R Gandhi: Securitisation in India - ambling down or revving up?
Inaugural speech by Mr R Gandhi, Deputy Governor of the Reserve Bank of India, at the
"India Securitisation Summit 2015", organized by the National Institute of Securities Markets
(NISM), Mumbai, 14 July 2015.
* * *
Assistance provided by Ms. Anupam Sonal is gratefully acknowledged.
1. Financial sector's primary role is intermediation between ultimate savers and ultimate
investors. Initially, it was banks which were the intermediaries. As the financial sector
evolved, other types of financial institutions came on the scene to undertake such
intermediation directly, or between and among other intermediaries. A parallel development
is the emergence of varieties of financial products, far removed from simple deposits and
advances, delivering such intermediation. Securitisation, as we all know, is among the latest
of such intermediating product.
Securitisation - definition
2. Securitisation is the financial practice of pooling various types of contractual debt such as
residential mortgages, commercial mortgages, auto loans or credit card debt obligations (or
other non-debt assets which generate receivables) and selling their related cash flows to
third party investors as securities, which may be described as bonds, pass-through
securities, or collateralized debt obligations (CDOs). Securitisation diversifies credit markets
as it breaks the process of lending and funding into several discrete steps, leading to
specialisation and economies of scale.
3. Securitisation actually has two major stages. In the first stage there is sale of single asset
or pooling and sale of pool of assets by the owner of the assets ("Originator") to a
"bankruptcy remote" special purpose vehicle ("SPV") in return for an immediate cash
payment, and in the second stage repackaging and/or selling of the security interests
representing claims on incoming cash flows from the asset or pool of assets to third party
investors by issuance of tradable debt securities.
4. Thus in a nutshell, Securitisation is the process of taking an illiquid asset, or group of
assets, and through financial engineering, transforming them into a security.
Advantages of Securitisation
5. Securitisation can offer a number of advantages for the stakeholders. Some of the benefits
of the traditional vanilla securitisation products are as under:
For originators
i. Securitisation frees up an originator's capital by removing the assets from the
balance sheet. This way, capital is now available for origination of fresh assets with
profitability potential.
ii. Through Securitisation, an originator with a relatively lower credit rating but with
better rated cash flow would be able to borrow/raise funds against such higher rated
cash flows at cheaper cost.
iii. It improves the liquidity position of the originator as the future receivables are
replaced by cash.
iv. Securitisation can be used as a potent tool for re-balancing and re-distributing risks
such as credit, market or liquidity risk or risk concentrations on the balance sheet of
the originator.
For investors
For the investing parties, Securitisation offers different set of benefits.
i. It provides another option for diversifying their debt portfolio.
ii. It facilitates participation in relatively lower or higher risk portion of the cash flows, as
per their own risk appetite.
iii. High rated and credit enhanced securities add to the safety of investments as well
as capital savings for the investors.
iv. The presence of the "Pool Servicer" provides certain additional assurance and
safety.
v. Securitisation allows flexibility in structuring the timing of cash flows to one's needs.
For servicers, trustees, credit rating agencies and brokers
Securitisation offers added business opportunities and increased fee income.
For financial markets
Securitisation provides alternate debt instruments in the financial markets and improves
market liquidity. It widens the markets and allow entry to new players. It enhances return on
capital, diversifies financial markets, and serves as an alternate route of funding.
Securitisation diversifies credit markets as it breaks the process of lending and funding into
several discrete steps, leading to specialisation and economies of scale. Securitisation
improves efficiencies in financial markets through risk diversification as the risks can be
bundled and hived off and distributed among counterparties better equipped to manage
these risks.
