Financing electric mobility: Evaluating BaaS structures

  • Qasim Saif | finserv@vinodkothari.com

The penetration of EVs in Indian vehicle market have gone up from 0.01% to 1.66% from FY 15 to September, 2021[1]. However, the growth of EVs faces several resistances in form of high upfront cost, the lack of public charging infrastructure, and travel range. In order to catapult the growth of EVs in India, there is need to increase infrastructural support to the industry in the form of charging stations, battery units etc.

The dire need of financing is felt in the entire supply chain of EVs beginning from the speciality chemicals used in batteries to the finished vehicle purchased by the end user.

If the demand side of the EVs is able to perform well this shall help the entire asset value chain to assimilate the required resources. Hence, ease of acquisition of asset, would act as a catalyst or rather a jet boost for the development of the entire EV supply chain. Enabling as well as financing the acquisition of EV asset by the end customer hence becomes a rather pivotal point for entire eco-system.

Leasing can be one of the mode of financing, and this article, we wish to discuss the prospects of leasing as a mode of finance for EVs in India.

EV segment in India

The most important drivers of the demand of EVs in India can be:

  1. Rapidly developing, Indian middle-class
  2. Increasing cost of petroleum products
  3. Growing sentiments for pollution control
  4. Promotion of social distancing

As the vehicle demand and the penetration of EVs both increase in India, this presents an opportunity to cater to this market. Even for the economy at large, this is an opportunity to drive significant growth in a new sector.

Increased EV adoption is likely to present an unprecedented opportunity for multiple market players, from battery manufacturers to commercial electric vehicle operators. Investments in EV segment could be an important driver for India’s post-COVID economic recovery, generating jobs and economic value and export promotion, across the value chain including in existing industries and through the creation of new sectors.

The distribution of EVs in India shows that the majority of the EV segment is dominated by the 2-wheeled vehicles, the trends are as follows:

 

One of the easiest ways to bridge the gap in upfront cost of the traditional vehicles and EVs is to improve the availability of finance for EVs, especially for fleets like 2-wheelers and 3-wheelers where adoption of EVs is financially more lucrative due to the accelerated recovery of costs.

Current and potential consumers of EVs see its higher upfront cost at present as a major barrier to its adoption. The overall investment opportunity that EVs present is akin to the amount of capital the end consumers will spend on the transition. Thus, access to consumer finance is a critical factor for the adoption of EVs due to the high upfront costs of EVs at present as compared to conventional vehicles and for building up EV infrastructure.

For some categories like car fleets, initial purchase cost hurdle seems to have been mitigated with improved availability of finance, where barriers like the availability of public charging stations do not majorly impact their adoption as they have private charging and optimised routes. High daily usage, as in the case of fleet operations, make EVs competitive or even cheaper than traditional vehicles owing to their low operating costs, including limited maintenance requirements.

Limitations of traditional financing sources for EVs

Moving to an e-mobility future will be a massive exercise that will require significant investment into the sector. Raising capital to finance OEMs, battery manufacturers, charging stations, and end consumers will require systemic policy support and shifts in market design, business models, and financial structuring. Together, these will have to address the barriers that hinder the growth of the sector and in turn channelise the flow of capital into the sector.

The lack of a performance track record is a significant barrier for financing the end-consumer. Financing for commercial vehicles like fleets takes place based on loan coverage ratios, which are dependent on the actual cash flows from operations. The continuous and rapid decline in the market value (due to decline in value of battery) of EVs acts as a barrier to financing, as the value of loan outstanding at any time may exceed the value of the vehicle being financed; this is likely to limit the possibility of financing via traditional methods. The barrier, when combined with the comparatively high purchase cost of EVs at present, can present a big challenge for financiers and thus may severely limit the penetration of EVs in the short term. These barriers, along with the low density of EVs in the market during the initial years, will make it difficult to assess the resale value of EVs. However, as seen with other products with a rapid declining price curve, the secondary market is small and unlucrative, making debt financing risky.

To address the additional risk in the segment the Niti Ayog and the World bank have jointly proposed setting up of a USD 300 million fund for first loss risk sharing instrument which would have State Bank of India as its program manager.

Further, as the time taken for charging of EVs pose a significant operational barrier for the user, along with ready availability of infrastructure, the industry has been increasing pushing for battery swap models. Under this the battery of the vehicle may be swaped at charging station for a charged one, however, in case of 2-wheeler the battery depreciates at a very high rate. Hence, in case the owner of the vehicle uses any such service, the determination of market value of the asset becomes impossible without a physical inspection. Also conducting a physical inspection of all vehicles financed is in itself a near to impossible task. The arrangement significantly increases the risk of financer acting as a restriction to financing the end user.

BaaS structures a probable solution?

As mentioned above, financing the acquisition of EV asset by the end customer is a pivotal point for development of entire eco-system. For the reasons mentioned the traditional sources find it difficult to adapt for the very different needs of the EV segment. The volatility of the market value along with lack of data for EVs further worsen the situation.

Further, the end customers have their sceptics for the, maintenance and life of battery. The people have reservations that at the end of the life of battery, they might have to shell out a prominent sum to get them replaced. Further, any issues in battery may also pose challenges due to lack of available facilities. Lack of charging facilities add to such concerns.

On the cursory analysis it may appear that adopting leasing as a solution for financing of the EVs, may again face the same challenges as in case of traditional loans. Rather, inability to determine the fair value of the asset after a given time may be a bigger challenge in leasing rather than in loans.

To better understand that how leasing can assist in overcoming the shortcoming of traditional financing, it shall be noted that in EV are very different than fossil fuel-based vehicles in the sense that battery and the vehicle can be treated as two separate assets. The life of vehicle and the battery differ significantly, and batteries may be severable from the vehicle. Top of all the manufacture of battery and vehicle parts are different which is in contrast to the fossil-fuel based vehciles.

The differential treatment of vehicle and battery can assist in servitisation of asset. This enables us to explore structures where battery is provided as a service whereas the vehicle as goods. Also, the two major concerns that is the higher upfront cost and maintenance of battery both can be addressed by servitising the battery.

The model of providing battery as services is referred to as BaaS.

Understanding servitisation of asset

In brief, servitisation refers to a transaction where an asset is provided by the manufacturer for use of the acquirer, ownership of the asset remains with the borrower. Say, a car manufacturer provides you an option to rent a car for a specified period, all the expenses of running and maintaining the car are taken care of by the manufacturer. In case any issues in car you may also have an option to get the car replaced. Here, there was no sale of asset, rather an asset was used to provide a service. This concept is popularly known as servitisation of asset.

In 1962, Rolls Royce, pioneered a concept – the idea of selling products as a service by offering power-by-the-hour for jet engine maintenance management. Over the years, the idea was well adopted by the industry and there was a shift in the global manufacturing. With decreasing product differentiation, escalating customer expectations, and evolving environmental and safety regulations providing further thrust for its development.

The servitisation is seeing a far better growth compared to the traditional sectors. The subscription economy index shows that service industry has grown five to eight times faster than traditional businesses. The rapidly growing service industry along with growing penetration of EVs put forward a rather ripe opportunity for vehicle financing companies to invest in.

