The Reserve Bank of India (RBI) recently released the final guidelines for the Securitisation of Standard Assets[1]. We had earlier commented on the draft guidelines[2], released mid last year, and highlighted some issues[3] with the proposed regulatory framework in the draft guidelines. In this post, we analyse whether these issues have been addressed and also highlight few other potentially impactful changes that are contained in the new framework.
Maintaining Capital Neutrality
Securitisation is a tool for risk transfer and, as such, should not result in lenders having to keep more/less capital, for a given level of risk exposure, than what they would have kept if they had the same exposure in their books. Maintaining capital neutrality ensures that securitisation transactions do not happen to take advantage of any capital arbitrage.
In the draft regulations, while banks were given the option of choosing between SEC-ERBA (Securitisation: External Ratings Based Approach) and SEC-SA (Securitisation: Standardised Approach), NBFCs were restricted to using only SEC-ERBA approach[4]. This had implications, in terms of capital charge, for NBFCs wanting to invest in junior tranches. However, the final guidelines mandate all lenders to use only SEC-ERBA for calculation of risk weighted assets for credit risk of securitisation exposures[5]. For unrated securitisation exposures, lenders have to maintain capital charge equal to the actual exposure[6]. While this might seem restrictive, it ensures consistency of application across types of entities and thus does not lead to any opportunities for capital arbitrage.
Listing of Transactions
The development of a secondary market enables greater liquidity and allows for better price discovery. Listing of securities is a necessary, but not sufficient, first step to develop an effective secondary market. Currently, there are no secondary market transactions happening, and to develop this market, the draft guidelines mandated listing of transactions in Residential Mortgage Backed Securities (RMBS) of value Rs. 500 Cr and above[7]. Our commentary on the draft guidelines highlighted the insufficiency of mandated listing and the concomitant issues that need to be addressed to develop the secondary market on a sustainable basis. The issues highlighted include streamlining the listing and reporting processes, especially for ‘potential investors’ and underlying infrastructural issues in the RMBS market.
However, the final guidelines lightens the listing requirement by only recommending it and not mandating it[8]. Additionally, the guidelines highlight the requirement to list under SEBI’s Issue and Listing of Securitised Debt Instruments and Security Receipts Regulations, 2008 for securitisation transactions offered to 50 or more persons. The RBI should try to reconsider the recommendation on listing and coordinate with SEBI to address the other regulatory and infrastructural bottlenecks on listing and reporting for securitised debt instruments.
Clarifying the distinction between First Loss and MRR
The draft guidelines gave the option of maintaining MRR either on the entire structure, through first loss and/or pari passu retention of tranches, or retaining a first loss exposure equal to MRR on all the tranches[9]. The concern here was that it was unclear as to what proportion, if not the entirety, of the MRR would need to be on a first loss basis. The final guidelines make it clear that the MRR would include the first loss facility but need not necessarily be entirely comprised of it[10]. However, as pointed out in our earlier commentary, this is still ambiguous when it comes to calculation of capital charge as the originator can manipulate the composition of first loss, equity tranche and pari passu proportions to achieve a lower capital charge on the same level of risk exposure.
The final guidelines also substantially improve upon the previous securitisation framework[11] in the following areas –
Expanding the Scope of Assets that can be Securitised
The previous framework explicitly disallowed single asset securitisation and securitisation of assets purchased from other entities. The rules for the latter implied that assets which had been purchased through Direct Assignment (DA) or acquired through mergers cannot be securitised. The final guidelines allow securitisation of individual assets as well as assets purchased from other lenders[12]. This substantially widens the universe and quantum of assets that can be securitised while providing greater flexibility to lenders by allowing them to arrange securitisation transactions from purchased assets.
Application of the STC Framework for Capital Relief
The final guidelines introduces the Simple, Transparent and Comparable (STC) framework for securitisation[13]. The rationale here is to encourage the issuance of securitisation transactions that do not have complex structures and whose risks are sufficiently transparent. The new guidelines seek to nudge the market participants towards such securitisation structures by providing lighter capital treatment for such securitisation exposures. To ensure that lenders do not take advantage of the framework and exploit any capital arbitrage, the guidelines specify a set of criteria, across various dimensions, that need to be complied with on an ongoing basis.
To conclude, the final guidelines are a major improvement over the previous securitisation framework, especially in terms of redefining the elements involved to allow a greater variety of securitisation structures to evolve. However, to develop this market on a sustainable basis, RBI need to take a more holistic view and coordinate with other regulators to ease the regulatory and infrastructural constraints hindering market development.
[1] Master Direction – Reserve Bank of India (Securitisation of Standard Assets) Directions, Sep 2021 – https://www.rbi.org.in/Scripts/NotificationUser.aspx?Id=12165&Mode=0
[2] Draft Framework for Securitisation of Standard Assets, RBI, Jun 2020 – https://www.rbi.org.in/Scripts/PublicationReportDetails.aspx?UrlPage=&ID=958
[3] George and Srinivas, A Commentary on RBI’s Draft Framework for Securitisation of Standard Assets, Dvara Research, July 2020
[4] Point 82, Draft Framework for Securitisation of Standard Assets, RBI, Jun 2020 – https://www.rbi.org.in/Scripts/PublicationReportDetails.aspx?UrlPage=&ID=958
[5] Chapter VI, clause 83, Master Direction – Reserve Bank of India (Securitisation of Standard Assets) Directions, Sep 2021 – https://www.rbi.org.in/Scripts/NotificationUser.aspx?Id=12165&Mode=0
[6] Ibid
[7] Section G, Draft Framework for Securitisation of Standard Assets, RBI, Jun 2020 – https://www.rbi.org.in/Scripts/PublicationReportDetails.aspx?UrlPage=&ID=958
[8] Section F, Master Direction – Reserve Bank of India (Securitisation of Standard Assets) Directions, Sep 2021 – https://www.rbi.org.in/Scripts/NotificationUser.aspx?Id=12165&Mode=0
[9] Section C, Draft Framework for Securitisation of Standard Assets, RBI, Jun 2020 – https://www.rbi.org.in/Scripts/PublicationReportDetails.aspx?UrlPage=&ID=958
[10] Section B, Master Direction – Reserve Bank of India (Securitisation of Standard Assets) Directions, Sep 2021 – https://www.rbi.org.in/Scripts/NotificationUser.aspx?Id=12165&Mode=0
[11] Revisions to the Guidelines on Securitisation Transactions, RBI, May 2012 – https://rbi.org.in/scripts/NotificationUser.aspx?Mode=0&Id=7184
[12] Chapter I and Chapter II A, Master Direction – Reserve Bank of India (Securitisation of Standard Assets) Directions, Sep 2021 – https://www.rbi.org.in/Scripts/NotificationUser.aspx?Id=12165&Mode=0
[13] Chapter III, Master Direction – Reserve Bank of India (Securitisation of Standard Assets) Directions, Sep 2021 – https://www.rbi.org.in/Scripts/NotificationUser.aspx?Id=12165&Mode=0
Cite this item:
APA
Srinivas, Madhu. 2021. “Brief Commentary on RBI’s Final Guidelines on Securitisation of Standard Assets.” Dvara Research.
MLA
Srinivas, Madhu. “Brief Commentary on RBI’s Final Guidelines on Securitisation of Standard Assets.” 2021. Dvara Research.
Chicago
Srinivas, Madhu. 2021. “Brief Commentary on RBI’s Final Guidelines on Securitisation of Standard Assets.” Dvara Research.
