Introduction
Securitization of stressed assets is a process where a lender sells its non-performing loans (NPAs) to a dedicated entity (SPE). This SPE finances the purchase by issuing investment notes to the market. The SPE then hires a servicing company, often paid based on performance, to manage the loans and maximize debt recovery. Investors in the notes get paid back from the recovered funds, with payments prioritized based on the risk level (tranche seniority) of their investment, following a ‘waterfall’ system. A strong securitization market helps banks manage credit risk and can lead to a secondary market for loans. Recognizing these advantages – providing banks with cash flow (liquidity) and a way to handle bad loans – the RBI recently issued the draft Master Directions on Reserve Bank of India (Securitisation of Stressed Assets) Directions, 2025 (“Draft SSA Framework”) to provide for securitization of stressed assets in the Indian banking economy.
Background
While the RBI introduced comprehensive rules in 2021 for Securitizing Standard Assets, aligning India with Basel norms and aiming for a robust market, these rules omitted a similar SPE-based mechanism for non-performing assets (NPAs). The existing SARFAESI Act (2002) permits NPA securitization, but restricts it to transactions conducted by licensed Asset Reconstruction Companies (ARCs) under its specific guidelines. To provide financial institutions with more flexibility, akin to the standard asset framework, the RBI released a discussion paper in early 2023. Consequently, a new stressed asset securitization framework is now proposed. Its purpose is to offer a wider pathway for regulated entities to securitize troubled loans, thereby supplementing the areas already covered by the SARFAESI Act.
Highlights of the Draft SSA Framework
The following are the key highlights of the Draft SSA Framework:
1. Definition of Securitisation under the Draft SSA Framework
- The framework defines “Securitisation” specifically for stressed assets. It refers to deals where the pool of underlying assets predominantly consists of non-performing assets (NPA).
- Specifically, the total outstanding amount of NPAs in the pool must be 90% or more of the total outstanding amount of all assets in the pool.
- This 90% threshold must be met at the origination cut-off date and also any time assets are later added or removed (due to replenishment, restructuring, etc.).
2. Conditions for Undertaking Securitisation
- Homogeneity: Lenders can securitize stressed assets, but the pool must be homogenous. This means loan exposures from the following two categories cannot be mixed in the same pool:
- a) “Specific loans”: This includes personal loans to individuals, business loans to individuals, and loans to Micro Enterprises, where the loan amount does not exceed ₹50 Crore.
- b) All Other Loans.
- Concentration Limit (“Pool of stressed assets” definition): The pool must meet the definition of a “Pool of stressed assets”, which refers to a portfolio where the sum of squares of the relative shares (each loan’s outstanding balance divided by the total pool balance) of the underlying stressed loans is 0.30 or less.
- Prohibited Assets: Lenders cannot undertake securitisation involving:
- a) Re-securitisation exposures.
- b) Deals where the underlying assets include:
- i. Exposures to other lending institutions.
- ii. Refinance exposures of All India Financial Institutions (AIFIs).
- iii. Farm Credit.
- iv. Education Loans.
- v. Accounts identified as Fraud or Red Flagged Accounts.
- vi. Accounts identified as or being examined for ‘Wilful Default’.
3. Originator’s Exposure Limits
- The originator’s total exposure to the notes issued in a single securitisation deal is capped at 20% of the total value of those notes.
- If an originator’s exposure is above 10% and up to the 20% limit, this portion (above 10%) is treated as first loss for regulatory purposes, regardless of the actual tranche it represents.
4. Asset Sale and Valuation Requirements
- Sale Basis: The originator must sell the stressed assets to the Special Purpose Entity (SPE) only on a cash basis.
- Price & Payment: The sale price is mutually determined. The originator must receive the full cash payment no later than the time the assets are transferred to the SPE. Loans can only be removed from the originator’s books after the entire sale consideration is received.
- Price Discovery Policy: Originators must have an internal policy detailing their price discovery methodology to ensure the value of the stressed loans is estimated fairly, transparently, and reasonably.
- External Valuation: Before securitizing pools containing “All Other Loans”, the originator must obtain two external valuation reports. These reports must be shared with the SPE and investors.
5. Facility Providers (General Conditions)
- The framework allows for Facility providers to offer support services like credit enhancement, liquidity facilities, underwriting, and servicing for stressed asset securitisations.
- However, if lenders provide credit enhancement (beyond specific forms like contractual risk retention or permitted first loss default guarantees), this enhancement must be restricted to covering losses only for the senior tranche investors.
6. Resolution Managers (ReM) – Distinct Role
- Unlike standard asset securitisation, this framework introduces a specific role: the Resolution Manager (ReM).
- The ReM is responsible for administering the resolution and recovery process for the underlying stressed loans, aiming to maximise the value realised.
- ReMs need relevant experience in areas like NPA workout, business planning, recovery strategies, loan management, legal networks, reporting, and IT systems.
7. Eligibility to Act as a Resolution Manager (ReM)
- For Pools of “Specified Loans”: The SPE must appoint an RBI regulated entity as the ReM. This includes Scheduled Commercial Banks (excluding RRBs), Non-Banking Financial Companies (including HFCs), and Asset Reconstruction Companies. The originator itself can act as ReM only if it retains at least 5% of the total securitisation notes.
- For Pools of “Other Loans”: Besides the RBI-regulated entities mentioned above, the SPE can also appoint:
- a) Any entity registered with another Indian financial sector regulator.
- b) Insolvency professionals (IPs) registered with the IBBI.
- c) An insolvency professional entity (IPE).
8. Additional Conditions for Resolution Managers (ReM)
- Disqualification: An ReM cannot be disqualified under Section 29A of the Insolvency and Bankruptcy Code, 2016.
- Independence: An ReM cannot be a ‘related party’ (as defined by the Companies Act, 2013) of the originator, except when the originator acts as ReM under the specific condition mentioned above. All dealings between the ReM and originator must be on an arm’s-length basis.
- Loss Support: ReMs are generally not obligated to cover losses incurred by the SPE. Exceptions include contractual indemnities (for ReM’s default, negligence, fraud) or credit enhancement provided by an originator acting as ReM.
- Cash Handling: If acting as a servicer, the ReM must remit all cash collected from the underlying loans to the SPE as agreed. During the collection period, these funds must be held in an escrow account on behalf of investors and must not be co-mingled with the ReM’s own funds.
- Resolution Funding: ReMs can borrow additional funds (up to 75% of the total requirement, and not from the originator) specifically for resolution activities related to the pool (e.g., administrative costs).
- Borrower Support: Lenders are permitted to provide additional finance (like working capital) directly to the underlying borrowers to support the resolution process, following existing regulations.
9. Reporting and Disclosure Norms
- Originator/SPE Reporting to RBI: The originator must report details of securitisation deals quarterly to the RBI. After the asset transfer, this responsibility falls to the SPE (as per the transfer agreement).
- Investor Data Access: The originator must ensure investors have ready access to all materially relevant data concerning the underlying loans, cash flows, and collateral, sufficient for comprehensive analysis and stress testing.
- Servicer/ReM Reporting to Investors: The servicer or ReM must provide investors with reports detailing the performance of the underlying loan pool at least quarterly.
Way Forward
The central bank’s recent decision during its April 7-9 MPC meeting to permit market-based securitization for stressed assets is a positive step. This initiative is intended to enhance the market for resolving troubled assets and is expected to bring in more participants beyond the existing Asset Reconstruction Companies (ARCs), offering greater flexibility.
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(This Banking & Finance update has been prepared by Shubham Sharma, student at Chanakya National Law University. He can be reached out at 2636@cnlu.ac.in)
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