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SECURITISATION—
AN OVERVIEW
Securitisation has emerged as a key word in the
world of finance. In a generic sense, the securiti-
sation is basic to the world of finance and it can be
said that it envelops the entire range of financial
instruments, and hence, the entire range of finan-
cial markets. Read on to have an insight into vari-
ous issues involved.
—Rajkumar S Adukia

decades; borrowers can afford to recent times. A typical securitisa-

transaction. A borrower wants ignore creditors’ demands and pay tion transaction consists of the fol-
money, and a lender offers it the legal fees instead. lowing steps:
n theory, a loan is a simple
and collects interest: this arrange- As a result, there are bad debts Creation of a special purpose
ment continues until the loan is across the entire financial system. vehicle to hold the financial
repaid. In some cases, however, the These drive up the cost of loans and assets underlying the securities;
borrower may be unable or unwill- ruin the lenders’ financials. Banks Sale of the financial assets by
ing to pay back the loan. Secured and financial institutions write off the originator or holder of the
loans, where the borrower offers huge sums each year to cover bad assets to the special purpose
collateral such as real estate or debts. Estimates of the size of these vehicle, which will hold the
machinery, are supposed to cater to “non-performing assets”–bankers’ assets and realize the assets
just such contingencies. In case of a jargon for bad debts– vary from Rs Issuance of securities by the
default, creditors can seize and sell 85,000 crore to twice as much. SPV, to investors, against the finan-
the asset to recover their money. cial assets held by it. This process
What is securitisation
This neat concept breaks down leads to the financial asset being
if the seizure of an asset is impossi- taken off the balance sheet of the
Securitisation is the process of
ble within reasonable time limits – pooling and repackaging of originator, thereby relieving pres-
as has been the case in India. A homogenous illiquid financial sures of capital adequacy, and pro-
tardy legal system makes it virtu- assets into marketable securities vides immediate liquidity to the
ally impossible to seize the assets of that can be sold to investors. originator.
defaulters. Endless hearings and Securitisation has emerged as an
Need for securitisation
appeals keep things in limbo for important means of financing in
The generic need for securitisation
is as old as that for organised finan- The author
is a member of the Institute. He can be reached
at
cial markets. From the distinction
radukia@vsnl.com

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Representative, who act in a

between a financial relation and a
financial transaction earlier, we fiduciary capacity safeguarding
understand that a relation invari- the interests of investors in the
ably needs the coming together and ABS.

remaining together of two entities. The Credit Rating Agency,

Not that the two entities would nec- which provides an objective
essarily come together of their estimate of the credit risk in the
own, or directly. They might securitization transaction by
involve a number of financial assigning a well-defined credit
intermediaries in the process, but rating.

nevertheless, a relation involves a The Regulators,whose princi-

Parties involved
fixity over a certain time. pal concerns relate to capital
Generally, financial relations are adequacy, liquidity, and credit
Securitization programmes usu-
created to back another financial ally involve several participants, quality of the ABS, and balance
relation, such as a loan being taken each carrying out a specialist func- sheet treatment of the transac-
to acquire an asset, and in that case, tion, such as, creating and tion.

the needed fixed period of the rela- analysing the asset pool, adminis- Service providerssuch as Credit
tion hinges on the other, which it tration, credit rating, accounting, Enhancers and Liquidity
seeks to back-up. legal negotiation, etc. These Providers, and,