Regulation of Securitisation - global initiatives
6. Securitisation emerged in the developed nations in 1970s as a financial innovation. The
regulatory ethos of those days let the innovation thrive with least regulations. However, the
lessons from the great financial crisis of 2008 activated a number of initiatives by the
international standard setting bodies, regulators and governments for re-building investor
confidence in the securitisation market. These initiatives were mainly aimed at addressing
the concerns on conflicts of interest created by misaligned incentives and compensation
systems for securitisers or originators within the securitisation chain, address information
asymmetry within the securitisation process by increasing transparency of the securitisation
structure, introduce risk retention or "skin in game" requirements and more stringent
disclosure requirements, enhance oversight of credit rating agencies governance and reduce
regulator reliance on ratings, better align the incentives of mortgage originators with those of
investors in mortgage loans, standardization of disclosure documentation, etc. The foremost
among these are the Basel III Standards and enhancements to the Basel II Norms by BCBS,
The Dodd Frank Wall Street Reforms and Consumer Protection Act in USA, Capital
Requirements Directive (CRD II) and a proposal for a Directive on Alternative Investment
Fund Managers Directive (AIFMD) in the European Union, issue of Disclosure Principles for
Public Offerings and Listings by IOSCO, and other such directives/ guidelines by G20, FSB,
etc.
7. As part of the Enhancement to the Basel II Norms in July 2009, the BCBS strengthened
the treatment for certain Securitisation exposures under Pillar 1 (minimum capital
requirements) and introduced higher risk weights for re-Securitisation exposures to better
reflect the risk inherent in these products. It also required the banks to conduct more rigorous
credit analyses of externally rated Securitisation exposures. The supplemental Pillar 2
(supervisory review process) guidance addressed several notable weaknesses that were
revealed in banks' risk management processes during the GFC. The areas addressed
include:
i. firm-wide governance and risk management;
ii. capturing the risk of off-balance sheet exposures and Securitisation activities;
iii. managing risk concentrations;
iv. providing incentives for banks to better manage risk and returns over the long term;
and
v. sound compensation practices.
8. The Pillar 3 (market discipline) requirements have been strengthened in several key areas,
including Securitisation exposures in the trading book; sponsorship of off-balance sheet
vehicles; re-Securitisation exposures; and pipeline and warehousing risks with regard to
Securitisation exposures.
9. Carrying forward, the BCBS has in December 2014, published revisions to address the
shortcomings in the Basel II Securitisation framework and to strengthen the capital standards
for Securitisation exposures held in the banking book. This framework, which will come into
effect in January 2018, forms part of the Committee's broader Basel III agenda to reform
regulatory standards for banks in response to the global financial crisis and thus contributes
to a more resilient banking sector. The most significant revisions relate to changes in:
i. the hierarchy of approaches;
ii. the risk drivers used in each approach; and
iii. the amount of regulatory capital banks must hold for Securitisation exposures (i.e.
the framework's calibration).
10. The revised hierarchy of approaches reduces reliance on external ratings. It also
simplifies and limits the number of approaches. At the top of this hierarchy is the Internal
Ratings-Based Approach, which banks may use if their supervisors have approved their use
of internal models. This is followed by the External Ratings-Based Approach - where credit
ratings are permitted to be used in the jurisdiction - and the Standardized Approach.
Additional risk drivers, notably an explicit adjustment to take account of the maturity of a
Securitisation's tranche, have been introduced.
11. Recently, a joint BCBS-IOSCO Task Force on Securitisation Markets (TFSM) undertook
a review of securitisation markets in order to identify the factors that may be hindering the
development of sustainable securitisation markets. TFSM has identified 14 criteria for
introduction of Simple, Transparent and Consistent (STC) Securitisation structures which, if
satisfied, could indicate that a securitisation transaction possesses minimal level of simplicity,
transparency and consistency. The consultative document on criteria to identify STC
securitisations was published for comments in December 2014 along with revised capital
framework for securitisations.
Early regulation of Securitisation in India
12. There is no comprehensive single regulatory framework for the securitisation market per
se. In effect, only the financial sector has a clear framework for participating in securitisation.
13. The recommendations of the High Level Committee on Corporate Debt and
Securitisation (Chairman: Dr.R.H.Patil) in 2005 proved to be the turning point towards the
development of the corporate debt and securitisation market.