[Our write-up explaining servitisation in detail can be accessed here]

 

India is a rare economy that leap-frogged the traditional model of economic evolution – from reliance on primary sector to one derived from reliance on the tertiary sector, this makes for a fertile ground for manufacturers to emulate this business model, given the dominance of services sector in Indian economy in terms of its contribution to the GDP.

That being said, what makes the case for servitization of manufacturing even more compelling is the onset of Covid-19 in the country and the consequent change in consumer behaviour in the country. Customers, have become sceptical about making discretionary purchases as they see their income shrinking. A way to re-establish customer trust for organizations is to adopt policies and processes that establish strong trust among employees, customers, partners and the community. Companies that can provide extremely high levels of service may win out over brands that cannot.

This is where servitization can step in and help bridge this trust deficit, while capitalizing on India’s strength in services sector.

At a time when consumers have ease of comparison and multiple options available readily, this model assures that the item they are purchasing will be well maintained and run as expected, for as long as expected, even if that means paying an incremental amount for service. Not only is servitization of manufacturing beneficial for the consumer since it is built on the foundation of trust and forging client relationship, it is also beneficial for manufacturers since the customer will continue to buy from the manufacturer. This will create a sustainable revenue source with the potential for growth for the asset providers.

Servitisation in case of EVs

The two models for servitisation of EVs can be to either opt for providing the EV itself as a service, that is to say that the vehicle is provided on a subscription basis. This model is currently being implemented for fossil-fuel based vehicles and the same companies have also been offering EVs under the same structure. [Our write-up on servitisation of vehicles can be accessed here.]

The above-mentioned model has nothing different for EVs. These models again pose challenges for the service providers because as mentioned above the life of battery and the vehicle differ significantly, the maintained requirement is also fulfilled at different facilities by use of different resources.

Hence, an interesting structure to evaluate would be where battery and the vehicle are treated as separate asset and accordingly acquired. Say, the battery is acquired as a service whereas the vehicle may be purchased by upfront payment or financed by service provider or a partner financier.

Understanding the model

Under the model the key function is performed by the service provider, whereby service provider purchases a vehicle and disintegrates the same into battery and the vehicle as two separate assets. It shall be pertinent to note that, the said disintegration is not by the manner of physical removal of battery rather, a legal disassociation. Whereby, the legal transfer of asset is undertaken separately though physically the asset is delivered as a single asset. Under GST, separate invoicing shall be issued for battery and the vehicle.

Legal permissibility of the structure

The Ministry of Road Transport and Highways has allowed registration of electric vehicles without pre-fitted batteries. In a letter to Transport Secretaries of all the States and UTs, the ministry has clarified that vehicles without batteries can be sold and registered based on the type approval certificate issued by the Test Agency. Further, that there is no need to specify the Make/Type or any other details of the Battery for the purpose of Registration. However, the prototype of the electrical vehicle, and the battery (regular battery or the swappable battery) is required to be type approved by the test Agencies specified under Rule 126 of the Central Motor Vehicles Rules, 1989.[2]

Though, there is clear permissibility in case of 2 and 3 wheelers the situation for cars and other vehicles still remains in a grey area.

Benefits of structure

As batteries form a major part of cost of electric vehicles, the BaaS structure shall result in significantly lower upfront cost to the customer and hence may result in wider adoption of EVs

Further, the structure enables the service provider to separately provide for the asset and accordingly, the maintenance can be taken care of by separate service provider, say battery manufacturer services all the batteries and the vehicle manufacturer services the vehicle.

The service provider may also provide an option whereby the battery, may be swapped in case of any defects or issues in the working of the batteries. The above options, can address the concerns of the end-user to a great extent.

Shortcomings of the structure

Though the model may help mitigate few of the major concerns of the EV segment, however, the model still has few leak points that needs to be addressed:

  • Legal permissibility – Though Ministry of Road Transport and Highways have explicitly permitted sale of 2 and 3-wheeler EV without batteries, however sale of cars and goods vehicle still remain a grey area.

Though it shall be noted that in the model provided above, the service provider purchases the vehicle along with the battery. Once the service provider further transfers the assets, we do not find any legal challenge in this transfer, though, the complete clarity in this regard is still absent.

  • GST – GST can result in a factor that increases the cost of acquisition of vehicle in this structure, as the GST on Electric vehicle is 5% and GST on battery is 18%. Accordingly, if the battery is supply fitted in the vehicle the entire vehicle would be subject to GST of 5% but if the battery is disintegrated as a separate asset, the battery would be subject to 18% GST. This shall result in additional cost burden on the EV buyer
  • Subsidy Schemes: Government of India and various state governments provide a subsidy benefit buyer of EVs, However, would the service provider not being the end-user of the vehicle be eligible to claim the subsidy benefit is not clearly articulated in the scheme.

Conclusion

The higher upfront cost results in a barrier to the growth of EVs. A major part of the cost of EVs in the form of battery cost. Enabling the acquisition of EVs by the end user without shelling out a higher price can help in development of the entire EV supply chain. Further, economic life of batteries and vehicle differ significantly as the manufacturing and maintenance of batteries are undertaken by entities, different from the vehicle manufacturers. These factors limit the availability of traditional financing sources, hence, the structures where batteries and asset are transferred as two separate assets can be of high relevance for the development of EV segment in this nascent stage.

[1] Refer graph below

[2] https://pib.gov.in/PressReleasePage.aspx?PRID=1645394

Summary of subsidy scheme for EVs in India

Qasim Saif I finserv@vinodkothari.com

The penetration of EVs in Indian vehicle market have gone up from 0.01% to 1.66% from FY 15 to September, 2021[1]. This shows a clear increase in penetration of the EVs in the Indian vehicle market. Though the growth of EVs faces a several resistances in form of high upfront costs, the paucity of public charging infrastructure, and travel range.  The policy support from the government can be of a major motivator for promotion of EVs in India.

Government policies have a significant role to play in India’s nascent EV industry, as they can lay down the ground work for future procurement of EVs, financial incentives to end consumers and OEMs, and funding for manufacturing and charging infrastructure development. The EV ecosystem in India has been shaped by policies at both the central and state level. The policy support can also provide a crucial support to the EV segment, as mentioned above, upfront cost to customer is a major factor limiting the growth of EV segment. Policy support can help bring down a portion of this cost, hence helping the industry. Several states have announced their EV policy providing for incentives to the EV industry as well the customer.

The Government of India and several state governments have provided several benefits to the EV segment. The article aims at providing a single point reference to various schemes.

Central Government

At the central level, under the National Electric Mobility Mission Plan, FAME (Faster Adoption and Manufacture of Hybrid and Electric Vehicles) was launched in 2015. In the first phase of the FAME scheme, demand incentives in the form of a reduced upfront purchase price for all EV segments were disbursed to create a market for them. This phase continued till 31 March 2019, supporting the sales of approximately 2.78 lakh EVs, with a total incentive disbursement of INR 343 crore.