Financial markets developed include: Specialist functionariessuch as

in response to the need to involve a legal and tax counsels, account-
The Originator– also inter-
large number of investors in the changeably referred to as the ing firms, pool auditors, et al.
market place. As the number of Seller – is the entity whose
Securities issued by
investors increases, the average receivable portfolio forms the
Special Purpose Entity
size per investors comes down - basis for Asset Backed Security
this is a simple rule of the market- (ABS) issuance.
1. Asset backed Securities
place because growing size means
Special Purpose Vehicle(SPV),
2. Mortgage backed Securities
involvement of a wider base of which as the issuer of the ABS
investors. The small investor is not ensures adequate distancing of the
Securities issued by SPV in a secu-
a professional investor: he is not as instrument from the originator. ritisation transaction are referred to
such in the business of invest- as Asset Backed Securities (ABS)
The Investors – The investors
ments. Hence, he needs an instru- may be in the form of Individuals because investors rely on the per-
ment which is easier to understand, or institutional investors like FIs, formance of the assets that colla-
and is liquid. These two needs set mutual funds etc. They buy a par- terise the securities. They do not
the stage for evolution of financial ticipating interest in the total take an exposure either on the pre-
instruments which would convert pool of receivables and receive vious owner of the assets
financial claims into liquid, easy to their payment in the form of (Originator) or the entity issuing
understand and homogenous prod- interest and principal as per the securities (the SPV).
ucts, at times carrying certified agreed pattern. In practice a further category is
quality labels (credit-ratings or identified – securities backed by
Other parties
security), which would be avail- mortgage loans (loans secured by

able in small denominations to suit The obligoris the originator’s specified real estate property,
every one’s purse. Thus, securitisa- debtor (borrower of the original wherein the lender has the right to
tion in a generic sense is basic to loan). sell the property, if the borrower

the world of finance, and it is a tru- The Servicer,who bears all defaults). Such securities are
ism to say that securitisation administrative responsibilities called Mortgage Based Securities
envelopes the entire range of finan- relating to the securitization (MBS). The most common exam-
cial instruments, and hence, the transaction. ple of MBS is securities backed by

entire range of financial markets. The Trusteeor the Investor mortgage housing loans.

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Investors will get

Let us take the example of
National Housing Bank and see paid through the
how the whole process of home money received in
loans receivables works. Home the form of loan
rental receivables, once securitisa- repayments by those
tion takes off, will work in much the borrowing home
same manner as this. loans through HFCs.
HFCs are in turn
Let us first take a look at the role
that housing finance compa- paid certain service
nies(HFCs) are going to play. charges by the SPV
The HFCs will be called mort- for the servicing of
gage originators and they will be the loan.
responsible for assessing loans,
Credit Enhancement
which are good and worthy of allows banks and financial institu-
being converted into mortgages. tions to recover their dues promptly
It refers to any of the various means
In this case, the HFCs involved that attempt to buffer investors without going through a costly and
are HDFC and LIC Housing against losses on the assets collater- time-consuming legal process.
Finance. ising their investment. There are The Act contains VI chapters and
following types of credit enhance- 42 sections:
Now these HFCs will pass on the
mortgages to a Special Purpose ments:
Vehicle, (SPV) which is NHB in Chapter I – Preliminary
External Credit enhancements:
this case. This means the loans Letter of credit, Third party Short title and commencement
will move from the books of the guarantee and Insurance are the (1)This Act may be called the
HFCs to the SPV. The SPV will types of external credit enhance- Securitisation and Reconst-
be responsible for pooling ments. ruction of Financial Assets and
together the loans received from Enforcement of Security
Internal Credit enhancements:
HFCs into securitized instru- Credit trenching, Over-collater- Interest Act, 2002.
ments, called mortgage backed alization, Cash collateral, spread (2) It extends to the whole of India.
securities (MBS). The SPV will account and Triggered amortisa- (3) It may come into force on the
in turn, pay upfront cash to the tion are types of internal credit 21st day of June 2002.
HFC for the loans received. The enhancements.
HFC can use this fund to gener- Chapter II- Regulation of
Securitisation Act
ate more mortgages. It will be Securitisation & Reconstruction of
the responsibility of the SPV to Financial Assets of Banks &
The Securitisation And Reco-
see that receivables of similar nstruction of Financial Assets and Financial Institutions
maturities, rate of interest etc. Enforcement of Security Interest
The Securitisation will be done
are pooled together while form- Act, 2002 (SARFAESI Act) is a through a new/existing com-
ing the securitized instrument. mix of three different things - pany, which must have mini-
Securitisation, Asset management mum paid up capital of Rs. 2
The third player in this game will
be the investor, who will sub- companies and enforcement of crores.
scribe to the mortgaged securi- security interests on loan defaults
Existing Securitisation compa-
ties (MBS). The MBS will be to banks. The basic intention nies have to comply with the
like an interest bearing bond or behind this act is to strengthen new regulation within next 3
debenture and through the sale creditor rights through foreclosure months till which time they will
of this instrument, the SPV will and enforcement of securities by be allowed to carry on business
get back the amount spent on banks and financial institutions. By of Securitisation.
acquisition of the loans. conferring on lenders the right to
Securitisation companies who
And how does the investor of the seize and sell assets held as collat- are registered with RBI cannot
mortgaged security get paid? eral in respect of overdue loans, it make substantial change in the