14. The Reserve Bank accepted several of its recommendations and in February 2006,
issued guidelines for securitisation of standard assets by Banks, FIs and NBFCs. These
guidelines provided the regulatory framework for several critical aspects of securitisation.
15. In 2007, the Securities Contracts (Regulation) Act 1956 was amended in 2007 to include
"securitised instruments" in the definition of "securities". The amendment has paved the way
for listing and trading of securitised debt on stock exchanges.
16. Consequently, the Securities and Exchange Board of India (SEBI) released draft
regulations for "Public Offer and Listing of Securitised Debt Instruments" in June 2007 which
is yet to be formalised. However, these guidelines envisage a very different transaction
structure compared to current market practices.
17. Earlier, the enactment of the Securitisation and Reconstruction of Financial Assets and
Enforcement of Security Interests Act, 2002 (SARFAESI Act 2002) enabled securitisation of
the non-performing assets of Banks, which could sell off their NPAs to asset reconstruction
companies registered with RBI. The SARFAESI Act also laid the framework to the
constitution of asset reconstruction companies (ARCs) specialising in securitising distressed
assets purchased from banks.
Role of the Reserve Bank of India in regulation of Securitisation
18. The Reserve Bank of India (RBI) is the regulator of the major players in the Indian
financial system (banks, financial institutions and NBFCs) and has to ensure that financial
intermediaries engage in Securitisation prudently.
19. The Reserve Bank issued the first set of comprehensive guidelines applicable to banks,
financial institutions and non-banking financial companies (NBFCs) on Securitisation in India
way back in February 2006. The guidelines covered following aspects relating to
Securitisation transactions:
• Broad definitions on important securitisation related concepts such as securitisation,
SPV, bankruptcy remote, credit enhancement, first loss facility, liquidity facilities,
service provider and underwriting facilities.
• Prescribed detailed "true sale" criteria and criteria to be met by originators and
SPVs. Some important criteria included that originators should not indulge in market
making on securities issued by SPV, originators shall not invest in more than 10% of
securities issued by SPV, securities cannot have any put option, etc.
• Detailed policy for originators and third parties on provision of credit enhancements,
liquidity support/ facilities, underwriting facilities, servicing arrangements, etc.
• Capital adequacy norms for Credit Enhancement - First loss credit enhancement is
deducted from capital and second loss facility is risk weighted according to the
rating. Credit enhancement cannot be withdrawn/ reduced by the provider
throughout the life of the transaction except to cover the losses suffered by SPV.
• Prudential Norms for investment in the securities issued by SPVs.
• Accounting treatment for securitisation transactions - An important feature was that
profit / premium arising on account of sale should be amortised over the life of the
securities issued or to be issued by the SPV.
• Due diligence framework for securitisation transactions and disclosures to be made
by the SPVs/ Trustee and originators.
20. Based on the lessons learnt from the global financial crisis on Securitisation and with a
view to develop an orderly and healthy securitisation market, the RBI guidelines of February
2006 were reviewed and enhancements to the guidelines issued in May 2012. While the
securitisation framework in India had been reasonably prudent, certain imprudent practices
had reportedly developed like origination of loans with the sole intention of immediate
securitisation and securitisation of tranches of project loans even before the total
disbursement was complete, thereby passing on the project implementation risk to investors.
In view of the same and in accordance with the on-going international work on Securitisation,
another important objective of the enhancements was to ensure greater alignment of the
interests of the originators and investors and retention of "skin in the game" by the
originators. These guidelines also covered prudential treatment for transfer of assets through
direct assignment of cash flows and underlying securities, if any. The important features of
the May 2012 guidelines are as follows:
• Prescription of the Minimum Holding Period (MHP): Minimum Holding Period varies
from 3 months to 12 months depending upon the tenor of the loan and repayment
frequency and is defined in terms of number of installments paid. The criteria
governing determination of MHP reflect the need to ensure that i) the project
implementation risk is not passed on to the investors and ii) a minimum recovery
performance is demonstrated prior to securitisation to ensure better underwriting
standards.