Building on the success of the first phase of FAME, the second phase was launched for four years, April 2019–March 2022, with a budget outlay of INR 10,000 crore. The incentives under the scheme are designed to focus on the following areas: demand creation, development of charging infrastructure, research and development of EV technologies, and push towards greater indigenisation. For the creation of market demand, the scheme provides incentives on the purchase of two-wheelers, three-wheelers, four-wheelers, and buses to be used for commercial purposes.

The incentives to customer are provided based on the size of the battery in the vehicle, the incentives available in the scheme are as follows:

Vehicle Category Permitted use Incentive to consumer
2-wheeler Personal and Commercial Use Lower of 15,000/ Kwh and 40% of Asset Cost
3-wheeler Commercial Use Lower of 10,000/ Kwh and 20% of Asset Cost
4-wheeler Commercial Use Lower of 10,000/ Kwh and 20% of Asset Cost
Buses Commercial Use Lower of 20,000/ KWh and 40% of Asset Cost

Figure 3: Incentive available to end customer under FAME-II

Source: VKCPL research

State Governments

At the state level, the focus of EV policies is similar to that of the FAME scheme. Currently, in India, 19 states have notified their EV policy. These policies offer a broad range of incentives, starting from capital and purchase subsidies and tax and fees exemptions to mandatory procurements of EVs by state agencies and reserved parking spaces.

The table below summaries the subsidy benefits under various state government policies on EVs

State Capital Subsidy Consumer Benefits
Manufacturing Charging Infrastructure Subsidy SGST Reimbursement Road tax Exemption Motor vehicle tax exemption Registration fee exemption
Andhra Pradesh Yes Yes No 100% (EV fleets) 100% No 100%
Assam Yes Yes 2W

INR 10,000/ kWh

3W

INR 10,000/ kWh

4W

INR 10,000/ kWh

No 100% No 100%
Bihar No Yes 2W

15% – first 24,000 –

upto INR 5,000

3W

15% – first 70,000 –

upto INR 12,000

4W

15%

(a) 4W BEV- first 4,000 – upto INR 1 lakh

(b) 4W hybrid -first 1000 – upto INR 1 lakh

Buses

15% – first 1000 – upto INR 20 lakh

Others

Top up (BPL/SC/ST) subsidy : INR 8,000 ; Special incentive (Li-ion) of INR 10,000

 

 

No 100% No 100%
Delhi No No 2W

Demand generation incentive: INR 30,000/ vehicle; Purchase incentive: INR 5,000/kWh – upto INR 30,0000

3W

Purchase incentive: INR 30,000/ vehicle; Interest subvention: 5% on loans

4W

INR 10,000/kWh -first 10,000 – upto INR 1.5 lakh

Others

Goods carrier: INR 30,000

No 100% No 100%
Goa Yes Yes 2W

INR 10,000/ kWh – upto INR 30,000/ vehicle

3W

INR 10,000/ kWh – upto INR 30,000/ vehicle

4W

INR 10,000/ kWh – upto INR 1,50,000/ vehicle

 

No 100% No No

 

Gujarat No No No No No No No
Haryana Yes Yes 2W     

30%

3W

User subsidy: 30% ; Coupon: INR 25,000

4W

User subsidy: 30% ; Coupon: (a) Car < INR 10 lakhs – INR 75,000 (b) Car > INR 10 lakh – INR 1 lakh

Buses

30%

Others

Interest free loans (Government employees): 100%

 

No 100% (Government Transport Vehicle) No No
Karnataka Yes Yes No No No No No
Kerala No Yes 3W

Incentive: INR 30,000 or 25% of EV

No 100% No 100%
Madhya Pradesh No Yes No No No 2W:

1% – first 15,000/5 years

Shared rickshaw: 1% – first 5,000/ 5 years

Electric auto rickshaw:

1% – first 5,000/5 years (d) Electric goods carrier- 1% – first 2,000/ 5 years

Car – 1% – first 6,000/ 5 years

Bus – 1% – first 1,500/ 5 years

100% :

(a) 2W – first 22,500

(b) 3W – first 7,500

(c) Rickshaw (shared and electric) – first 7,500

(d)Goods – first 3,000

(e) Car – first 9,000

(f) Buses – first 2,250

Maharashtra No Yes 2W

INR 5,000/ kWh – first 1 lakh – upto INR 10,000

3W

INR 5,000/ kWh – first 15,000 – upto INR 30,000

4W

INR 5,000/ kWh – first 10,000 – upto INR 1.5L

 

No 100% No 100%
Meghalaya No No 2W

INR 10,000/ kWh – first 3,500 – upto INR 1.5 lakh

3W

INR 4,000/kWh – first 200 – upto INR 5 lakh

4W

(a) 4W: INR 4,000/ kWh – 2,500 – upto 15 lakh

(b) Strong Hybrid 4W: INR 4,000/ kWh – first 30 – upto INR 15 lakh

Buses

INR 4,000/ kWh – first 30 – upto INR 2 crore

No 100% No 100%

 

Odisha Yes Yes 2W

15% – upto INR 5,000

3W

15% – upto 12,000

4W

15% – upto 1 lakh

Buses

10% – upto 20 lakh

Others

Fleet owners – INR 30,000/ vehicle – first 5,000 EV goods carrier

No No No No
Punjab No Yes No No No 100% (50% for hybrid) 100% (e-rickshaws)
Tamil Nadu Yes No No No 100% No 100%
Telangana Yes No No No Road tax: 100% exemption (a) 2W – 2 lakh (b) 3W – 20,000 (c) Commercial 4W – 5,000 (d) Light goods carriers – 10,000 (e) Pvt. cars – 5,000 (f) Buses – 5,000 (g) Tractors – all No 100%
Uttar Pradesh No Yes No No (a) 2W – 100% (b) Others: 75% No 100%
Uttarakhand No No No No No 100% – 5 years No
West Bengal No No No No No No No

[1] Refer graph below

Our article on financing electric mobility through BaaS structures can be read here

FAQs on Transfer of Loan Exposure

We invite you all to join us at the Indian Securitisation Summit, 2021. You are sure to meet the who’s-who of the Indian structured finance space – the originators, investors, rating agencies, legal counsels, accounting experts, global experts, and of course, regulators. The details can be accessed here

The RBI has consolidated the guidelines with respect to transfer of standard assets as well as stressed assets by regulated financial entities under a common regulation named Reserve Bank of India (Transfer of Loan Exposures) Directions, 2021 (“Directions”).

The Directions divided into five operative chapters- the first one specifying the scope and definitions, the second one laying down general conditions applicable on all loan transfers, the third one specifying the requirements in case of transfer of loans which are not in default, that is standard assets, the fourth one provides the additional requirement for transfer of stressed assets and the fifth chapter is on disclosure and reporting requirements.

Under the said Directions, the following entities are permitted as transferor and transferee to transfer loans-

We bring you this frequently asked questions on Transfer of Loans to assist you better understand the guidelines.

The file can be downloaded at this link: https://mailchi.mp/887939b2f979/qa32ogwo2t

We have also published FAQs on Securitisation of Standard Asset, the contents of FAQs can be accessed here and the file can be downloaded at this link.

FAQs onTLE Framework_content

 

Summary of Scale Based Regulations

A brief highlights of the regulations along with charts summarising classification of NBFCs can be viewed here. Our Youtube elaborating on the subject can be viewed here.

