The Reserve Bank of India vide its communication dated June 8, 2020 has placed on its web site a draft document titled “Comprehensive framework for sale of loan exposures” for public comments to be received not later than 30th June 2020 which will be applicable to Scheduled Commercial Banks, All India Financial Institutions like NABARD, SIDBI, NHB, EXIM BANK and other non-Financial companies including Housing Finance Companies.

Website address is as under:

https://www.rbi.org.in/Scripts/PublicationReportDetails.aspx?UrlPage=&ID=957

Elaborated over 5 chapters and interspersed over 83 paras, it clearly explains the salient features of the new frame work an out come to merge with Basel guidelines 3 on securitization which came into effect from Jan 1, 2018 in India. It simply means whether commercial institutions can sell its loans and if so, under what terms and conditions. In India today, if any commercial or other financial company finances a car for any customer, it is forced to hold on to it till it is fully paid, becomes a NPA and meets its fate if paid earlier by the borrower. Internationally, among the banks it has been discussed that why should one lender hold on to any borrower till end? Basel guidelines, applicable among most of the nations who are signatories to it provides for transfer of borrowed accounts among financial institutions.

Yes, we are moving away from narrowed outlook as a nation tied to 1947 to the current scenario as a leading emerging nation ready to offer its expertise to the world. Just like foreign institutions crown India with vast resources as investments, bonds or other types of investments the same may happen under the revised guidelines when made applicable by RBI.

Let us learn what RBI wants to say.

Let us go by the chapter wise information coined by RBI for easy understanding.

Chapter 3: Sale of standard assets

Transfer of following assets have no application in following categories which are prohibited for transfer:

a. transfer of loan accounts of borrowers by a lender to other lenders and vice versa, at the request/instance of borrower; (My views: This indicates transactions not at arm’s length ones, as we call in financial terms)

b. inter-bank participation s covered by the circular DBOD.No.BP.BC.57/62-88 dated December 31, 1988 as amended from time to time; (Not possible to explain since one can refer to the said instruction)

c. trading in bonds; (bonds carry their own instructions for transfer which is obviously a separate subject. Even a simple bond holder can sell, buy or pledge for loans etc.)

d. sale of entire portfolio of assets consequent upon a decision to exit the line of business completely; (Obviously, this is a different cup of tea and involves different set of scenarios)

e. sale of stressed assets;(RBI instructions have been separately in our article)

f. consortium and syndication arrangements; and

g. any other arrangement/transactions, specifically exempted by the Reserve Bank of India.

Let us understand the details of actual transfers:

  • Transferors can transfer a single standard asset or a part of such asset or a portfolio of such assets to financial entities through novation without any exceptions. (Yes, even your car loan can be transferred by your lender to another subject to holding period. We shall discuss terms of restrictions during the course of the article)
  • A single standard asset or a part of such asset or a portfolio of such assets can also be transferred to financial entities through a loan participation contract without any exceptions.
  • What is the holding period necessitated before venturing to transfer? Let us narrate them. Loans with original maturity up to 24 months – 2 quarters: In case maturity up to 5 years but from 2 years – 3 quarters and the same above 5 years is 4 quarters. This clearly indicates that the borrowing was not a book entry but with seriousness to repay.
  • Transferors’ retention of interest, if any, in the loans transferred should be supported by a legally valid documentation. At a minimum, a legal opinion on matters pertaining to legal validity of the interest transferred to transferee, his/her not becoming an agent or a trustee of the transferee or not eligible to involve with the risk/rewards related to transfer of loans. Not as a formality but as a legal shield to fight in future legal battles if any complications do arise.
  • An interesting question arises. Do the documentations of the original borrower enable transfer of title and if so, was his/her acceptance taken. In the West where transfer of tranche of loans is order of the day for big banks/other financial institutions, an acceptable documentation mutually agreeable to all institutions has been prescribed. Unlike in India, lot of emotions entail any loans, in reality, any loaning is just a commercial transfer between two parties. So, all the legal formalities are a must.
  • Loans with bullet payments of capital/interest alone are eligible for transfer under this discussion.

Let us transit to Chapter 1 which contains the legal conditions applicable to all cases of loan transfers.

I need to quote some from original material provided by RBI for reference and later discussion.

“A loan sale should result in immediate legal separation of the transfer-or from the assets which are sold to the extent that the interest has been transferred. The transferred interest should stand completely isolated from the transfer-or, after its transfer to the buyer, i.e., put beyond the transferor’s as well as its creditors’ reach, even in the event of bankruptcy of the transfer-or.

In case of any retained interest in the exposure by the transfer-or, the loan sale contract should clearly specify the distribution of the interest income from the transferred asset among the transfer-or and the transferee.”