• Prescription of Minimum Retention Requirement (MRR) - 5 % for loans up to
24 months and 10% for loans of tenor beyond 24 months. The MRR is primarily
designed to ensure that the originating banks have a continuing stake in the
performance of securitised assets so as to ensure that they carry out proper due
diligence of loans to be securitised.
• "True sale criteria" made applicable to assignment transactions also.
• Liberalised recognition of cash profit received allowed in view of the mitigation of
concerns on "Originate to Distribute" models.
• Disclosures requirements were strengthened and due diligence expectations were
elaborated.
• Stress testing requirements were laid for banks/FIs/ NBFCs in respect of their
Securitisation positions. The factors for stress tests could include rise in default
rates in the underlying portfolios in a situation of economic downturn, rise in
prepayment rates due to fall in rate of interest or rise in income levels of the borrowers
leading to early redemption of exposures, fall in rating of the credit enhancers
resulting in fall in market value of securities (Asset Backed Securities/ Mortgage
Backed Securities) and drying of liquidity of the securities resulting in higher prudent
valuation adjustments, etc.
• Outsourcing of credit decision is not allowed.
• In case of non-compliance with the guidelines, as applicable to originators, no
capital relief will be available for originators. For investors, in case of
noncompliance with guidelines as applicable to investors, the asset will be risk weighted
at 1111% (revised to 1250% in March 2015).
• Certain forms of Securitisation transactions / structures are not allowed - Complex
structures such as Re-Securitisation and Synthetic Securitisation is not allowed.
Revolving credit facilities cannot be securitized / assigned. Single asset
Securitisation are not allowed - as they do not fit into the definition of Securitisation.
Securitisation / assignment of loans where both interest and principal are due only at
maturity are not allowed - as it is not possible to assess the repayment track record.
• Credit enhancement is not allowed in case of assignment transactions - as the
assignment deals are generally carried out among two financial institutions. It is
expected that the purchasing institution will do its own due diligence while acquiring
assets rather than relying on credit enhancement.
Indian Securitisation market and transaction volumes
21. The Indian market is still at a nascent stage driven as it is by the needs for meeting
priority sector lending targets by banks. The band of originators and investors is narrow with
NBFCs as the main originators and banks as investors. Public Sector Banks are mostly
absent. Asset backed securitisation (ABS) is the largest securitisation class in India, driven
by retail loan portfolio of banks. NBFCs like the Asset Finance Companies (AFC) operating in
the SME and Transport financing segments and Micro Finance Institutions (MFI) are very
active as originators. Though the market had begun since the year 2000, the GFC obviously
has its repercussions in Indian market as well. It is reported that the Indian Securitisation
market which reached a high of ₹ 63,730 crore by March 2008 dwindled down to ₹ 28,800
crore in by March 2014.
22. The micro finance companies play a larger role mainly due to their PSL underlying pools.
Another positive development witnessed in recent years is the preference for multiple
tranche products as against single tranche structures. Another encouraging factor is the
preference for the lower rated senior tranches by the investors. It is reported that during the
financial year 2014, the number of AAA ratings at initiation dropped from 45% in 2012 to
26%.
23. Insurance, Pension and Mutual Funds can play an important role in the Indian
securitisation market as they can invest long term and at the same time have the risk
appetite, capacity and expertise for taking exposures to the lower tranches. However, the
Pension Funds are not allowed to invest in securitisation PTCs and Insurance companies are
allowed to invest in high investment grade AAA securities only. MFs are still hesitant to invest
in the securitised papers due to past pending court cases as well as lack of clarity on the tax
implications for their investments. In the Finance Bill 2013, Mutual Funds were exempted
from application of the Distribution Tax imposed on securitisation SPV's.