List of Regulatory Provisions
NBFC-NSI NBFC-SI HFC
Without customer interface and public funds With customer interface or public funds Asset size between 500-1000 crores Asset size 1000 crores and above Top 10 or identified as such Not in Top 10 Top 10 or identified as such
Supervisory category BL BL BL ML UL ML UL
NOF No change, that is, Rs 2 crores Rs 5 crores by March 31, 2025
Rs 10 crores by March 31, 2027
No change, that is,
Rs 15 crores by March 31, 2022
Rs 20 crores by March 31, 2023
NPA Norms >150 days overdue By March 31, 2024
>120 days overdue By March 31, 2025
> 90 days By March 31, 2026
No change, that is, > 89 days
Appointment of Director Appoint at least one of the directors having relevant experience of having worked in a bank/ NBFC
IPO funding ceiling, if extending such loans Rs 1 crore per borrower [effective from 1st April, 2021]
Internal Capital Adequacy Assessment Process (ICAAP) NA NA NA Applicable Applicable Applicable Applicable
Maintain Common Equity Tier 1 capital of at least 9 per cent of Risk Weighted Assets NA NA NA NA Applicable NA Applicable
Leverage limits (in addition to CRAR) NA NA NA NA To be prescribed NA To be prescribed
Differential standard asset provisioning NA NA NA NA To be prescribed NA To be prescribed
Limits on Concentration of credit/investment NA NA Merged single exposure limit of 25% for single borrower/ party and 40% for single group of borrowers/ parties Merged single exposure limit of 25% for single borrower/ party and 40% for single group of borrowers/ parties To be followed till Large Exposure Framework is put in place Merged single exposure limit of 25% for single borrower/ party and 40% for single group of borrowers/ parties To be followed till Large Exposure Framework is put in place
Sensitive Sector Exposure (SSE), that is, exposure to commercial real estate and capital markets NA NA NA Fix board-approved internal limits Fix board-approved internal limits Same as existing
Regulatory Restrictions on
1. Loans to directors, senior officers, relatives of directors, entities where directors or their relatives have major shareholding
2. Need for ensuring appropriate permission while appraising real loan proposals
NA NA NA Applicable Applicable Applicable Applicable
Large Exposure Framework NA NA NA NA Applicable NA Applicable
Internal Exposure Limits to be set by the Board on certain specific sectors to which credit is extended NA NA NA NA Applicable; details awaited NA Applicable; details awaited
Risk Management Committee, at board or executive level To be constituted To be constituted To be constituted To be constituted To be constituted To be constituted To be constituted
Disclosures to include types of exposure, related party transactions, loans to Directors/ Senior Officers and customer complaints. Applicable Applicable Applicable Applicable Applicable Applicable Applicable
Board approved policy on grant of loans to directors, senior officers and relatives of directors and to entities where directors or their relatives have major shareholding Applicable Applicable Applicable Applicable Applicable Applicable Applicable
Except for directorship in a subsidiary, KMP shall not hold any office (including directorships) in any other NBFC-ML or NBFC-UL NA NA NA To ensure
compliance by October 1, 2024
To ensure
compliance by October 1, 2024
To ensure
compliance by October 1, 2024
To ensure
compliance by October 1, 2024
Independent director shall not be on the Board of more than three NBFCs (NBFC-ML or NBFC-UL) at the same time NA NA NA To ensure
compliance by October 1, 2024
To ensure
compliance by October 1, 2024
To ensure
compliance by October 1, 2024
To ensure
compliance by October 1, 2024
Additional Disclosures in annal financial statements NA NA NA Applicable with effect from March 31, 2023 Applicable with effect from March 31, 2023 Applicable with effect from March 31, 2023 Applicable with effect from March 31, 2023
Appointment of a Chief Compliance Officer (CCO) NA NA NA To be ensured by October 1, 2022 To be ensured by October 1, 2022 To be ensured by October 1, 2022 To be ensured by October 1, 2022
Composition of the Board should ensure mix of educational qualifications and experience within the Board NA NA NA To be ensured by October 1, 2022 To be ensured by October 1, 2022 To be ensured by October 1, 2022 To be ensured by October 1, 2022
Other Governance matters
i) The Board shall delineate the role of various committees (Audit Committee, Nomination and Remuneration Committee, Risk Management Committee or any other Committee) and lay down a calendar of reviews.
ii) Formulate a whistle blower mechanism for directors and employees to report genuine concerns.
iii) Board shall ensure good corporate governance practices in the subsidiaries of the NBFC.
NA NA NA To be ensured by October 1, 2022 To be ensured by October 1, 2022 To be ensured by October 1, 2022 To be ensured by October 1, 2022
Adoption of Core Banking Solution NA NA NA Applicable if having more than 10 branches Applicable if having more than 10 branches Applicable if having more than 10 branches Applicable if having more than 10 branches
Composition of the Board should ensure mix of educational qualification and experience within the Board NA NA NA NA Applicable NA Applicable
Mandatory listing of equity within 3 years of identification NA NA NA NA Applicable NA Applicable
Reporting removal of Independent Directors before tenure NA NA NA NA Applicable NA Applicable

A layered approach to NBFC Regulation:

A summary of the regulations can be viewed here. Our Youtube elaborating on the subject can be viewed here.

A layered approach to NBFC Regulation_ICSI

 

Indian Securitisation Awards, 2021

As the securitization market in India is on an upswing, it is time to recognize performance, innovation and service. Awards are not merely a sense of accomplishment – awards are to encourage players to move to better services and consistent performance. The awards will be given by the Indian Securitisation Foundation at the 9 th Securitisation Summit 2021 on November 18, 2021 at Four Seasons Hotel, Mumbai and may be handed over to the awardees during the Securitisation Summit.

Details for 9th Indian Securitisation Summit may be accessed at this Link.

FAQs on Securitisation of Standard Assets

We invite you all to join us at the Indian Securitisation Summit, 2021. You are sure to meet the who’s-who of the Indian structured finance space – the originators, investors, rating agencies, legal counsels, accounting experts, global experts, and of course, regulators. The details can be accessed here

On September 24, 2021, the RBI released Master Direction – Reserve Bank of India Securitisation of Standard Assets) Directions, 2021. The same has been released after almost 15 months of the comment period on the draft framework issued on June 08, 2020. This culminates the process that started with Dr. Harsh Vardhan committee report in 2019.

It is said that capital markets are fast changing, and regulations aim to capture a dynamic market which quite often leads the regulation than follow it. However, the just-repealed Guidelines continued to shape and support the securitisation market in the country for a good 15 years, with the 2012 supplements mainly incorporating the response to the Global Financial Crisis.

We bring you this frequently asked questions on Securitisation to assist you better understand the Directions.

The file can downloaded at this link: https://mailchi.mp/607563e4f4d0/faq-on-sec-guidelines

We have also published FAQs on Transfer of loan exposures, the contents of FAQs can be accessed here and the file can be downloaded at this link.

