, the power of the assignee is questioned in court rulings	Recommendation has been made by  SEBI to RBI to include SSFs under the  definition of ‘Secured Creditor’ under  SARFAESI
Stamp Duty implications	Stamp duty as per Indian Stamp Act, 1899	No stamp duty (8F of the Indian Stamp  Act, 1899)	Stamp duty as per Indian Stamp Act,  1899, till any specific exemption is  granted similar to ARCs
Tax Treatment	Income-tax Act section 115TCA currently does not cover this mode, as it refers to standard assets only.Listed PTCs may be the option.	Pass through treatment u/s 115TCA of the Income Tax Act 1961	SSF exempted under Section 10(23FBA) Income is taxable directly in the hands of the investors under Section 115UB
Due Diligence	RBI-regulated lenders making investment shall do DD.	ARC do DD of the stressed assets.	Initial and continuous DD of it’s Investors- as applicable on ARCs

Eligible Lenders

Eligible Lenders who were eligible to securitise under the Securitisation of Standards Asset Master Directions (SSA Directions) are also the permissible/eligible lenders who can securitise their stressed asset under these Draft Directions. Hence accordingly the lenders who can securitise their stressed loans shall mean:

1. Scheduled Commercial Banks (except RRBs)
2. All India Financial Institutions
3. Small Finance Banks
4. All NBFCs (Including HFCs)

Eligible Assets

Stressed Loans under the Draft Directions will include loans having a DPD status of more than 0 days. It should be mentioned here that under the current SSA Directions, loans having a DPD status of upto 89 days can be securitised. Thus, the current draft directions will cover both, i.e.,

• Loans having a DPD status of 1-89 days as well as
• Loans classified as Non performing assets

However, certain conditions are required to be met for the securitisation of a pool of assets under the Draft Directions:

a. The sum of the outstanding exposures in the underlying pool classified as NPA is equal to or higher than 90% of the total outstanding amount

Here, it may be mentioned that our recommendation made to RBI in February 2023, we discussed including standard assets as a part of the stressed loan pool. Our submission was that considering that regulatory frameworks world over do not restrict the inclusion of standard assets and therefore the composition of the pool should be left for the market forces to determine.

b. Sum of squares of relative shares of underlying stressed loans is 0.30 or less calculated as follows:

1. Calculate the outstanding balance of each loan
2. Divided this figure by total outstanding balance of the portfolio on the origination cut-off date
3. Square the figures obtained
4. Calculate the total sum of these squares
5. The resulting number should be equal to or less than 0.30.

Let us illustrate the same with an example:

	Outstanding Balance of each loan (L)		L/B	(L/B)^2 = S
L1	100	L1/B	0.1063829787	0.01131733816
L2	120	L2/B	0.1276595745	0.01629696695
L3	130	L3/B	0.1382978723	0.01912630149
L4	150	L4/B	0.1595744681	0.02546401086
L5	110	L5/B	0.1170212766	0.01369397918
L6	90	L6/B	0.09574468085	0.009167043911
L7	80	L7/B	0.08510638298	0.007243096424
L8	160	L8/B	0.170212766	0.02897238569
Total outstanding balance of the portfolio (B)	940		Sum of S	0.1312811227

This approach has been mandated to prevent a single loan from comprising a significant portion of the pool. Given that these are stressed loans, ensuring diversification and avoiding concentration of any one loan is particularly important.

Assets that cannot be securitised

Similar to the present SSA Directions, the Draft Directions for securitisation of stressed loans also contain a list of assets that cannot be securitised. These include,

1. Re-securitisation exposures
2. Exposures to other lending institutions
3. Refinance exposures of AIFIs
4. Farm Credit
5. Education Loan
6. Accounts identified as Fraud/Red Flagged Account, and
7. Accounts identified as or being examined for ‘Wilful Default

It may also be noted that under the Draft Directions, where standard assets form part of the pool (up to a maximum of 90% of the total outstanding amount), it must be ensured that such standard loan assets do not fall under the negative list prescribed under the SSA Directions.

