Mumbai: The practice common among finance companies and microlenders to originate loans and then quickly sell them off to commercial banks through securitization deals could take a hit, with the Reserve Bank of India (RBI) tightening the screws on such transactions.
In its second draft guidelines announced on Tuesday, RBI said banks extending loans to clients should mandatorily keep them on their books for a minimum period and keep a portion of such loans, depending on their maturity. The public can submit comments for this draft till 14 October.
Securitization was one of the villains of the global financial crisis, with lenders selling housing loans to subprime borrowers and then packaging these loans into marketable securities that were sold to investors around the world.
“The recent crisis in the credit markets has called into question the desirability of certain aspects of securitization activity as well as of many elements of the ‘originate to distribute’ business model, because of their possible influence on originators’ incentives and the potential misalignment of interests of the originators and investors,” RBI said, announcing the guidelines.
The central bank’s concern stems from the fact that some of the companies, especially non-banking financial companies (NBFCs), originate such loans and sell them off immediately to other institutions to make profits within a short period. This increases the risk of such transactions as many times the buyers are unable to ascertain the risk of the original investor.
“While the securitization framework in India has been reasonably prudent, certain imprudent practices have reportedly developed, like origination of loans with the sole intention of immediate securitization and securitization of tranches of project loans even before the total disbursement is complete, thereby passing on the project implementation risk to investors,” RBI said.
As per the new norms, for loans with a maturity of two years, the originator should hold the loans for a minimum period of one year.
Also, the originating institution has to retain at least 10% of the loan portfolio in its books, which, according to the central bank, will ensure that the project implementation risk is not passed on to investors and a minimum recovery performance is demonstrated prior to securitization to ensure better underwriting standards.
Banks are also required to carry out regular stress tests and monitor the portfolio on an ongoing basis, the central bank said.
Experts say the new rules are intended to control securitization transactions primarily done by NBFCs, which have increased risk.
“The entire guidelines have been framed to strengthen the securitization market from any kind of unhealthy practices, which had led to the 2008 global financial crisis,” said Vaibhav Agarwal, vice-president, research, at Angel Broking Ltd.
According to the guidelines, originating firms need to hold loans below two years of maturity for a minimum period of nine months and need to retain 5% of the portfolio in its books. This could impact loan flow to microfinance institutions (MFIs), which are reeling under a crisis due to a state law enacted by Andhra Pradesh government, last year.
“This would virtually mean that the securitization loan deals in the microlending space will take an immediate hit, as most of the MFI loans are for one-year maturity and holding it for a long period will be difficult,” an executive with an Andhra Pradesh-based MFI said, requesting anonymity.
According to the apex bank, the total exposure of banks to the loans securitized in certain categories, such as in the form of investments in equities, should not exceed 20% of the total securitized instruments issued. If a bank exceeds this limit, the excess amount would be risk-weighted at 1,111%, RBI said.