Securitisation-FAQ-contents

 

Participation in loan exposure by lenders

Anita Baid | anita@vinodkothari.com

Introduction 

The Reserve Bank of India (RBI) has issued the new guidelines, viz. Master Directions- Reserve Bank of India (Transfer of Loan Exposures) Directions, 2021 and Master Directions- Reserve Bank of India (Securitisation of Standard Assets) Directions, 2021, on September 4, 2021, that replaces and supersedes the existing regulations on securitisation and direct assignment (DA) of loan exposures. The new directions have been made effective immediately which introduces several new concepts and compliance requirements.

The TLE Directionshave consolidated the guidelines with respect to the transfer of standard assets as well as stressed assets by regulated financial entities in one place. Further, the scope of TLE Directions covers any “transfer” of loan exposure by lenders either as transferer or as transferees/acquirers. In fact, the scope contains an outright bar on any sale or acquisition other than under the TLE Directions, and outside permitted transferors and transferees, apart from securitisation transactions.

Notably, the TLE Directions refer to all types of loan transfers, including sale, assignment, novation and loan participation. While the loan market in India is quite familiar[1] with assignments and novations, ‘loan participation’ to some, might appear to be an innovation by TLE Directions.  However, loan participation is not a new concept, and is quite popular in international loan markets, as we discuss below.

This article discusses the general concept of loan transfer and specifically delves into the ‘loan participation as a mode of such transfer. 

Loan Transfers: Assignment vs. Novation vs. Loan Participation

One of the important amendments under the TLE Directions has been the insertion of the definition of “transfer”, which is reproduced herein below- 

“transfer” means a transfer of economic interest in loan exposures by the transferor to the transferee(s), with or without the transfer of the underlying loan contract, in the manner permitted in these directions; 

Explanation: Consequently, the transferee(s) shall “acquire” the loan exposures following a loan transfer.  

This definition is customised to suit the objectives of the TLE Directions – that is, the TLE Directions would cover all forms of transfers where “economic interest” is transferred, but the legal ownership may or may not be transferred. This definition is specific to these Directions intended essentially to cover the transfer of economic interest, and is different from the common law definition of ‘transfer’. 

The provisions of TLE Directions are applicable to all forms of transfer of loans, irrespective of whether the loan exposures are in default or not. However, the TLE Directions limit the mode of transfer of stressed assets. Novation and assignment are the only ways of transferring stressed assets, whereas, in case of loans not in default, loan participation is also a mode of transfer. The said modes of loan transfers that have been permitted are not new and have existed even before. 

By inclusion of “loan participation” in the TLE Directions for the transfer of loans not in default means that the loans could be transferred by transferring an economic interest even without the transfer of legal title. However, in cases of loan transfers other than loan participation, legal ownership of the loan has to mandatorily be transferred. 

The graphic below summarises the various modes permissible mode of transfer of loans not in default, as per the TLE Directions:

In the case of assignments and novations, the assignee or transferee becomes the lender on record either by virtue of the assignment agreement (along with notice to the borrower) or by becoming a party to the underlying agreement itself. On the contrary, in the case of loan participation, the transfer is solely between the originator and the participant or transferee and thus creates no privity between the participant and the ultimate borrower. Under the participation arrangement, it is an understanding that the originator or lender on record passes to the participant whatever amount it receives from the borrower. Hence, by virtue of the transfer of the economic interest, there is a trust relationship created between the originator and the participant. 

The concept of Loan Participation

It is important to understand participation as a mode of transfer of economic interest under the TLE Directions. TLE Directions define loan participation as –

loan participation” means a transaction through which the transferor transfers all or part of its economic interest in a loan exposure to transferee(s) without the actual transfer of the loan contract, and the transferee(s) fund the transferor to the extent of the economic interest transferred which may be equal to the principal, interest, fees and other payments, if any, under the transfer agreement; 

Provided that the transfer of economic interest under a loan participation shall only be through a contractual transfer agreement between the transferor and transferee(s) with the transferor remaining as the lender on record

Provided further that in case of loan participation, the exposure of the transferee(s) shall be to the underlying borrower and not to the transferor. Accordingly, the transferor and transferee(s) shall maintain capital according to the exposure to the underlying borrower calculated based on the economic interest held by each post such transfer. The applicable prudential norms, including the provisioning requirements, post the transfer, shall be based on the above exposure treatment and the consequent outstanding.

Based on the aforesaid definition, it is essential to note the following-

  1. A loan exposure can be said to consist of two components- economic interest and legal title
  2. The economic interest in a loan exposure is not dependent on the legal title and can be transferred without a change in the lender on record
  3. In case of transfer of economic interest without legal title, the borrower interface shall be maintained entirely with the lender on record- hence, one of the benefits of loan participation would be that any amendments to the terms of the loan or restructuring could be done by the lender on record without involving the transferee
  4. The loan participation cannot be structured with priorities since the same may lead to credit enhancement- which is prohibited
  5. To the extent of loan participation based on the economic interest held post the transfer, income recognition, asset classification and provisioning must be done by the transferor and transferee, respectively

Note also, that para 12 of TLE Directions states that in loan participations, “by design”, the legal ownership remains with the originator (referred to as ‘grantor’ under TLE Directions), while whole or part of economic interest is passed on to the transferee (referred to as “participant” under TLE Directions). 

The following is therefore understood as regards loan participation –

  • Legal ownership is necessarily retained by the grantor, while it is only the ‘economic interest’ or a part of it, which is transferred to the participant.
  • As such, the originator remains the ‘face’ for the borrower, and is, therefore, called “lender on record”.
  • The TLE Directions do not prescribe any proportion (maximum/minimum) for which participation can happen. Though the Directions say that “all or part” of economic interest can be transferred. Also, the law seems flexible enough not to put any kind of restrictions on the categories or limits of economic interest which can be transferred. For instance, economic interest involves the right to receive repayments of principal as well as payments of interest (among others). The grantor can simply delineate these rights and grant participation for one but retain the other. 
  • The participant shall fund the grantor only to the extent of economic interest transferred in the former’s favour and nothing more. 
  • The participation has to be backed by a formal arrangement (agreement) between the parties

Post the “transfer”, the participant has no recourse on the grantor for the transferred interest. The recourse of both the grantor and the participant lies on the underlying borrower. Both these parties are required to maintain capital accordingly.

Essentially, the loan participation agreement, setting forth in detail the arrangement between the original lender and the participant, should specify the following- 

  1. that the transaction is a purchase of a specified percentage of a loan exposure by the participant, 
  2. the terms of the purchase of such participation, 
  3. the rights and duties of both parties, 
  4. the mechanism of holding and disbursing funds received from the borrower, 
  5. the extent of information to be shared with the participant, 
  6. the extent of right on collateral in the participated loan provided by the borrower, and
  7. procedures for exercising remedies and in the event of insolvency by any party, and clarification that the relationship is that of seller/purchaser as opposed to debtor/creditor

Is Loan Participation a True Sale?

The essential feature of loan participation is that the lender originating the loan remains in its role as the nominal lender and continues to manage the loan notwithstanding the fact that it may have sold off most or even all of its credit exposure. True Sale means that a sale truly achieves the objective of a sale, and being respected as such in bankruptcy or a similar situation. Securitisation and direct assignment transactions have inherently been driven by financing motives but they are structured as sale transactions. 

