RBI | Alternative to ARCs on anvil as RBI issues discussion paper on Securitization of Stressed Assets Framework
On January 25, 2023, the RBI released a discussion paper on securitization of stressed assets framework leading to creation of one more alternative for lenders for resolving loans. Securitization refers to a process that includes the pooling of loans and then selling them to a Special Purpose Entity (SPE) which then issues securities backed by the loan pool and RBI seeks views that these SPEs and resolution managers should be under regulatory purview.
Pursuant to 'market feedback, stakeholder consultations and the recommendations of the Task Force on Development of Secondary Market for Corporate Loans (RBI, 2019)', the RBI had, in September 2022, announced its intent to look beyond the ARCs for securitization of NPAs. Presently, the SARFAESI Act, 2002 provides for securitization of stressed assets/NPAs through securitization by ARCs.
In the case of securitization of stressed assets, the originator of non-performing assets (NPAs) sells them to an SPE, which in turn appoints an entity to manage the stressed assets. Investors who buy securitization notes are paid based on recovery from the underlying assets. Securitization of Stressed Assets Framework (SSAF) is a relatively new concept globally as well, with European Union and UK having introduced some regulations around it.
Key aspects
- The discussion paper said the main difference between the securitization of stressed assets and the standard assets is related to the lower degree of certainty of cash flows from the underlying pool in the case of stressed assets
- The role of SPEs and the resolution managers is of paramount importance because of their involvement with resolution/recovery exercise of the underlying exposures and reporting requirements to financial regulators
- Investors are exposed to the risk that the resolution exercise may not generate sufficient recoveries to cover the net value of the transferred underlying assets
- A set of questions has been raised including whether the framework should apply only for loans recognized NPAs or it should include loans that are in categories like special mention accounts or tagged as standard assets. Responses to the question may draw upon pertinent implications regarding regulatory arbitrage and impact on resolution strategy and effectiveness. Such an approach would balance out the desirability of the resolution manager to have 'skinin-the-game' as well without putting the onus solely on the Resolution Manager to finance expenses from own funds solely.
- The market is keen to choose retail stressed assets such as mortgages, unsecured personal loans and loans taken by MSMEs. In these categories of loans, where the borrower base is diversified, the cash flows are relatively predictable even where the assets are stressed, and borrowers often continue to make regular payments.
While the RBI had in September 2021 issued a revised framework for securitization of standard assets, at present there is no corresponding mechanism for securitization of NPAs through the SPE route. Based on market feedback, the RBI decided to enable such a process.
The discussion paper can be accessed here:
https://www.rbi.org.in/Scripts/PublicationsView.aspx?id=21728
RBI | Diversification of control and ownership of Banking Companies
The RBI with the objective of ensuring that the ultimate ownership and control of banking companies are diversified, and the major shareholders of such companies are 'fit and proper', has recently issued the Master Direction – RBI (Acquisition and Holding of Shares or Voting Rights in Banking Companies) Directions, 20231 (Directions).
Key aspects
- The Directions shall be applicable to all banking companies as defined under Section 5 of the Banking Regulation Act, 1949 (Act) including to Local Area Banks (LABs), Small Finance Banks (SFBs) and Payments Banks (PBs) operating in India (Banking Companies).
- The Directions are to be read along with the Guidelines on
acquisition and holding of shares or voting rights in Banking
Companies (Guidelines). As per the said
Guidelines, limits have been set on the shareholding of promoters
and nonpromoters of a Banking Company, wherein:
- Promoters are permitted to hold 26% of the paid-up share capital or voting rights of the Banking Company (after the completion of 15 years from commencement of business). Prior to the above, the promoters may be allowed to hold a higher percentage of shareholding as part of the licensing conditions.
- Non-promoters are permitted to hold 10% of the paidup share capital or voting rights in case of natural persons, non-financial institutions, etc. and 15% in case of financial institutions, PSUs and central/state government.
- The Directions require any person proposing to acquire shares in a banking company, which acquisition would result in such person holding 5% or more of the paid-up capital of the banking company, to seek prior approval by making an application to the RBI.
- In respect of a person who is permitted to have a shareholding of 10% or above but not more than 40% of the paid-up equity share capital of the Banking Company, the shares so acquired shall remain under lock-in for the first 5 years from the date of completion of acquisition. However, in case any person is permitted by the RBI to have a shareholding of 40% or more, then only 40% shares shall remain under lock-in for the first 5 years from acquisition.
- As per the Directions, any person, whether a natural or a legal person, intending to make an acquisition which is likely to result in major shareholding in a Banking Company is required to seek a prior approval of the RBI by submitting an application in this regard.
