JAIIB RBWM Paper-4 Module-B Unit 12: Securitisation

15/02/2023

Table of Contents

JAIIB Paper 4 (RBWM) Module B Unit 12: Securitisation (New Syllabus)

IIBF has released the New Syllabus Exam Pattern for JAIIB Exam 2023. Following the format of the current exam, JAIIB 2023 will have now four papers. The JAIIB Paper 4 (Retail Banking and Wealth Management) includes an important topic called “ Securitisation”. Every candidate who are appearing for the JAIIB Certification Examination 2023 must understand each unit included in the syllabus. In this article, we are going to cover all the necessary details of JAIIB Paper 4 (RBWM) Module B Retail Products and Recovery Unit 12: Securitisation Aspirants must go through this article to better understand the topic, Important Retail Asset products and practice using our Online Mock Test Series to strengthen their knowledge of Banker Customer Relationship. Unit 12: Securitisation

Securitisation

Securitisation is the financial practice of pooling various types of contractual debt such as residential mortgage, commercial mortgages, auto loans or credit card debt obligation (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 Certificates, or Collateralized Debt Obligations (CDOs).

Securitisation of Assets

Definition of some of the terminologies used in securitisation

Obligor: means a person who is liable, whether under a contract or otherwise, to pay a debt or receivables in discharge any obligation in respect of a debt or receivables.
Originator: refers to a bank that transfers from its balance sheet a single asset or a pool of assets to an SPV as a part of a securitisation transaction and would include other entities of the consolidated group to which the bank belongs.
Securitisation: means a process by which a single performing asset or a pool of performing assets are sold to a bankruptcy remote SPV and transferred from the balance sheet of the originator to the SPV in return for an immediate payment.
Special Purpose Vehicle (SPV): means any company, trust, or other entity constituted or established for a specific purpose – (a) activities of which are limited to those for accomplishing the purpose of the company, trust or other entity as the case may be; and (b) which is structured in a manner intended to isolate the corporation, trust or entity as the case may be, from the credit risk of an originator to make it bankruptcy remote.
Sponsor: means any person who establishes or promotes a special purpose distinct entity.

Securitization Process

The process of securitization begins when the lender (or originator) segregates loans/lease/ receivablesinto pools which are relatively homogenousin regard to types of credit, maturity and interest rate risk. The pools of assets are then transferred to a Special Purpose Vehicle (SPV).

Securitization thus follows a two stage process:

In the first stage, there is sale of single asset or pooling and sale of pool of assets to a Special Purpose Vehicle (SPV)in return for an immediate cash payment.
In the second stage repackaging and selling 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. The securitization can be diagrammatically represented as follows:

Advantages of Securitization

Securitization is designed to offer a number of advantages to the seller, investor and debt markets. Advantages of securitization can be summarised as follows:

With its support, banks can keep loans off their balance sheet, thus reducing need for additional capital
It is an alternative form to banks and financial institutions of funding risk transfer and capital market development
It helps reduce lending concentration and improve liquidity
Supports attainment of funds at lower costs since these are isolated from potential bankruptcy risk of originator
Provides better matching of assets and liabilities and development of long-term debt market
Provides diversified pool of uniform assets to banks and financial institutions
Supports converting non-liquid loans or assets into liquid assets or marketable securities.
Facilitates transfer of funds from less efficient debt market to more efficient capital market through securitization.

RBI new directives for securitization of standard assets, Loan transfer

Reserve Bank of India (RBI) has issued separate master directions on transfer of loan exposures and securitization of standard assets. These master directions came after considering public comments on draft rules issued on June 8, 2020.
These master directions will apply to all scheduled commercial banks, excluding Regional rural banks, All-India Term financial institutions, Small Finance Banks, NBFCs on securitization of standard assets, RBI has directed that while complicated and opaque securitization structures could be undesirable with the perspective of financial stability, prudentially structured securitization transactions can be an important facilitator in a well-functioning financial market as it improves risk distribution and liquidity of lenders in originating fresh loan exposures.
In the Master Direction Reserve Bank of India (Securitization of Standard Assets) Directions, 2021, RBI specified the Minimum Retention Requirement (MRR) for different asset classes.
For underlying loans with original maturity of 24 months or less, the MRR will be 5 per cent of the book value of the loans being securitised. For those with original maturity of more than 24 months as well as loans with bullet repayments, the MRR shall be 10 per cent of the book value of the loans being securitised.
In the case of residential mortgage-backed securities, the MRR for the originator shall be 5 per cent of the book value of the loans being securitised, irrespective of the original maturity. The minimum ticket size for issuance of securitization notes shall be ₹1 crore, the direction added.

Securitisation by transfer of assets through securitisation

Assets Eligible for Securitisation

In a single securitisation transaction, the underlying assets should represent the debt obligations of a homogeneous pool of obligors. Subject to this condition, all on-balance sheet standard assets, except the following, will be eligible for securitisation by the originators:

Revolving credit facilities (e.g., Cash Credit accounts, Credit Card receivables, etc.)
Assets purchased from other entities
Securitisation exposures (e.g., Mortgage-backed/asset-backed securities)
Loans with bullet repayment of both principal and interest*

Minimum Holding Period (MHP)

Originating banks can securitise loans only after these have been held by them for a minimum period in their books. The criteria governing the determination of MHP for assets listed below reflect the need to ensure that:

The project implementation risk is not passed on to the investors, and
A minimum recovery performance is demonstrated prior to securitisation to ensure better underwriting standards.

Minimum Retention Requirement (MRR)

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 securitized. The guidelines stipulate MRR of 5% of the book value of the loans being securitized for Loans with an original maturity of 24 months or less and 10% of the book value of the loans being securitized for Loans with an original maturity of more than 24 months. For Bullet repayment loans! receivables, 10% of the book value of the loans being securitized.

Minimum Retention Requirement (MRR)

Type of asset	MRR
Assets with original maturity of 24 months or less	Retention of right to receive 5% of the cash flows from the assets transferred on pari-passu basis.
Assets with original maturity of above 24 months	Retention of right to receive 10% of the cash flows from the assets transferred on pari-passu basis.
Assets with bullet repayment of both principal and interest

Accounting and Asset Classification of MRR

The asset classification and provisioning rules in respect of the exposure representing the MRR would be as under:

The originating bank may maintain a consolidated account of the amount representing MRR if the loans transferred are retail loans. In such a case, the consolidated amount receivable in amortisation of the MRR and its periodicity should be clearly established and the overdue status of the MRR should be determined with reference to repayment of such amount. Alternatively, the originating bank may continue to maintain borrower-wise accounts for the proportionate amounts retained in respect of those accounts. In such a case, the overdue status of the individual loan accounts should be determined with reference to repayment received in each account.
In the case of transfer of a pool of loans other than retail loans, the originator should maintain borrower-wise accounts for the proportionate amounts retained in respect of each loan. In such a case, the overdue status of the individual loan accounts should be determined with reference to repayment received in each account.
If the originating bank acts as a servicing agent of the assignee bank for the loans transferred, it would know the overdue status of loans transferred which should form the basis of classification of the entire MRR/individual loans representing MRR as NPA in the books of the originating bank, depending upon the method of accounting followed.