Essentially, the TLE Directions are entirely based on this crucial definition of ‘transfer’ which is stressing on the transfer of an economic interest in a loan exposure. Accordingly, even without transferring the legal title, the loan exposure could be transferred. Hence, the age-old concept of ensuring true sale in case of direct assignment transaction seems to have been done away with. 

However, the question that arises is whether in the case of secured loans, loan participation arrangements would transfer the right to collateral with the original lender or is it merely creating a contractual right against the originator towards proceeds of the collateral. This issue of the characterization of loan participation and when participations are true sales of loan interests has been discussed by the Iowa Supreme Courtin the case of Central  Bank and Real Estate Owned, L.L.C. v. Timothy C. Hogan, as Trustee of the Liberty and Liquidating Trust et. al., 891 N.W.2d 197 (Iowa 2017)

In this case, Liberty Bank extended loans between 2008 and 2009 to Iowa Great Lakes Holding, L.L.C. secured by the real estate and related personal property of a resort hotel and conference center. Liberty entered into participation agreements with five banks covering an aggregate of 41% (approximately) of its interest in these loans. The participation agreements were identical in terms; each provided that Liberty sold and the participant purchased a “participation interest” in the loans. It was held that Liberty had transferred an undivided interest in the underlying property, including the mortgage created on the property, pursuant to the participation agreements. The court ruled against Liberty Bank, reasoning that the participation agreements transferred “all legal and equitable title in Liberty’s share of the loan and collateral” to the participating banks. The participants were given undivided interests in the loan documents. In addition, the court noted that the default provisions emphasized that the participants shared in any of the collateral for the loan. 

Based on the discussion, the court suggested that participants should use the language of ownership, undivided fractional interest and trust, as well as avoid risk dilution devices to ensure that their interest is treated as an ownership and not a mere loan.

Loan Participation in US and UK

In the international financial market, loan participation has been a predominant component for a long time. The reason for favouring loan participation is that it allows participants to limit its exposure upto a particular credit and enable diversification of a portfolio without being involved in the servicing of loans.

The English law (prevalent in the UK) has widely adopted the Loan Market Association (LMA) recommendation that states- the lender of record (or grantor of the participation) must undertake to pay to the participant a percentage of amounts received from the borrower. This explicitly provides that the relationship between the grantor and the participant is that of debtor and creditor, provided the right of the participant to receive monies would be restricted to the extent of the assigned portion of any money received from any obligor. Hence, in case the grantor becomes insolvent, the participant would not enjoy any preferred status as a creditor of the grantor with respect to funds received from the borrower than any other unsecured creditor of the grantor. There are methods to structure transactions that enable participants to mitigate the risk of insolvency of the guarantor, as provided in the LMA’s paper ‘Funded Participations – Mitigation of Grantor Credit Risk’, however, these methods add complexity to what many regard as routine trades and are not generally adopted. 

In US banking parlance, these instruments are known simply as “participations”. The Loan Syndications and Trading Association (LSTA) had proposed that the relationship between grantor and participant shall be that of seller and buyer. Neither is a trustee or agent for the other, nor does either have any fiduciary obligations to the other. This Agreement shall not be construed to create a partnership or joint venture between the Parties. In no event shall the Participation be construed as a loan from participant to grantor. There have also been cases to draw a distinction between ‘true participation’ and ‘financing’. In a true participation, the participant acquires a beneficial ownership interest in the underlying loan. This means that the participant is entitled to its share of payments from the borrower notwithstanding the insolvency of the grantor (so the participant does not have to share those payments with the grantor’s other creditors) even though the beneficial ownership does not create privity between the participant and the borrower. On the other hand, a participation that is characterised as financing would have the same consequences as discussed above, which is to be considered at par with any other unsecured creditor of the grantor.

The following four factors typically indicate that a transaction is a financing rather than true participation: 

  1. the grantor guarantees repayment to the participant; failure by a participant to take the full risk of ownership of the underlying loan is a crucial indication of financing rather than a true participation
  2. the participation lasts for a shorter or longer-term than the underlying loan that is the subject of the participation; 
  3. there are different payment arrangements between the borrower and the grantor, on the one hand, and the grantor and the participant, on the other hand; and 
  4. there is a discrepancy between the interest rate due on the underlying loan and the interest rate specified in the participation. 

Apart from the similarity in the basic structure and business impetus for participation, the legal characterisation of these arrangements and some of their structural elements are different under UK and US law.

Conclusion

The recognition of this concept of loan participation would expand the scope for direct assignment arrangements and hence, there seems a likely increase in the numbers as well. However, it must be ensured that such arrangements are structured with care and keeping in mind the learnings from precedents in the markets outside India, to avoid any discrepancies and disputes in the future between the originator and the participant.

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[1] In India, during Q1 2020-21, DA transactions were around Rs.5250 crore, which was 70% of the total securitisation and DA volumes. With a growth of 2.3 times in the total volume of securitisation and DA transactions (due to the pandemic the number may be an outlier), in Q1 2021-22, the DA transactions aggregated to Rs.9116 crores, with a reduced share of 53% [Source: ICRA Research]

We invite you all to join us at the Indian Securitisation Summit, 2021. You are sure to meet the who’s-who of the Indian structured finance space – the originators, investors, rating agencies, legal counsels, accounting experts, global experts, and of course, regulators. The details can be accessed here

 

Workshop on RBI Master Directions on Securitisation and Transfer of loans

We invite you all to join us at the Indian Securitisation Summit, 2021. You are sure to meet the who’s-who of the Indian structured finance space – the originators, investors, rating agencies, legal counsels, accounting experts, global experts, and of course, regulators. The details can be accessed here

Our workshop on 28th and 29th September, went full and, hence we are coming up with this repeat workshop.

Please do register your interest here: https://forms.gle/vwM2G7boj4uvyiqM6

Details would be announced shorlty

Workshop-MasterDirection-8th

Our Write-ups on the topic:

One stop RBI norms on transfer of loan exposures

– Financial Services Division (finserv@vinodkothari.com)

[This version dated 24th September, 2021. We are continuing to develop the write-up further – please do come back]

We invite you all to join us at the Indian Securitisation Summit, 2021. The details can be accessed here

The RBI has consolidated the guidelines with respect to transfer of standard assets as well as stressed assets by regulated financial entities under a common regulation named Reserve Bank of India (Transfer of Loan Exposures) Directions, 2021 (“Directions”).

The Directions divided into five operative chapters- the first one specifying the scope and definitions, the second one laying down general conditions applicable on all loan transfers, the third one specifying the requirements in case of transfer of loans which are not in default, that is standard assets, the fourth one provides the additional requirement for transfer of stressed assets and the fifth chapter is on disclosure and reporting requirements.