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Chapter III – Enforcement of

management or location etc
without prior approval of RBI. Security Interest
They are not allowed to carry
The new Act –
on any other business activi- Securitisation & Reconst-
The new Act – Securitisation
ties except that of Securi- ruction of Financial Assets
& Reconstruction of Fina-
tisation & Reconstruction of & Enforcement of Security
ncial Assets & Enforcement
Assets. The expression “sub- Interest w.e.f 21.06.2002
of Security Interest w.e.f
stantial change in manage- allows secured lenders to
21.06.2002 allows secured
ment” means the change in the sell or lease assets, which
lenders to sell or lease ass-
management by way of trans- are charged with them by
ets, which are charged with
fer of shares or amalgamation defaulting borrower (classi-
them by defaulting borrower
or transfer of the business of fied as NPA) without pro-
(classified as NPA) without
the company. tracted legal tussle.
protracted legal tussle.
The Reserve Bank may cancel ‘Non-performing
a certificate of registration Assets’ means an asset or
A Securitisation company or
granted to a securitisation com- reconstruction company may account of a borrower, which has
pany or a reconstruction com- raise funds from the qualified been classified by bank or finan-
pany, if such company— institutional buyers by formulat- cial institution as sub-standard,
(a) ceases to carry on the business ing schemes for acquiring finan- doubtful or loss asset, in accor-
of securitisation or asset recon- cial assets and shall keep and dance with the directions or
struction; or maintain separate and distinct guidelines relating to the asset
(b) ceases to receive or hold any accounts in respect of each such clarification issued by RBI.
investment from a qualified scheme for every financial asset
The Act overrides some of the
institutional buyer; or acquired out of investments provisions of the Companies
(c) has failed to comply with any made by a qualified institutional Act, 1956 as well as the Transfer
conditions subject to which the buyer and ensure that realisations of Property Act.
certificate of registration has of such financial asset is held and
The Act requires 60 days notice
been granted to it; or applied towards redemption of to be given to the defaulter. The
(d) at any time fails to fulfil any of investments and payment of notice has to be very specific
the conditions referred to in returns assured on such invest- about defaulted amount.
clauses (a) to (g) of sub-section ments under the relevant scheme.
On receiving the notice, no bor-
(3) of section 3; or rower can sell, lease or transfer
Any securitisation company or
(e) fails to reconstruction company regis- the secured assets mentioned in
(i) comply with any direction tered under section 3 may the notice, without the lenders
issued by the Reserve Bank consent.
under the provisions of (a) act as an agent for any bank or
Bankers can act, even on those
this Ordinance; or financial institution for the pur- cases that are pending with the
(ii) maintain accounts in accor- pose of recovering their dues BIFR, provided more than 75%
dance with the require- from the borrower on payment of such secured creditors agree
ments of any law or any of such fees or charges as may to the same.
direction or order issued by be mutually agreed upon
No fresh reference shall be made
the Reserve Bank under the between the parties; to BIFR after commencement of
provisions of this Ordi- (b) act as a manager referred to in this Act where financial assets
nance; or clause (c) of sub-section (4) of have been acquired under this
(iii) submit or offer for inspec- section 13 on such fee as may Act. Now of course SICA i.e.
tion its books of account or be mutually agreed upon BIFR has been repealed w.e.f.
other relevant documents between the parties; 01.01.2004 and the SICA (spe-
when so demanded by the (c) act as receiver if appointed by cial provisions) Repeal Bill will
Reserve Bank; or any court or tribunal: become effective after notifica-

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normally given for 1 year.