Let me conclude the above information as a total transfer of all legal titles along with all benefits to transferee without any recourse. In large transactions of thousands of individual loans of particular categories, like car loans, consumer loans, salary loans etc. it is hardly a situation where transfer-or would ever bother to look back. Let us go ahead with our discussion with more matters.

Chapter 4

Sale of Distressed Assets (SDA)

“The instructions contained in this Chapter do cover sale of stressed assets undertaken as a resolution plan under the Reserve Bank of India (Prudential Framework for Resolution of Stressed Assets) Directions, 2019 issued vide circular DBR.No.BP.BC.45/21.04.048/2018-19 dated June 7, 2019 as well as standalone sale of stressed assets between transferors and eligible transferees”

Let us keep the above statement as a forward for our discussion. SDA invited untold miseries to financial institutions and detailed guidelines, complete supervision by RBI and periodical reporting to Board of Directors have become the necessary monitoring tools.

The policy decisions to identify the stressed assets beyond a specified value by formulation of strong board policies, reviewing of doubtful debts by board/committee at periodical intervals by persons involved who did not result in such accounts, fixing up of accountability at various levels so that non business considerations in collusion with borrowers not resulting in bulging of NPAs, ensuring the transferee is not ineligible under Section 29A of IBC 2016 etc. need careful consideration at the highest levels.

Normally calls for sale of distressed assets require legal tenders called public ally though the transferee need not be a financial entity. The transferee for obvious reasons be eligible to get distressed assets in terms of statutory or regulatory frame work.

Unfortunately, recent events have reinforced the notion that transferors at all cost do not pass on the liability of stressed assets again to companies in associate/subsidiary or any one related to promoter group of companies. Recent CMDs of both private/public sector banks have brought disrepute to their organizations by avoiding laid down RBI or statutory guidelines.

The following statement of RBI enlists added attention.

“Excess provisions arising on sale of NPAs shall be eligible for Tier II status in terms of paragraph 4.2.5 of Master Circular DBR.No.BP.BC.1/21.06.201/2015-16 dated July 01, 2015 on Basel III Capital Regulations.”

Disclosures and Reporting

I am forced to reproduce the following related to disclosures which assume the highest importance related to distressed assets which have virtually wrecked the financial institutions due to active collusion among the stake holders who should have kept arm’s length transactions.

Highly technical in nature, please bear with me for non-simplifying of RBI language.

“The lenders should make appropriate disclosures in their financial statements, under ‘Notes on Accounts’, relating to the total amount of standard assets / stressed assets sold and purchased to / from other entities with breakups as to the category of the purchaser in case of sale of loans.

The disclosures should cover aspects of aggregates such as weighted average maturity, weighted average holding period, asset classification break-up (including SMA classification), beneficial interest retained, tangible security coverage available, rating-wise distribution of rated loans, frequency distribution of LTV ratios (in case of housing loans and commercial real estate loans), industry and geographical distribution of assets etc. of the loans sold / purchased in a particular quarter / financial year, as the case may be.

Specifically, a transferor should disclose all instances where it has agreed to replace assets sold to a transferee or pay damages arising out of any representation or warranty.”

I have not intentionally discussed transfer of distressed assets to ARCs since these institutions are struggling to serve the Indian society. Let the concerned officials do read the instructions and send their suggestions directly to RBI.

Conclusion

RBI wants you, me or any one who would bother to read these instructions to specifically send their observations to following questions: (popularly known as discussion paper)

“Discussion Question: Do you see any types of assignment transactions permitted under the current guidelines, which may not be possible under the revised guidelines?

Do you see any concerns with regard to the legal modes of loan transfer that have been enabled for transfer of loan exposures from the lending institutions?

Do you see any concerns with regard to the legal modes of loan transfer that have been enabled for transfer of stressed loan exposures from the lending institutions?

Do you agree with the proposal to deregulate the price discovery process in the case of sale of stressed assets, or should the process be still prescribed by RBI as was the case with the Swiss Challenge method prescribed in the extant regulations?”

 I do expect emergence of any reader of this serious note from RBI for sale of loans by financial institutions, marking an era of mental stability by holding on to original securities which was a feature of 1970s as the ultimate business model, as a welcome move. Yes, you must express your views on discussion paper questions actually reproduced by me for direct knowledge and reaction.

By active participation of stake holders only Indian economic situation will blossom into a developed economy to serve the common man better. Please do read and send your views to ice@rbi.org.in.

(Full definition of the words like original lender, transfer, transfer-or, stressed assets, transferee or others having legal meaning have been clearly covered by RBI notifications whose web site details given in this article. While discussing serious matter like transfer of loans by financial institutions, an epoch-making event in the annals of banking history, I did not give any place for definitions. +

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