RBI’s move to revamp loan transfers in India

On June 08, 2020, the Reserve Bank of India (RBI) released two draft frameworks — one for the securitization of standard assets (Draft Securitisation Framework) and the other on sale of loan exposures (Draft Sale Framework). In our previous article (available here), we had dealt with key revisions introduced by the RBI under the Draft Securitisation Framework. This article contains a brief summary of the Draft Sale Framework.

The Draft Sale Framework is addressed to the same constituents as the Draft Securitisation Framework and is expected to operate as an umbrella framework, which will govern all loan transfers (standard and stressed assets).

The Draft Sale Framework is broadly divided into three parts viz., (i) general conditions applicable to all loan transfers; (ii) provisions dealing with sale and purchase of standard assets; and (iii) provisions dealing with sale and transfer of stressed assets (including the purchase by ARCs).

Transfer

The core principles of transfer appear like the previous guidelines on direct assignment. However, the scope of transfer has now been expanded to include various kinds of economic transfers of loan assets, including participation arrangements and transactions in which the loan exposure remains on the books of the transferor even after the said transactions.

Three types of transfers that have been recognized under the Draft Sale Framework viz., (i) assignment; (ii) novation; and (iii) loan participation (which includes both risk participation and funded participation). Whilst loans can be transferred via any of the aforesaid transfer methods, (a) revolver loans and loans with bullet payments of principal and interest can only be transferred through novation and loan participation; and (b) stressed assets can only be transferred through assignment and novation. Transfer by way of novation is exempt from the applicability of the guidelines, except for a diktat that approval of all parties, including the borrower, is required for novation.

RBI has indicated that all these transfers are required to result in immediate legal separation of the transferor from the assets, which are transferred and put beyond the reach of the transferor as well as the creditors of the transferor. RBI has also suggested that these should be bankruptcy remote and a legal opinion should be obtained in this regard.

In line with the position in the 2012 guidelines, transferors are not permitted to offer any credit enhancement or liquidity facility for loan transfers. Diligence requirements continue to be strict and the purchasing lender is required to apply the same standard of care while assessing the asset, as if it were originating the asset directly and cannot outsource its due diligence.

The RBI has also permitted the transfer of a single loan asset or part of a single asset to a financial entity through novation or loan participation. Only financial entities carrying on business in India will be eligible to participate. Loans acquired from other entities can also be assigned.

Participation Agreements

The Draft Sale Framework also seeks to permit and regulate participation arrangements. Participation arrangements though popular in certain other jurisdictions were not common here, except inter alia, in accordance with the guidelines issued by the RBI on December 31, 1998. The1998 guidelines permitted two types of participations, inter-bank participation with risk sharing and inter-bank participation without risk-sharing. While the assignment agreements that were entered into earlier were akin to participation agreements in spirit, the permissibility of participation is an interesting development and a regulatory headway made in the growth of the loan market. The Draft Sale Framework seeks to allow both risk participation and funded participation in loans. Participation agreements in respect of stressed assets have not been specifically permitted.

ECB

The Draft Sale Framework specifically recognizes the transfer of external commercial borrowings by ‘eligible lenders’ (as defined under the Master Direction on External Commercial Borrowings, Trade Credits, and Structured Obligations), subject to any loss or hair cut being to the account of the transferor.

It is expected that the RBI will provide further clarity on whether all lenders (i.e. overseas branches, onshore branches, etc.) can purchase such assets and whether the exposure must continue to remain in foreign currency, both for standard and stressed assets

MRR/ MHP

The RBI has not stipulated the requirement for a transferor to maintain minimum risk retention for loan transfers. This will enable the transferee to deal with the loan independently. However, transferors will have to comply with the ‘minimum holding period’ requirement.

Exemptions

Transfer of loan accounts at the instance of the borrower, inter-bank participation, trading in bonds, sale of an entire portfolio of assets consequent upon a decision to exit the line of business completely, sale of stressed assets and consortium and syndication arrangements continue to remain exempt from the applicability of Chapter III of the Draft Sale Framework (which only applies to transfer of standard assets).

Stressed Assets

Stressed assets have been defined as: ‘assets that are classified as NPA or as special mention accounts, and generally includes accounts, which are in default, as well as where lenders have given concessions for economic or legal reasons relating to the borrower’s financial difficulty’.