tion in official gazette.
If borrower fails to respond to
The Supreme Court, in its
the notice by offering payment, Chapter IV—Central registry
judgement in case of Mardia
the security lender at his discre-
The Central Government may,
Chemicals Ltd. and Others vs.
tion can take any of the follow- by notification, set up the
Union of India and Others
ing actions: Central Registry with its own
seal for the purposes of registra-
upheld the constitutional
(a) Take possession of the tion of transaction of
validity of SARFAESI Act but
assets mortgaged and Securitisation and reconstruc-
struck down Sub-Section (2)
transfer the same either by tion of financial assets and cre-
of Section 17 which provides
selling or by leasing. ation of security interest.
(b) Takeover the management
for deposit of 75% of claimed
The central government may
of the Secured Assets of also notify the territorial limits
amount before appeal is
the defaulting borrower. within which an office of a
admitted by DRT
(c) Can appoint manager to Central Registry may perform.
take charge of secured
The central registrar is to be
assets taken into posses- informed within 30 days of any
sion. authority in respect of action Securitisation transaction, asset
taken under this Act. reconstruction or security inter-
If there are more than one
secured creditors, the decision to est.
Rights of the borrower
make provisions of this Act will
The particulars of Securitisation
be made applicable only when or reconstruction or security
A borrower can object to the mea-
75% of them are agreeable. sures taken under this Act within 45 interest entered in the Central
days subject to condition of Register of such transactions
In the event of the total dues of
the secured creditors are not depositing 75% of the amount out- kept under section 22 shall be
recovered from sale of secured standing with DRT, or lower open during the business hours
assets, they will have right of amount if approved by DRT. for inspection by any person on
approaching DRT for recovery If at appeal level, it can be estab- payment of such fees as may be
lished that the possession of secured prescribed.
assets by the secured creditor was
wrongful then DRT/Appellate tri- Chapter V— Offences and
bunal will direct the secured creditor Penalties
to return such secured assets to the If a default is made;
concerned borrower. (a)in filing under section 23, the
Limitation as prescribed under particulars of every transaction
Limitation Act, 1963 will be of any Securitisation or asset
applicable even to this Act. reconstruction or security
Borrowers can also apply to interest created by a
the State Government in Securitisation company or
Maharashtra and Gujarat for relief reconstruction company or
under, Bombay Relief Under- secured creditors; or
of balance amount from the bor- taking Act. The stay against Secu- (b)in sending under section 24, the
rowers/guarantors. ritisation proceedings may be particulars of the modification
granted on a case-by-case basis on referred to in that section; or
Chief Metropolitan Magistrate
or District Magistrate will assist merits. Normally, it will be decided (c)in giving intimation under sec-
the secured creditors on request by Industries Minister or Chief tion 25,
being made to them. Minister, though very few
Every company and every offi-
instances have been witnessed for cer of the company or the
No injunction shall be granted
by any civil court or other such relief at present. The relief is secured creditor and every offi-

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ARC’s accounting must be in consonance with the

