Treatment Of Credit Risk Finance Essay

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Date added: 17-06-26


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Receivables are to be treated as NPAs if the same remain overdue for a period of 180 days or more. While this is in accordance with existing RBI norms for classification of debts as NPAs, section 3(vi) of the Guidelines also states that the board of directors of a Securitization (or Reconstruction) Company may, on default by the borrower, classify an asset as a non-performing asset even earlier that the said 180 days for the purposes of facilitating enforcement as provided for in section 13 of the Act. As per section 13, where any borrower makes a default in repayment of a secured debt and his account is classified as an NPA, the secured creditor (or as the case may be the Securitization Company) becomes entitled to exercise the recovery rights under the Act, after providing for a 60 day notice to the borrower. The Guidelines therefore permit a Securitization (or Reconstruction) Company to classify a debt as an NPA and proceed to give the aforesaid 60 day notice under the Act immediately upon default by the borrower, without having to wait for the aforesaid 180 day period.

Registration under the Act

The Guidelines clarify that a Securitization (or Reconstruction) Company that has obtained a certificate of registration issued by the RBI under the Act can undertake both Securitization and Reconstruction activities. The Guidelines also clarify that an entity that is not registered with the RBI may conduct the business of Securitization or Asset Reconstruction outside the purview of the Act. This is a significant clarification as the Act is silent in this regard. In view of this clarification, banks and financial institutions that were engaged in securitization activities prior to the Act can continue the same without having to obtain a certificate of registration under the Act. The benefits of the enhanced enforcement rights under the Act however, will not be available to them.

Restrictions on raising monies from the public

The guidelines prohibit a Securitization (or Reconstruction) Company from raising monies by way of deposit. A Securitization Company is permitted to raise funds from qualified institutional buyers (as defined in the Act) by issuing security receipts to them. It has been clarified that the security receipts would be transferable/assignable only in favour of other qualified institutional buyers.

Issue of security receipts

The Guidelines state that security receipts are to be issued thorough one or more trusts set up exclusively for the purpose. The trusteeship of such trusts is required to vest with the Securitization (or Reconstruction) Company. The Securitization (or Reconstruction) Company is required to transfer the financial assets to the said trust at the price at which those were acquired. It is important to note that this transfer of assets will double the incidence of stamp duty, as stamp duty will have to be paid in respect of the transfer of the financial asset from the originator to the Securitization (or Reconstruction) Company, and also for the transfer of the financial asset from the Securitization (or Reconstruction) Company to the trust.

Policies and plans required to be framed

The Guidelines require that a Securitization (or Reconstruction) Company shall formulate policies for asset acquisition, including valuation procedure, rescheduling of debts of borrowers (to be supported by an acceptable business plans, projected earnings and cash flows of the borrower), settlement of debts due from borrower, and plans for realization of assets.

Change or take over of management/sale or lease of the business of the borrower

The Act allows lenders and securitization companies to change or take over the management of the borrower and sell or lease the business of the borrower for the purpose of recovery of loans. However, the Guidelines state that no Securitization (or Reconstruction) Company shall take any measures for change or take over of management/sale or lease of the business of the borrower until the RBI issues necessary guidelines in this behalf.

Enforcement of Security Interest

While taking recourse to the sale of secured assets, it has been clarified that a Securitization (or Reconstruction) Company may itself acquire the secured assets only if the sale is concluded through a public auction.

Deployment of funds

The Guidelines impose restrictions upon the permissible modes of deployment of funds by Securitization (or Reconstruction) Companies. A Securitization (or Reconstruction) Company is permitted to invest in the equity share capital of another Securitization (or Reconstruction) Company, as a sponsor and for the purpose of establishing a joint venture. A Securitization (or Reconstruction) Company is allowed to deploy any available surplus in government securities and deposits with scheduled commercial banks in accordance with a policy framed in this regard by its board of directors. No Securitization (or Reconstruction) Company is allowed to invest its owned funds in land and building. However, this restriction would not apply to funds borrowed as also to owned funds in excess of the minimum prescribed.

