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Regulatory Alert - Overview of the RBI Master Directions (Transfer of Loan Exposures) 2021

14 October 2021

1. Preface

The Reserve Bank of India (RBI) released the draft Comprehensive Framework for sale of loan exposures on 8 June 2020, for comments of the stakeholders. Basis the comments from stakeholders and keeping financial stability as the end-state vision, the RBI issued master directions on transfer of loan exposures vide its circular RBI (Transfer of Loan Exposures) Directions, 2021 which were issued with immediate effect from 24 September 2021 (Directions). The Directions are a unified and singular framework for the sale of loan exposures by banks and other financial institutions

By effective implementation of the framework prescribed under the said Directions, it is targeted to effectuate an efficient financial market by way of enhancement in risk distribution alongside a parallel betterment in liquidity of lenders for procurance of fresh loan exposures. To sum up, the Directions are likely to create additional avenues for raising liquidity, management of the credit exposure provided by lending institutions are creating a robust & efficient loan transfer mechanism. It is crucial to note that these Directions supersede all the existing instructions on the matter of sale/transfer of loan. This article covers the guidelines issued in relation to transfer of stressed loans provided under Chapter IV of the guidelines.

2. Applicability

The applicability of the directions is for the following entities (i.e., the below mentioned entities are permitted as Transferor1/Transferee2 to Transfer3 loans)

  • Scheduled Commercial Banks
  • Regional Rural Banks
  • Primary (Urban) Co-operative Banks/State Co-operative Banks/District Central Co-operative Banks
  • All India Financial Institutions (NABARD, NHB, EXIM Bank & SIDBI)
  • Small Finance Bank
  • All Non-Banking Finance Companies (NBFCs) including Housing Finance Companies

Provided that:

  • Lenders specified at sub-clauses (b) and (c) above are permitted only as transferor(s) of Stressed Loans4 and are not permitted to be transferors(s) or transferee(s) in any other type of loan transfers.
  • All lenders, who are permitted to acquire loans, shall only do so, from transferor mentioned in sub- clause (a) to (f) unless specifically permitted.

The Directions are applicable to all loan transfers undertaken by the lenders (including loan transferred through novation or assignment, and loan participation, provided that in cases of loan transfers other than Loan Participation5, legal ownership of the loan shall be mandatorily transferred to the transferee(s) to the extent of economic interest transferred.

 

3. Key Terms Pertaining to Transfer of Stressed Asset Loans 

PARTICULARS

KEY HIGHLIGHTS

Applicability of Transfer of stressed loans

The transfer of stressed loans must be done through assignment or novation only. Loan participation is not permitted in the case of stressed loans.

Non-Compliant Transfers

The transferee is under an obligation to maintain capital charge equal to the actual exposure & failure to do the same shall have to be recognized as if it was not transferred at all in the first place by the transferor.

Applicability of Section 29A of the Insolvency and Bankruptcy code, 2016 (IBC)

A transferee shall not be a person disqualified in terms of Section 29A of the IBC.

The board approved policies transfer and / or acquisition of stressed loans

The board approved policies of every lender on transfer and / or acquisition of stressed loans shall, inter alia, cover the following key aspects:

  • Norms and procedure for transfer or acquisition of such loans
  • Valuation methodology to be followed to ensure that the realizable value of stressed loans, including the realizability of the underlying security interest, if available, is reasonably estimated.
  • Delegation of powers to various functionaries for taking decision on the transfer or acquisition of the loans
  • Purpose for acquiring stressed assets.
  • Risk premium associated with the stressed assets
  • manner of transfer

Minimum Holding PeriodRequirement before transfer of loan exposure

For domestic transactions, the onus is on the transferee(s) to ensure that the transferor has strictly adhered to the MHP criteria in respect of loans acquired by them under the Directions.

Valuation Requirement

Transferor shall lay down clear policies with regard to valuation of loan exposures proposed to be transferred including the grounds which will determine the type of the valuation.

However, in case credit exposure of the transferor being transferred (without netting for provisions) is INR 100 crore or more, the transferor shall obtain two external valuation reports.

Adoption of Swiss Challenge Method

In cases where the transfer is negotiated on a bilateral basis and the aggregate exposure (including investment exposure) of lenders to the borrower/s whose loan is being transferred is INR100 crore or more, the negotiations must necessarily follow by Auction through Swiss Challenge.

In other cases, the method adopted by the transferor shall be as per the board approved policy which may inter-alia include the Swiss Challenge Method. 

Transfer of ownership/rights

The transferor shall ensure that after transfer of the stressed loans, they do not take up any operational, legal or any other type of risks relating to the transferred loans including additional funding or commitments to the borrower / transferee(s) with reference to the loan transferred. Fresh exposure may be taken on the borrower after a cooling period laid down in the respective Board approved policy of the transferor, which in any case, shall not be less than 12 months from the date of such transfer.

Exception to the Circular for transfer of stressed assets loan

Notwithstanding the stipulations provided in clause 54-57 of the Directions, if the transfer of stressed loans are undertaken as a resolution plan under the Reserve Bank of India (Prudential Framework for Resolution of Stressed Assets) Directions, 2019 (Prudential Norms) resulting in an exit of all lenders (to whom the Directions apply) from the stressed loan exposure, such transfer is permitted to any class of entities, including a corporate entity, that are permitted to take on loan exposures in terms of a statutory provision or under the regulations issued by a financial sector regulator and regulators which are listed at “Annex” of the Directions. 