cer of the secured creditor who is
relevantAccounting Standards and Generally Accepted
in default shall be punishable
with fine that may extend to five
Accounting Principles. There is a specific requirement to the
thousand rupees for every day
effect that income on any recoveries on an NPA should be
during which the default contin-
only on cash basis
ues.
If any Securitisation company or
reconstruction company fails to
comply with any direction The provisions of this Act shall not gages, credit card receivables,
issued by the Reserve Bank apply to lease/hire receivables, which are
under section 12, such company not marketable in their original
Alien on any goods.
and every officer of the company forms are converted into mar-
A pledge on movable property.
who is in default, shall be pun- ketable securities.
Creation of any security in an
ishable with fine which may Aircraft.
Transfer of Risks:Transfer of
extend to five lakh rupees and in assets to a Special purpose
Creation of any security interest
the case of a continuing offence, in any vessel. Vehicle (SPV) results in transfer
with an additional fine, which to all associated risks such as risk
Any conditional sale, hire pur-
may extend to Rs. 10,000 for chase or lease or any other con- of default, currency risk and
tract in which no security inter- inherent risk.
est is created.
RBI guidelines for
Any right of unpaid seller under
Securitisation & ARC
Section 47 of the sale of Goods
Act. Any property not liable
to attachment.
The RBI guidelines cover the fol-
lowing aspects
Any security interest
for repayment of any 1.Guidelines and directions cov-
financial asset not ering the registration and opera-
exceeding one lakh tion of ARC.
rupees. 2.Guidance notes in relation to the
financing and accounting poli-
Any case in which the
amount due is less than cies thereof.
20% of the principal 3.Guidelines to the lenders in
every day during which the amount and interest thereon. relation to transfer of financial
default continues. assets to ARCs.
Any security interest created on
agricultural land.
If any person contravenes or
attempts to contravene or abets As per amendment (29.03.2004)
Benefits of Securitisation
the contravention of the provi-
Every Securitisation company
sions of this Ordinance or of any or reconstruction company seek-
Liquidity:Selling a portfolio
rules made thereunder, he shall results in availability in ready ing the Bank’s registration under
be punishable with imprison- cash. Section 3, or carrying on busi-
ment for a term which may ness on commencement of the
Raise cheaper funds: Experience
extend to one year, or with fine, in the US and Europe shows that Securitisation Companies and
or with both. Securitisation is a cheaper form Reconstruction Companies
of raising finance for the origina- (Reserve Bank) (Amendment)
No court inferior to that of a
Metropolitan Magistrate or a tor than the traditional forms of Guidelines and Directions,
Judicial Magistrate of the First debt financing. 2004, shall have a minimum
Class shall try an offence punish- Owned Fund not less than fifteen
Convert of Marketable
able under this Ordinance. Securities:Assets such as per- percent of the total financial
Chapter VI –Miscellaneous sonal loan, residential mort- assets acquired or to be acquired

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by the Securitisation Company