Under the said Directions, the following entities are permitted as transferor and transferee to transfer loans-

Permitted Transferors Permitted Transferees
Scheduled Commercial Banks; Scheduled Commercial Banks;
All India Financial Institutions Th(NABARD, NHB, EXIM Bank, and SIDBI); All India Financial Institutions (NABARD, NHB, EXIM Bank, and SIDBI);
Small Finance Banks; Small Finance Banks;
All Non Banking Finance Companies (NBFCs) including Housing Finance Companies (HFCs); All Non Banking Finance Companies (NBFCs) including Housing Finance Companies (HFCs)
Regional Rural Banks; 

(only for stressed loans under Chapter IV)

Asset Reconstruction Companies registered with the Reserve Bank of India under Section 3 of the Securitisation and Reconstruction of Financial Assets and Enforcement of Security Interest Act, 2002; 

(only for stressed loans under para 58)

Primary (Urban) Co-operative Banks/State Co-operative Banks/District Central Co-operative Banks; 

(only for stressed loans under Chapter IV)

A company, as defined in sub-section (20) of Section 2 of the Companies Act, 2013 other than a financial service provider as defined in sub-section (17) of Section 3 of the Insolvency and Bankruptcy Code, 2016. Acquisition of loan exposures by such companies shall be subject to the relevant provisions of the Companies Act, 2013 

(only for stressed loans under para 58)

An entity incorporated in India or registered with a financial sector regulator in India and complying with the other conditions under clause 58 

(only for stressed loans under para 58)

Coverage

The Directions state that no lender shall undertake any loan transfers or acquisitions other than those permitted and prescribed under the Directions and the provisions of Reserve Bank of India (Securitisation of Standard Assets) Directions, 2021. Therefore,  loans originated by the Transferor (mentioned above) cannot be transferred outside the purview of the aforesaid guidelines. Accordingly, the loans cannot be transferred to anyone, other than the transferee mentioned above, hence, this would now prohibit any loan transfers that happened outside the purview of the Directions. This in turn would also restrict covered bonds transactions wherein the loan pool was assigned to an SPV- unless the same is specifically permitted by the RBI. However, if the transfer does not result in transfer of economic interest, the same shall not be considered as a ‘transfer’ per se. Hence, covered bonds transactions that are structured in a way that the legal title is transferred, however, the economic interest is retained by the originator, the same shall be considered as ‘loan transfer’. 

At the time of occurence of default, the actual loan transfer happens and the same shall be

Further, the Directions shall be applicable even in case of sale of loans through novation or assignment, and loan participation.

In cases of loan transfers other than loan participation, legal ownership of the loan shall be mandatorily transferred to the transferee(s) to the extent of economic interest transferred.

Meaning of the word ‘Transfer’

The term transfer has been defined to mean a transfer of economic interest in loan exposures by the transferor to the transferee(s), with or without the transfer of the underlying loan contract, in the manner permitted in the Directions.

It is to be noted that loan participation transaction have also been recognised under the Directions (for transfer of standard loans) wherein the transferor transfers all or part of its economic interest in a loan exposure to transferee(s) without the actual transfer of the loan contract, and the transferee(s) fund the transferor to the extent of the economic interest transferred which may be equal to the principal, interest, fees and other payments, if any, under the transfer agreement.

General Conditions on all loan transfers

The Directions lays down some generic requirements on all loan transfers. Some of the crucial ones are as follows:

  1. Having a board approved policy
  2. Must result in transfer of economic interests without resulting in a change in underlying terms and conditions of the loan contract.Must result in transfer of economic interests without resulting in a change in underlying terms and conditions of the loan contract.
  3. Clearly delineated roles and responsibilities of the transferor and the transferee
  4. No credit enhancement or liquidity facilities in any form
  5. Transferor cannot reacquire, except as a part of Resolution Plan
  6. Immediate separation of the transferor from the risks and rewards associated with loans
    1. For retained exposure- the loan transfer agreement should clearly specify the distribution of the principal and interest income from the transferred loan between the transferor and the transferee(s)
  7. Transferee to get right to transfer or dispose off the loans transferred
  8. Rights of obligors not to be affected Immediate separation of the transferor from the risks and rewards associated with loans
    1. For retained exposure- the loan transfer agreement should clearly specify the distribution of the principal and interest income from the transferred loan between the transferor and the transferee(s)
  9. Transferee to get right to transfer or dispose off the loans transferred
  10. Rights of obligors not to be affected
  11. Monitor on an ongoing basis and in a timely manner performance information on the loans acquired, including through conducting periodic stress tests and sensitivity analyses, and take appropriate action required, if any.

The aforesaid clauses are applicable on all loan transfers under the Directions- this should not include the ones exempted from the purview of the Directions. The transactions that are specified under the exclusion list should be exempted from the applicability of the entire guidelines. However, the language is suggesting that the aforesaid general conditions including the requirement of not having any form of credit enhancement is applicable, even if the transaction is exempt from purview of Chapter III regulations on Transfer of Standard Assets.

Transferor as a service provider

As allowed under the existing guidelines as well, the transferor may act as servicing facility provider for the loans transferred. While appointing a servicing facility provider, following conditions must be fulfilled:

  • Execution of written agreement outlining:
    • nature and purpose and extent of services, 
    • standards of performance
    • duration (limited to amortisation of loans, payment of all claims of transferee or termination by parties) 
    • Right of transferee to appoint other facility provider
    • No obligation on facility provider, being transferor, to transfer funds until they are received;
    • Facility provider, being transferor, must hold cashflows in trust for transferee and avoid commingling
  • Facility to be on arm’s length basis;
  • Fee must not be subject to deferral, waiver or non-payment clauses; Also, no recourse to servicing facility provider beyond contractual obligations;

Transfer of Standard Loans

Transfer of all standard loans, except the following, shall be covered under the Directions:

Exclusion List:

●      transfer of loan accounts of borrowers by a lender to other lenders, at the request/instance of borrower;

●      inter-bank participations covered by the circular DBOD.No.BP.BC.57/62-88 dated December 31, 1988 as amended from time to time;

●      sale of entire portfolio of loans consequent upon a decision to exit the line of business completely;

●      sale of stressed loans; and

●      any other arrangement/transactions, specifically exempted by the RBI

Minimum Risk Retention

The Directions specifically require that the due diligence in respect of the loans cannot be outsourced by the transferee(s) and should be carried out by its own staff, at the level of each loan, with the same rigour and as per the same policies as would have been done for originating any loan.

However, in case of loans acquired as a portfolio, in case a transferee is unable to perform due diligence at the individual loan level for the entire portfolio, the transferor has to retain at least 10% of economic interest in the transferred loans. In such a case as well, the transferee shall perform due diligence at the individual loan level for not less than one-third of the portfolio by value and number of loans in the portfolio and at the portfolio level for the remaining.

In case of multiple transferees, the MRR would still be on the entire amount of transferred loan, even if any one of the transferees is unable to perform the DD at individual level.