Other requirements

The Guidelines also provide for provisioning requirements, income recognition norms, disclosures required to be made in balance sheets, etc. Guidelines to banks/FIs on sale of Financial Assets to Securitization Company (SC)/ Reconstruction Company (RC) (created under the Securitization and Reconstruction of Financial Assets and Enforcement of Security Interest Act, 2002) and related issues ("Sale Guidelines") These guidelines are applicable to the sale of financial assets by banks and Financial Institutions ("FIs") for asset reconstruction and securitization under the Act.

Financial assets which can be sold

As per the Sale Guidelines, the following classes of assets can be sold by banks/FIs to Securitization (or Reconstruction) Companies : An NPA; A standard asset (i.e., an asset that is not an NPA) where : the asset is under consortium /multiple banking arrangements, at least 75% by value of the asset is classified as NPA in the books of other bank/FIs, and at lease 75% by value of the banks/FIs who are under the consortium/multiple banking arrangement agree to the sale of the asset to the Securitization (or Reconstruction) Company.

Procedure for sale

The sale of financial assets from a bank/FI may be on a "without recourse" basis, i.e., with the entire credit risk associated with the financial asset being transferred to the Securitization (or Reconstruction) Company, as well as on a "with recourse" basis, i.e., subject to the unrealized part of the asset reverting to the seller bank/FI. Banks/FIs are however, required to ensure that the effect of the sale of the financial assets should be such that the asset is taken off the books of the bank/FI and after the sale there should not be any known liability devolving on the bank/FI. It has also been clarified that under no circumstances can a transfer to the Securitization (or Reconstruction) Company be made at a contingent price whereby in the event of shortfall in the realization by the Securitization (or Reconstruction) Company, the banks/FIs would have to bear a part of the shortfall. Further, in the case of specific financial assets, where it is considered necessary, banks/FIs may enter into agreements with the Securitization (or Reconstruction) Company to share, in agreed proportion, any surplus realized by the Securitization (or Reconstruction) Company on the eventual realization of the concerned asset. In the case of financial assets that cannot be revived, the Sale Guidelines recognize that a Securitization (or Reconstruction) Company may not take over these assets but act as an agent for recovery for which it will charge a fee. In such a case, the assets will not be removed from the books of the bank/FI but realizations as and when received will be credited to the asset account. Securities offered by the Securitization (or Reconstruction) Company to the banks/FIs The securities offered by the Securitization (or Reconstruction) Company to the banks/FIs are required to satisfy the following conditions: The securities must not have a term in excess of six years. The securities must carry a rate of interest which is not lower than 1.5% above the Bank Rate in force at the time of issue. The securities must be secured by an appropriate charge on the assets transferred. The securities must provide for part or full prepayment in the event that the Securitization (or Reconstruction) Company sells the asset securing the security before the maturity date of the security. The commitment of the Securitization (or Reconstruction) Company to redeem the securities must be unconditional and not linked to the realisation of the assets. Wherever the security is transferred to any other party, notice of transfer should be issued to the Securitization (or Reconstruction) Company.

Other provisions

The Sale Guidelines also provide various prudential norms for the sale transaction, including provisioning/valuation norms, capital adequacy and exposure norms and disclosure requirements. The Sale Guidelines also provide that in the event of consortium/multiple banking arrangements, if 75% (by value) of the banks/FIs accept the offer for purchase of financial assets from a Securitization (or Reconstruction) Company, than the remaining banks/FIs will be obligated to accept the offer.


The new RBI guidelines seek to provide healthy and uniform directions for regulating securitization activities. While these guidelines and the enhanced enforcement rights provided to Securitization Companies under the Act will provide an impetus to securitization in India, many legal impediments remain. Prominent among these legal impediments are the excessive stamp duty rates applicable to securitization transactions in several states. Also, a number of cases including the Mardia Chemicals case, are currently pending at the Supreme Court, where the constitutionality of the Act has been challenged. These cases remain pending till date with no indications as to the possible outcome of the challenge.


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