Currently, the Master Circular on Prudential Norms on Income Recognition, Asset Classification and Provisioning (pertaining to advances), 2015, detail the criteria for standard assets, special mention accounts, and non-performing assets. The classification has also been replicated in the Reserve Bank of India (Prudential Framework for Resolution of Stressed Assets) Directions 2019 (Prudential Stressed Asset Directions).

The Draft Sale Framework does not replace or limit the application of existing RBI directions (especially the Prudential Stressed Asset Directions). Any regulated entity (that is permitted to take on loan exposures by its statutory or regulatory framework), can purchase stressed assets directly.

Promoters and Similar Persons Not Eligible to Buy Stressed Assets

The transferor is required to ensure that the transferee is not disqualified in terms of Section 29A of the Insolvency and Bankruptcy Code, 2016, and is not otherwise a promoter, associate, subsidiary or related person of the underlying obligor. Therefore, if there is an existing option to put loans on a promoter / similar entity, then the same may not be possible if the loan is a stressed asset.

In the case of standard assets, the Draft Sale Framework has stipulated a table for MHP based on the tenure of the loan. However, stressed assets are required to be held in the books of the lender for a period of 12 months.

Asset Classification and Provisioning

A purchased stressed asset can be classified as a ‘standard asset’ by the purchasing entity, in cases where the purchasing entity has no existing exposure to the borrower. However, in case, the purchasing entity has an existing exposure to the borrower whose stressed loan account is acquired, the asset classification of the purchased exposure shall be the same as the existing asset classification of the borrower with the transferee.

Transfer of Stressed Assets to ARCs

The Draft Sale Framework also deals with the sale of stressed assets to asset reconstruction companies (ARC).

While Section 7 of the Securitisation and Reconstruction of Financial Assets and Enforcement of Security Interest Act, 2002 (SARFAESI) always provided that ARCs could issue debt instruments in lieu of the consideration payable for the acquisition of assets, RBI has now specifically provided for the same in the Draft Sale Framework. If such deals are done, it must clearly be established that the sale is effective. However, the Draft Sale Framework also provides that these instruments will have to be considered as debt on the books of the ARC, therefore implying that the ARC has an obligation to repay the debt and such obligation cannot be linked to the realization of the underlying asset. While this enabling provision is useful, ARCs are unlikely to opt for this route given that there is an obligation to repay the debt, the present structure of PTC may be the preferred option.

It is relevant to note that FPI entities continue to have the right to invest in security receipts and will also have the right to invest in the bonds issued by the ARC.

It is specifically clarified that the transfer of stressed assets to non-ARCs can only be on a cash-consideration basis.

Swiss Challenge Method

In an attempt to de-regulate price discovery, the mandatory Swiss Challenge Method has been done away with. Lenders are now expected to put in place board-approved policies on the adoption of an auction-based method for price discovery.

Right of First Refusal

Under the current Guidelines on Sale of Stressed Assets by Banks, issued by the RBI on September 1, 2016, a bank selling a stressed asset is required to offer the right of first refusal to an ARC, which has already acquired the highest and significant share (~25-30%) in the asset. Such ARC is required to be provided the right to match the highest bid. In line with these guidelines, the Draft Sale Framework also provides the right of first refusal to ARCs, which hold a significant stake in the asset. Additionally, the Draft Sale Framework also provides that in the event such ARC does not want to purchase the asset or if no ARC holds a significant portion, then such right of refusal will have to be extended to a ‘financial institution’ if such institution holds a significant stake in the asset.

Conclusion

The Draft Sale Framework is a significant move by the RBI and is expected to streamline loan transfers in the country. This framework reinforces the RBI’s focus on addressing the health of banks and bad debt in the country, whilst remaining committed to a balanced approach to the sale of assets. If passed in its current form, it will be a positive move by the regulator in developing a robust market for secondary transfers.

*Authors would like to thank Vidhi Sarin, Associate for her inputs.

Leena Chacko: Partner at the Mumbai Office of Cyril Amarchand Mangaldas. Leena has extensive experience in general corporate and financing transactions, including acquisitions, structured finance, and securitization transactions.

Meeta Kurpad: Principal Associate in the Mumbai office of Cyril Amarchand Mangaldas. Meeta has extensive experience in financing transactions, including structured debt, stressed asset transactions, securitization, and project finance.