Lenders to be allowed to bundle and sell bad loans to investors

Mumbai: RBI has proposed a new route for banks and NBFCs to offload bad loans, allowing them to bundle and sell stressed assets directly to investors through special purpose entities set up by regulated financial firms. Until now, only asset reconstruction companies handled such assets. The move, announced with the Apr monetary policy, is intended to broaden the market for distressed debt and reduce dependence on ARCs.

A key feature is the appointment of resolution managers, tasked with recovering value from the underlying assets. These must be independent of the originating lender. For such loans, RBI-regulated entities can act as resolution managers. For others, insolvency professionals and regulated institutions may qualify. Lenders must gradually provision for the securitised notes over five years. Capital requirements vary with recovery ratings, favoring senior tranches. Any exposure left after five years is to be marked down to Re 1.

With the new dispensation, ARCs may lose some of their market. Larger cases are presently going to the NARCL, and the new framework will now allow lenders to bypass ARCs for mid-sized and retail loans. RBI has also mandated that ARCs must raise their net owned fund to Rs 300 crore by FY26, a threshold many have yet to meet.

The new framework retain a key principle of RBI’s regulations on bad loans that are aimed at preventing defaulters get control of their assets through the back door. The rules require that investors must not be related parties or disqualified under Section 29A of the Insolvency and Bankruptcy Code (IBC) which bars defaulters from bidding for their assets.

“While there may be an additional option available for lenders, it will take time for the framework to develop and mature. One big difference vis-a- vis standard asset securitization is the valuation and resultant haircut, for which ARC mechanism with existing detailed guideline on competitive bidding and Swiss challenge, can give more comfort to lenders. Competition will bring the best in ARCs, provided the new participants do not have regulatory arbitrage and there is level playing field.” Hari Hara Mishra, CEO, Association of ARCs in India

RBI’s draft framework, open for public comment, permits securitisation of loan pools where at least 90% of the value is classified as non-performing. Farm loans, education loans, frauds, and wilful defaults are excluded. Transactions must be cash-settled, and lenders can retain no more than 20% of the securitised exposure. Two external valuations will be required for larger loan pools.


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