Low appetite for Securitisation in Indian financial market
24. The appetite for Securitisation in India has been on the lower side; it is used largely to
meet priority sector lending targets by banks as investors, NBFCs being the originators. This
low appetite can be ascribed to several factors, including legal, taxation and stamp duty
issues.
25. Recently, we undertook an informal and quick survey of the securitisation market in India.
The primary objective was to assess the issues facing the market along with the reasons for
poor take off in securitisation as a risk transfer and liquidity enhancing product. The sample
survey included originators, investors, third party liquidity and credit enhancement providers,
servicers and arrangers, SPVs / trustees, credit rating agencies, etc. The major issues
highlighted by the participants related to disclosures, low demand for Long Tenor
Receivables, lack of Investor base, absence of Secondary market besides the Taxation,
Stamp Duty and Legal aspects including Foreclosure Laws.
The way forward - ambling down or revving up
26. Though significant progress has been made in reconfiguring Securitisation markets in the
aftermath of the global financial crisis, the task of ensuring that these markets contribute to
economic growth and financial stability is unfinished.
27. In this context, we must note that fingers are pointed at the regulatory framework itself. It
is alleged that the regulations are conservative, and inhibit the growth of the segment. The
restrictions on assignments, the prohibition of re-securitisation, the restrictions on the
insurance and pension funds, the restrictive first-loss provisions, the restrictive credit
enhancement provisions etc. are mentioned as impediments. With tax related disincentives
driving away investors like Mutual funds, and even banks, the critics say the Indian
Securitisation market can only be ambling forward.
28. I beg to differ. In my opinion, the Indian Securitisation Market is raring to go. Let me
explain.
29. Firstly, the priority sector obligations will continue to be a good reason for securitisation.
While the upcoming Priority Sector Lending Certificates (PSLC) can kind of dent the market,
there will still be need for diversification of portfolios and hence the Securitisation will still
have its place.
30. Secondly, the NBFCs, be they Asset Finance Companies specialising in SME financing
or transport financing, or be they MFIs or Housing Finance Companies (HFC), their USP is
their capacity to originate loans and advances in sectors where the main stream banks have
least penetration. They have comparative advantage and to leverage that they will have good
opportunities in resorting to Securitisation.
31. Thirdly, the new set of differentiated banks, the Small Finance Banks, whose major
portfolio will be small loans, will resort to securitisation for diversifying their balance sheet. In
all likelihood, they are unlikely to build capacity in large sized lending and will resort to build
diversified portfolio of large credit through Securitisation.
32. Fourthly, given recent experience relating to the stress and non-performance of
infrastructure finance and project finance, questions have been raised about the capacity of
other than large banks in the credit appraisal of such large credits. This can compel these
banks to participate in large infrastructure and project credits through Securitisation after the
project has taken off, rather than participating through consortium or multiple banking
arrangement before the cash flows have emanated.
33. For these to happen, there is a need for a change in the mind set and attitude of banks
and financial institutions, including the NBFCs.
34. These institutions should reflect on the following questions:
• Are we good in originating or holding?
• Do we have deep pockets?
• Do we find value in continuous turning over, or in holding on without growth?
• For diversification, do we build our entire portfolio or acquire a part?
• Should we build capacity in all segments of credit or focus on the best suited?
35. They also need to be ready to let go. Primarily, they should be prepared to parcel out
high quality cash flows and share the spoils of good cash flows.
36. We as regulators are ever ready to assist financial market development. As I understand,
initiatives are underway by SEBI to formulate a detailed template mandating disclosure
requirements covering granular details of all aspects of securitisation transactions / products.
Similarly, SEBI is further examining the prospects of setting up a trading and reporting
platform where all securitisation transactions will be reported and a central data repository
will be available to the securitisation market participants. IRDA and PFRDA have been
requested to look into their rules and regulations to facilitate long term investments by
Insurance and Pension funds in securitised products. Reserve Bank will also review the
guidelines on an ongoing basis.
37. Thank you all for your patient attention.