CASES OF SECURITISATION
or Reconstruction Company on
an aggregate basis, or Rs. 100
crore, whichever is less; irre- Securitised deals have been taking place in India during last few
spective of whether the assets years. Some of them are listed below
are transferred to a trust set up
First deal in India between Citibank and GIC Mutual Fund, in
for the purpose of securitization
1990 for Rs. 160 million.
or not.
Securitisation of cash flow of high value customers of Rajasthan
Further the Securitisation
Company or Reconstruction State Industrial and Development Corporation in 1994-95, struc-
tured by SBI cap.
Company should continue to
hold this owned fund level until
NHB-HDFC Securitisation deal of Rs. 597 million based on the
the realization of the assets and
receivables of 8330 housing loans in August 2001.
redemption of security receipts
Securitisation of overdue payments of UP government to
issued against such assets.
HUDCO by issue of tax- free bonds worth Rs. 500 million
The Securitisation Company or
Reconstruction Company can
NHB entered into a securitisation deal with HDFC, LIC Housing
utilize this amount towards the
Finance, Canfin Homes and Dewan Housing.
Security Receipts issued by the
Securitisation of Sales Tax deferrals by Government of
trust under each scheme. This
Maharashtra in August 2001 for Rs. 1500 million with a green
will ensure the stake of the
shoe option of Rs. 75 million.
Securitisation Company or
Reconstruction Company in the
First deal in power sector by Karnataka Electricity Board for
assets acquired.
receivables worth Rs. 1940 million and placed them with
No subsidiaries of Bank:Some
HUDCO.
of the ARCs are currently being
The second MBS transaction through HUDCO.
promoted by Bank and FIs. The
shareholding of such ARCs are
Mega securitisation deal of Jet Airways for Rs. 16000 million
dispersed in such a manner that
through offshore SPVs.
they do not become subsidiaries
ILFC sponsored securitisation of receivables by Varun Shipping.
of any of the promoting institu-
tions.
Data indicate that ICICI had securitised assets to the tune of Rs.
27500 million in its books at end March 1999.
NPA to be taken over at proper
price:Care has to be taken in
Securitisation of lease receivables on power project by L&T
constituting the management
structure and operations of the
ARC such that even if the
Every ARC is required to have a
promoting bank or FIs trans- “financial asset acquisition pol-
fer their NPA portfolio, then icy” which interalia must lay
it will be treated as transfer to down policies and guidelines for
an independent or non-sub- the valuation of NPAs acquired
sidiary ARC. Valuation of by the ARC (having realizable
the NPA portfolio will have value and capable of being rea-
to be negotiated at arms sonably estimated and indepen-
length and upsides on recov- dently valued).
ery can be even shared with
True sale and not adjustment:
ARC. The acquisition of financial
assets by an ARC must conform
NPA acquisition based on
properly framed policies: to the principles of a “true sale”
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asset has been taken, the borrower
ment in the matter of Mardia
can file an application before the
Chemicals Ltd. and Others Vs
DRT without any deposit. If the
Union of India and Others upheld
DRT does not dispose off the peti-
the constitutional validity of the
tion within four months, the bor-
SARFAESI Act but struck down
rower or the Secured Creditor can
Sub-Section (2) of Section 17
move the Debt Recovery Appellate
which provides for a deposit of 75%
Tribunal (DRAT) for directing the
of the claimed amount before the
DRT for expeditious disposal of
appeal is admitted by DRT. The
the application.
Supreme Court also held that after
the service notice, if the borrower After the disposal of the case by
raises any objection or places facts the DRT the borrower, if aggrieved,
for consideration of the creditor, the can appeal to the DRAT with a
Due Diligence: Proper due dili-
gence and NPA portfolio valua- same may be considered with due deposit of 50% of the decreed
tion before any transfers should application of mind and the reasons amount or as determined by the
be made by banks or FIs to the for not accepting the objection must DRT but not lower than 25%.
ARCs. This means that the pric- be communicated to the borrower. (ii) To confer power upon the
ing of NPA portfolio transfers However, the borrower will be able Appellate Tribunal to transfer all
will take place through a process to move the Secured Creditor has pending applications before differ-
of discovery, as in the case of a taken the DRT only after the pos- ent DRTs to one DRT.
business acquisition. session of secured asset. (iii) To empower RBI to call for
2. To bring the provisions of the periodic returns and information
The provisions of paragraph 9 of
the above guidelines and direc- Act in conformity with the from Securitisation Companies and
tions relating to maintaining on Judgement of the Hon’ble Supreme Asset Re-construction Companies.
an ongoing basis, a capital ade- Court Order, to dissuade the bor- (iv) To provide for taking over
quacy ratio, which shall not be rower from indulging in dilatory of management of the business of
less than fifteen percent of the tactics with a view to postpone the the borrower under Section 13(4).
total risk weighted assets of the repayment of dues and to enable This was omitted in the original
Securitisation Company or secured creditors to make speedy Act. Though Section 15 provides
Reconstruction Company, shall recovery by enforcement of securi- for the manner and effect of take
be applicable. ties, the Securitisation and over of management of business,
Reconstruction of Financial Assets Section 13(4) did not provide for
Accounting for ARCs
and Enforcement of Security taking over the borrower’s business
Interest Act, 2002 has been by the Secured Creditor.
As such, the ARC’s accounting
must be in consonance with the rel- amended by promulgation of the 4. Other amendments are of
evant Accounting Standards and Enforcement of Security Interest clarificatory and consequential
Generally Accepted Accounting and Recovery of Debt Laws nature.
Principles. There is a specific (Amendment) Ordinance, 2004
Conclusion
requirement to the effect that (Ord. 5 of 2004) on 11.11.2004.
income on any recoveries on an
NPA should be only on cash basis.
The Act and the notice could be pri-
3. The salient amendments are as
The RBI guidelines essentially marily used as a powerful bargain-
under:(i) The Secured Creditor
require that the ARC should account ing tool while negotiating with the
will be able to take possession of
for the NPA portfolio (from a provi- defaulter. This puts banks on
the secured assets only after rea-
sioning perspective) in the same stronger ground in salvaging sticky
sons for not accepting the objec-
way as required of a bank or FI. loans. The Banks will now have a
tions of the borrower have been
clear edge in negotiations and also
Mardia Chemicals case
communicated to him in writing.
of recovering most of the dues par-
After possession of the secured
1. The Supreme Court, in its judge-
ticularly from willful defaulters. ¦

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