“Without wisdom, gold is quickly lost by those, who have it.”
The Reserve Bank of India has permitted the setting up and creation of a Secondary Market for Loans vide circular RBI/DOR/2021-22/86 24.09.2021. These directions are called the Reserve Bank of India (Transfer of Loan Exposures) Directions, 2021 for the sale of Corporate Loans between financial players in India. Currently, the Secondary Loan market is undertaken for the sale of stressed assets by banks to ARCs. RBI’s new directions facilitate the sale and purchase of Standard Performing Assets.
When a person takes a home loan, the loan is funded and serviced by a bank, who use their own funds to make the loan, but they can’t risk eventually running out of money, so they often sell the loan on the secondary market to replenish their available funds, so they can continue to offer to finance to other customers. A secondary loan market is a market where investors buy and sell loans they already own. A vibrant, deep, and liquid secondary market goes a long way in increasing the efficiencies of the debt market.
A well-developed secondary market for debt also aids in transparent price discovery of the inherent riskiness of the debt being traded. The concept is an important mechanism for credit intermediaries to manage credit risk and liquidity risk on their balance sheets. Loan transfers are resorted to by lending institutions for a multitude of reasons ranging from liquidity management, rebalancing their exposures, or strategic sales.
The provisions of these directions shall apply to:
(a) Scheduled Commercial Banks;
(b) NABARD, NHB, EXIM Bank, SIDBI
(c) Small Finance Banks; and
(d)All Non-Banking Finance Companies (NBFCs) including Housing Finance Companies (HFCs).
As per the RBI scheme, all lenders, were permitted to acquire loans, shall only do so from a transferor specified as a lender.No lender shall undertake any loan transfer other than those permitted under these directions. The above provision shall be without prejudice to the provisions of RBI (Securitisation of Standard Assets) Directions, 2021. The directions will also be applicable to the sale of loans through novation, assignment, and loan participation. In case of loan transfers other than loan participation, legal ownership of the loan shall be mandatorily transferred to the transferee to the extent of economic interest transferred.
Loan transfers should result in the transfer of economic interest without being accompanied by any change in underlying terms and conditions of the loan contract usually. In all cases, if there are any modifications to terms and conditions of the loan contract during and after the transfer, the same shall be classified as Restructured Assets and evaluated within the ‘restructuring’ guidelines of the Reserve Bank of India (Prudential Framework for Resolution of Stressed Assets) Directions 2019, dated June 7, 2019.
In loan participation transactions, the legal ownership completely remains with the transferor even after economic interest has been transferred to the transferee. Lenders regardless of whether they are transferors or otherwise, should not offer credit enhancements or liquidity facilities in any form in the case of loan transfers. A transferor cannot re-acquire a loan exposure, either fully or partially, that had been transferred by the entity previously. The transfer shall be only on a cash basis and the consideration shall be received not later than at the time of transfer of loans. The transfer consideration should arrive at an arm’s length basis.
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 rigour and as per the same policies as would have been done for originating any loan. The above due diligence requirements shall be applicable at the level of each loan. In India, banks typically tend to hold loans till maturity or till they go bad. Neither the bank nor the corporate debt have the feasibility of changing hands during the life cycle of a loan.
Ten major lenders, SBI, ICICI Bank, Canara Bank, and Standard Chartered Bank, have joined hands to set up an online platform for trading corporate loans in the secondary market. Called the Secondary Loan Market Association (SLMA), it has been formed on the recommendation of the RBI’s Task Force on the Development of Secondary Market for Corporate Loans. Kotak Mahindra Bank, Deutsche Bank, Bank of Baroda, Punjab National Bank, Axis Bank, and HDFC Bank are also its members. This is of vital importance for the price discovery of loans and to restore the health of Indian banks.
Ten Benefits to Cheer Secondary Loan Market in India :
1. Facilitation of Sale & Purchase of Standard Loans
It will facilitate, promote and set up an online system for standardisation of primary loan documentation, and a trading mechanism for secondary loan market to trade performing loans.
2. Seamless Settlements
It will promote standard trading, settlement and valuation procedures for seamless settlements immediately on sale.
3. Setting Rules & Timelines for Transactions
It will set rules and timelines for the members for conducting the business. Post transaction, any delay in parting or owning of the asset shall attract a penalty.
4. Pricing Discovery Mechanism
It will lay down ground rules for pricing and fix transaction-related charges. Few loans might even attract a good price, based on the perception of the market, despite the loan being declared as impaired by the Regulator. The decision of the Regulator/Auditor would not entirely dictate the price or its intrinsic value and cash flows.
5. Capital Optimisation
Within the given capital, banks shall be able to churn the credit portfolio by the sale and purchase of standard assets.
6. Liquidity Management
The regular sale of loans shall bring in cyclical liquidity inflows.
7. Risk Management
Loans perceived as risky could be downloaded in the Secondary market at a discount to ARCs/ NBFCs as per risk appetite.
8. Additional Credit Creation
Coupon on loan, cost of funds, remaining tenor, industry, sector, rating, government policies and risk appetite shall make banks operate actively in the Loan market to create additional credit opportunities.
9. Prestigious Corporates in Books of Small Banks
Smaller banks are generally constrained from participating in large and creditworthy lending exposures at the time of origination; the secondary market shall provide a chance to participate in taking such exposures and the constraints faced under the Large Exposure Framework will be a thing of the past.
10. Premium on Loans
Price discovery might take place instantaneously. For par loans, the price generally varies from 95 percent to a premium of 101 percent of the loan and it mainly depends upon the available coupon. In India, as the average interest rate is around 10 percent which is higher than developed markets, it may fetch a higher premium than the usual 101 levels. Akin to equity markets, any news either negative or positive will reflect on the secondary price. Performing corporates shall command a premium in resale.
Win-Win for Banks & Borrowers
For borrowers, the principal benefits is the lower cost of capital, greater credit availability and developing new relationships with a bank and non-bank providers of capital. The secondary market will evolve on the strength of a systematic digital loan trading platform, standardisation of documents, active participation by stakeholders and an effective price discovery mechanism.
In effect, a secondary market would bring in the required liquidity to bank loans, enable price discovery at every stage elongating the underlying asset value. It is now up to the Indian markets to encash the huge potential available.
“Financial markets are inherently risky. There is only one big risk we should avoid at all costs; it is the risk of doing nothing.”
About the author:
Mr. Hargovind Sachdev is an Ex-Banker, GM(Retd) of State Bank of India. Has over 39 years of experience in banking, having occupied senior positions in UCO Bank, United Bank of India, State Bank of Patiala, State Bank of Travancore & State Bank of India where he headed the Central European Credit Desk at Frankfurt, Germany from 2006 to 2011 covering 15 countries of Central Europe. Has undergone International Banking Training from Asian Institute of Management, Manila, the Philippines in the Year 2003 and a Multi-currency lending-technique training at the Euro Money Institute, London in 2009.
He has specialisation in Credit, Foreign Exchange, Vigilance, Monitoring & appraisal of Corporate Loans, MSME Credit, Gold Loans, Agricultural Loans & NRI Business Management in assets & liabilities. As a Forensic Auditor, he has conducted various Transaction Audits allotted by Banks.
He was felicitated by the Central Vigilance Commissioner, Sh. C.V Chowdhry for winning first prize for best article on Preventive Vigilance in 2015. He is also an accomplished Public Speaker having conducted multiple Motivational Seminars for institutions like ONGC, the National Housing Bank & the Bank of Baroda. He is an Independent Director & consultant to various big entities in the corporate sector at present.
hargovindsachdev@gmail.com