The following graphic summarises the position of MRR in case of transfer of loan exposures:

Minimum Holding Period

Under the erstwhile framework, there were three blocks of minimum holding periods, however under the new Directions there are two major brackets – one for loans with original maturity less than 2 years and one with more than 2 years. The table below summarises the MHP requirements for different classes of loans:

  Secured Loans

 

Unsecured Loans Project loans Acquired Loans
Loan Tenor MHP MHP MHP MHP
Upto 2 years 3 months  from the date of registration of the underlying security interest 3 months  from the date of first repayment of the loan 3 months  from the date of commencement of commercial operations of the project being financed Six months from the date on which the loan was taken into the books of the transferor
More than 2 years 6 months from the date of registration of the underlying security interest 6 months from the date of first repayment of the loan 6 months from the date of commencement of commercial operations of the project being financed
MHP requirement is not applicable to loans transferred by the arranging bank to other lenders under a syndication arrangement

 The intent of having a MHP is to ensure that the loan has been seasoned in the books of the originator for a certain specified time period. However, in case of secured loans, the MHP is being counted from the date of creation of security interest- this does not seem to be in sync with the intent of having a MHP.

Accounting of transfer of loans

If the transfer of loans result in loss or profit, which is realised, should be accounted for accordingly and reflected in the Profit & Loss account of the transferor for the accounting period during which the transfer is completed. However, unrealised profits, if any, arising out of such transfers, shall be deducted from CET 1 capital or net owned funds for meeting regulatory capital adequacy requirements till the maturity of such loans.

Borrower-wise accounts will have to be maintained for the loans transferred and retained by the transferee and the transferor, respectively.

The income recognition, asset classification, and provisioning norms will be followed by the transferor and the transferee with respect to their share of holding in the underlying account(s).

Transfer of Stressed Loans

The transfer of stressed loans can be done through assignment or novation only; loan participation is not permitted in the case of stressed loans. .In general, lenders shall transfer stressed loans, including through bilateral sales, only to permitted transferees and ARCs

Contents of the Board approved policies on Transfer and / or acquisition of Stressed Loans:

●      Norms and procedure for transfer or acquisition of such loans;

●      Manner of transfer- including e-auctions;

●      Valuation methodology to be followed to ensure that the realisable value of stressed loans, including the realisability of the underlying security interest, if available, is reasonably estimated;

●      Delegation of powers to various functionaries for taking decision on the transfer or acquisition of the loans;

●      Stated objectives for acquiring stressed assets;

●      Risk premium to be applied considering the asset classification, for discounting the cashflows to arrive at the difference between the NPV of the cashflows estimated while acquiring the loan and the consideration paid for acquiring the loan;

●      Process of identification of stressed loans beyond a specified value;

●      Price discovery and value maximization approach;

The Directions also restrict the transferor to not assume any operational, legal or any other type of risks relating to the transferred loans including additional funding or commitments to the borrower / transferee(s) with reference to the loan transferred. Any fresh exposure on the borrower can be taken only after a cooling period laid down in the respective Board approved policy, which in any case, shall not be less than 12 months from the date of such transfer.

Transfer of stressed loans undertaken by way of a resolution plan

In case of transfer of stressed loans undertaken as a resolution plan under the RBI (Prudential Framework for Resolution of Stressed Assets) Directions, 2019 resulting in an exit of all lenders from the stressed loan exposure, such transfer is permitted to the prescribed class of entities, including a corporate entity, that are permitted to take on loan exposures in terms of a statutory provision or under the regulations issued by a financial sector regulator, a

However, in case such transferee(s) are neither ARCs nor permitted transferees, the transfer shall be additionally subject to the following conditions:

  • The transferee entity should be incorporated in India or registered with a financial sector regulator in India (Securities and Exchange Board of India, Insurance Regulatory and Development Authority of India, Pension Fund Regulatory and Development Authority, and International Financial Services Centres Authority).
  • The transferee should not be classified as a non-performing account (NPA) by any lending institution at the time of such transfer;
  • The transferee(s) should not fund the loan acquisition through loans from Permitted Transferors.
  • Permitted transferors should not grant any credit facilities apart from working capital facilities (which are not in the nature of term loans) to the borrower whose loan account is transferred, for at least three years from the date of such transfer.
  • Further, for at least three years from the date of such transfer, the Permitted Transferors should not grant any credit facilities to the transferee(s) for deployment, either directly or indirectly, into the operations of the borrower.

Accounting treatment in the books of the transferee

Treatment of stressed loan in the books of the transferee for the purpose of prudential requirements such as asset classification, capital computation, income recognition shall be as follows-

Pool of stressed loans acquired on a portfolio basis shall be treated as a single asset provided that the pool consists of homogeneous personal loans.

 

Homogeneity should be assessed on the basis of common risk drivers, including similar risk factors and risk profiles.

In all other cases, the stressed loans acquired shall be treated as separate assets

Additional requirement for Transfer of NPAs

For Transferor For Transferee
Continue to pursue the staff accountability aspects as per the existing instructions in respect of the NPAs transferred Cash flows in excess of the acquisition cost, if any, can be recognised as profit only after amortising the funded outstanding in the books, in respect of the loans
If classified as standard upon acquisition, assign 100% risk weight to the NPA

 

If classified as NPA, risk weights as applicable to NPA shall be applicable

Additional requirement for Transfer to ARCs

The following stressed loans may be transferred to ARCs:

  • loans in default for more than 60 days
  • classified as NPA
  • Including loans classified as fraud as on the date of transfer- along with proceedings related to such complaints shall also be transferred to the ARC

The Directions provide for sharing of surplus between the ARC and the transferor, in case of specific stressed loans. The Directions, however, do not specify what kinds of stressed loans these will be.

Further, the Directions also allow repurchase of the accounts from ARCs where the resolution plan has been successfully implemented.

The Directions also allow ARCs to take over loans only for the purpose of recovery (as recovery agents), without the same being removed from the Originator’s books. In such cases, the loans shall be treated as existing in the books of the Originator only.

Swiss Challenge Method[1]

Swiss Challenge method would be mandatory in the following cases:

  1. In case of a bilateral transfer of stressed loans on a bilateral basis, if the aggregate exposure (including investment exposure) of lenders to the borrower/s whose loan is being transferred is Rs.100 crore or more
  2. In case of transfer of stressed loans undertaken as a resolution plan under the Reserve Bank of India (Prudential Framework for Resolution of Stressed Assets) Directions, 2019 with the approval of signatories to the intercreditor agreement (ICA) representing 75% by value of total outstanding credit facilities (fund based as well non-fund based) and 60% of signatories by number, for the exit of all signatories to the ICA from the stressed loan exposure, irrespective of any exposure threshold.

Disclosure and Reporting Requirement

Appropriate disclosures shall be made in the financial statements, under ‘Notes to Accounts’, relating to the following

  1. total amount of loans not in default / stressed loans transferred and acquired to / from other entities as prescribed under the Directions, on a quarterly basis starting from the quarter ending on December 31, 2021
  2. quantum of excess provisions reversed to the profit and loss account on account of sale of stressed loans
  3. distribution of the SRs held across the various categories of Recovery Ratings assigned to such SRs by the credit rating agencies

Additionally, transferors must maintain a database of loan transfer transactions with adequate MIS concerning each transaction till a trade reporting platform is notified by the RBI.

 

[1] Refer our write-up on Swiss Challenge Method- https://vinodkothari.com/wp-content/uploads/2017/03/sale_stressed_assets-1.pdf

 

Refer our write-up on revised securitisation guidelines here- https://vinodkothari.com/2021/09/rbi-master-directions-on-securitisation-of-standard-assets-and-transfer-of-loan-exposures/