Homogeneity of the Pool

The Draft Directions prescribe that the underlying loans must be homogenous. In this regard, the Draft Directions provide that loan exposures from the following two categories of loans should not be mixed as a part of the same pool:

1. Personal loans and business loans to individuals; and Loans to Micro Enterprises, not exceeding ₹50 Crore and,
2. All other Loans

Minimum Holding Period (MHP)

The Draft Directions do not prescribe any MHP requirements, aligning with their objective of facilitating the securitisation of NPAs. Since assets must be held for a certain period to be classified as NPAs, the intent behind MHP is inherently met.

While the framework allows up to 10% of the pool to consist of stressed assets not yet classified as NPAs, we believe MHP should not apply to these either.

Minimum and Maximum Risk Retention

1. Minimum Retention Requirements

Under the Draft Directions, unlike the SSA Directions, maintaining a MRR is not a mandatory requirement. In our representation submitted to RBI, we discussed how imposing a MRR requirement might be unnecessary. We submitted that, under the SSA Directions, MRR is intended to ensure that the originator maintains a continuing stake in the securitised pool, thereby discouraging an originate-to-sell model that could lead to weak origination or underwriting standards.

However, in the context of NPAs, the originator has already demonstrated a continuing stake in the assets, and the objective of securitisation is now to offload these stressed exposures from its books. This changes the risk dynamics, making a mandatory MRR less relevant in such cases.

It may however be noted that paragraph 8 of the Draft Directions provides that the originator, the relationship manager (ReM), or both may retain a portion of the risk, in accordance with the terms of the contractual arrangement between them. Notably, where the originator is also appointed by the Special Purpose Vehicle (SPV) to act as the ReM for the purposes of resolution and recovery, a retention requirement is triggered.

2. Maximum Retained Exposure

Like the SSA Directions the Draft Directions provide a maximum retention of 20% by the originator, however interestingly one stipulation that has been introduced under the Draft Directions requires that any exposure above 10% upto 20% should be recognized as a first loss piece for all prudential purposes.

Structure

The Draft Directions has referred to the present SSA Directions for provisions around providing of credit enhancement facilities, liquidity facilities, underwriting facilities and servicing facilities to securitisation of stressed assets.

Resolution Manager

The Draft Directions also discuss that a ReM may be appointed who shall be responsible for administering the resolution/recovery of the underlying stressed exposures. Such ReM is required to have requisite expertise in the resolution of NPAs, including drawing of effective business plans, recovery strategies, and loan management.

It may be mentioned here that, the representation made to RBI in 2023 discussed how globally, a resolution manager is not a common feature in most NPA securitisation Structures and therefore, in this regard, the suggestion will be to provide for enabling provisions which will allow the market participants to appoint a resolution manager should there be a need to appoint one, depending on the characteristics of the underlying pool. Thus, our suggestion was to allow discretion with the market participants to appoint a RM.

Requirements relating to Resolution Manager

1. Should not be a person disqualified under Section 29 A of IBC;
2. Should not be a related party of the originator;
3. Should not support losses of SPV except to the extent contractually agreed upon;
4. Should remit all cashflows as per agreed terms;
5. During interim period from cash collection to remitting to SPE, collections to be made in escrow account;
6. ReM can raise additional finance for the purpose of resolution related activities of the pool to the extent of 75% of total requirement. However finance cannot be taken from originator
7. ReM to adhere to guidelines of FPC issued by RBI

Comparison of SSA, TLE and Proposed SOSTRA Framework

	SSA framework	TLE framework	Proposed SOSTRA framework
Loans not in default	Permitted	Permitted	Not permitted
DPD 1-89 days (Classified as Standard)	Permitted	Permitted	Permitted upto 10% of the pool size
DPD 1-89 days (Classified as NPA)	Not permitted	Permitted	Permitted
DPD > 90 days	Not permitted	Permitted	Permitted
Intent of the originator	Liquidity, capital relief etc	Liquidity, capital relief, off-balance sheet, concentration relief	NPA clean up
Intent of the investor	Yield	Inorganic book building	Yield
MRR	Required	Not required	Not required
MHP	Required	Required	Not required
Credit Enhancement	Can be provided	Cannot be provided	Can be provided
Liquidity Facility	Can be provided	Cannot be provided	Can be provided

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^[1] Availabe at: https://rbi.org.in/scripts/BS_SpeechesView.aspx?Id=1402