Further, the Directions carve out special conditions to transfer of loans in cases where the transferee(s) are neither ARCs nor permitted transfers. 

Execution of Inter Creditor Agreement (ICA)

 

The loan transfer agreement shall clearly specify that in the event an ICA is required to be signed in terms of the Prudential Norms, the transferee, regardless of the nature of the entity, shall sign the ICA as and when required.

 

 Deal transfer of stressed loans to transferees other than ARC s

The transferor shall transfer the stressed loans to transferee(s) other than ARCs, only on cash basis

Classification of the borrower accounts after transfer

If the transferee(s), except ARCs,

  • have no existing exposure to the borrower whose stressed loan account is acquired the acquired stressed loan shall be classified as “Standard” by the transferee(s).
  • Have existing exposure to the borrower whose stressed loan account is acquired, the asset classification of the acquired exposure shall be the same as the existing asset classification of the borrower with the transferee.

Restriction on outsourcing of due diligence by the transferee

The due diligence in respect of the loans cannot be outsourced by the transferee and should be carried out by its own staff with the same rigor and as per the same policies as would have been done for originating any loan.

Minimum holding period requirement for transfer of stressed assets loans after its acquisition

The lenders shall hold the acquired stressed loans in their books for a period of at least six months before transferring to other lenders.

Transfer of loans to ARCs

Stressed loans which are in default for more than 60 days or classified as NPA are permitted to be transferred to ARCs.

This shall include loan exposures classified as fraud as on the date of transfer provided that the responsibilities of the transferor with respect to continuous reporting, monitoring, filing of complaints with law enforcement agencies and proceedings related to such complaints shall also be transferred to the ARC.

Accounting requirement on transfer of stressed loan to ARCs

When the stressed loan is transferred to ARC:

  • At a price below the NBV7 (at the time of transfer) - lenders shall debit the shortfall to the profit and loss account for the year in which the transfer has taken place.
  • For a value higher than the NBV (at the time of transfer) - lenders shall reverse the excess provision on transfer to the profit and loss account in the year the amounts are received and only when the sum of cash received by way of initial consideration.

Umbrella shelter available to the lenders on re-acquisition of standard accounts from ARCs

There is no prohibition on lenders from taking over standard accounts from ARCs.

In cases where ARCs have successfully implemented a resolution plan for the stressed loans acquired by them, lenders may, at their discretion and with appropriate due diligence, take over such loans after the period equivalent to the ‘monitoring period’ as defined in the Prudential Norms, provided that the account performed satisfactorily as defined in the said circular.

Reporting requirement in case of stressed loans transferred

The lenders should make appropriate disclosures in their financial statements, under ‘Notes to Accounts’, relating to the total amount of stressed loans transferred and acquired to / from other entities as prescribed under the said circular, on a quarterly basis starting from the quarter ending on December 31, 2021.

 

BDO Comments

To conclude, the Directions endeavor to make the banking systems and the regulations stringent, and efficient, by establishing a mechanism for better liquidity management and a way forward towards the improved procedures for transfer of loan exposures. The direction shall also enable a pro-active mechanism with respect to identification & resolution of stressed loans. The transferor has been made the torchbearer & is entrusted to guide the way under the light of these directions.

The direction broadens the participation by way of inclusion of other corporate entities for takeover of stressed loans through Resolution Plan under the Prudential Norms. The Directions also allow loan exposures classified as fraud to be transferred to the ARCs which is a major carveout to the traditional regime.

The Directions also provide stringent disclosure and reporting frameworks for stressed loans. Introduction of such disclosures opens many doors towards restoring and reforming the banking system & financial markets.

The Master Directions – Reserve Bank of India (Transfer of Loan Exposures) Directions, 2021 can be accessed from here.

Master Direction – Reserve Bank of India (Securitization of Standard Assets) Directions, 2021 can be accessed from here.

Disclaimer

The contents of this article are for internal circulation and discussions only. This article should not be relied upon as a legal advice or opinion. BDO makes no representations or warranties of any kind as to the content of this article, including, but not limited to, implied warranties. Information contained in this article (including any analysis), should not be considered as advice or a recommendation to the readers of this article for any purpose whatsoever.


1 Transferor means the entity which transfers economic interest in a loan exposure.

2 Transferee means the entity to which the economic interest in a loan exposure is transferred provided the transferee cannot be a person disqualified in terms of Section 29A of the Insolvency and Bankruptcy Code, 2016 and the transferee shouldn’t be a part of the promoter group or be a subsidiary/associate/related party of any borrower in whose accounts instances of fraud have been detected.

3 Transfer of economic interest in loan exposures by the transferor to the transferees(s) with or without the transfer of the underlying loan contract.

4 Loan exposures that are classified as Non-Performing Assets (NPA) or as a Special Mention Accounts (SMA).

5 A Transaction through which the transferor transfers all or part of its economic interest in a loan exposure to Transferee(s) without the actual transfer if the loan contract, and the transferee(s) fund the transferor to the extent of the economic interest transferred which may be equal to the principal, interest, fees, and other payments, if any, under the transfer agreement. Provided that the transfer of economic interest under a loan participation shall only be through a contractual transfer agreement between the transferor and transferee(s) with the transferor remaining as the lender on record. Provided further that in case of loan participation, the exposure of the transferee(s) shall be to the underlying borrower and not to the transferor.

6 The Minimum period for which a transferor must hold the loan exposures before the same is transferred to the transferee(s).

7 The funded outstanding in a loan exposure reduced by the specific provisions made against such exposure.