- The RBI would undertake due diligence to assess the 'fit and proper' status (as provided in Annex II of the Directions) of the applicant, pursuant to which it may: (a) accord or deny permission, or (b) accord permission for acquisition of a lower quantum of aggregate holding than that has been applied for. Any decision by the RBI in this respect shall be binding on both the applicant and the concerned Banking Company.
- Subsequent to such acquisition, if at any point in time the aggregate holding of the person falls below 5%, as per Section 12B (1) of the Act, then in such a case the person will be required to again obtain prior approval from RBI to raise the aggregate holding to 5 % or more
- In addition to the above, under the Directions, following
monitoring arrangements are required to be adhered by Banking
Companies:
- Due Diligence: Under the latest Master Direction, banking companies are now required to have their own 'fit and proper' criteria, too, for such major shareholders (for this, the Master Direction also lays down certain illustrative minimum criteria which ought to be followed/referred to). Hence, for any such acquisition to go through, the banking company is required to assess the relevant person on the yardstick of its own said criteria, conduct due diligence, and then pass a board resolution and forward its comments (in a prescribed form) to the RBI. The RBI thereafter undertakes its own due diligence on the said applicant to assess if it is 'fit and proper', before deciding on the application. Henceforth, no person from FATF non-compliant countries may acquire any shares of a banking company which would make it a major shareholder (i.e., with >5% shareholding/voting rights). Even after the acquisition, the banking company is required to monitor the 'fit and proper' status of major shareholders on a continuous basis
- Monitoring mechanism for SBO: Banking Companies shall put in place a mechanism to obtain information on any change in Significant Beneficial Owner (SBO) or acquisition by a person to the extent of 10 % or more of paid-up equity share capital of the major shareholder.
- Regular reporting: Banking Companies shall submit periodical reports on the continuous monitoring arrangements to its board.
- Diversification of shareholding: Banking Companies (excluding Payments Banks) in which a person has an aggregate holding which is not in conformance with the Guidelines, as on the date of issue of the Directions, shall within 6 months from the date of issue of the Directions submit a shareholding dilution plan.
RBI | Operationalization of Central Bank Digital Currency – Retail (e?- R) pilot
On November 29, 2022, the RBI launched the first pilot for Retail Digital Rupee, which commenced from December 1, 2022. Earlier, the RBI had launched the first pilot in the Digital Rupee - Wholesale segment (e?-W) which was initiated from November 1, 2022. The e-Rupee is a Central Bank Digital Currency (CBDC), which is defined by the RBI as the legal tender issued by a Central Bank in a digital form. It is the same as a sovereign currency and is exchangeable one-to-one at par (1:1) with the fiat currency2 . Not long ago, the Reserve Bank of India Act, 1934 was also amended to include digital currency in the definition of bank notes3 .
As per the Concept Note on CBDC released by the RBI on October 7, 2022, the Retail Digital Rupee is primarily devised for consumption of common public with features akin to physical cash viz. anonymous, unique serial numbers, etc. It is a tokenbased system where a type of digital token issued by and representing a claim on the central bank. The digital token would effectively function as the digital equivalent of a banknote that could be transferred electronically from one holder to another.
A token CBDC is a 'bearer-instrument' like banknotes, meaning that whoever 'holds' the tokens at a given point in time would be presumed to own them. Under a token-based Retail Digital Rupee regime, users would be able to withdraw digital tokens from banks in the same way they can withdraw physical cash. They would maintain their digital tokens in a wallet and could spend them online or in person or transfer them via an app.
The pilot aims to cover select locations in Closed User Group (CUG) comprising participating customers and merchants4 . Around 50,000 individuals and merchants have been selected for the pilot along with four banks - State Bank of India (SBI), ICICI Bank, Yes Bank and IDFC First Bank. The pilot initially covers four cities, viz., Mumbai, New Delhi, Bengaluru and Bhubaneswar and will later extend to Ahmedabad, Gangtok, Guwahati, Hyderabad, Indore, Kochi, Lucknow, Patna and Shimla5 . Users will be able to transact with Retail Digital Rupe through a digital wallet offered by the participating banks and stored on mobile phones/devices. Transactions can be both Person to Person (P2P) and Person to Merchant (P2M). Payments to merchants can be made using QR codes displayed at merchant locations6 . As of February 1, 2023, Infibeam Avenues Limited flagship brand - CCAvenue, has become India's first payment gateway player to process CBDC or e? transactions for online retail merchants7 .
This is a welcome step taken by the RBI, as a proposed full roll out of a CBDC in the entire country would reduce time and costs in transactions, reduce operational costs involved in managing physical cash in the country, enable real-time tracking and ledger maintenance all due to its blockchain technology. In addition, India will be at par with countries such as the Bahamas (Sand Dollar), Jamaica (JAM-DEX), Nigeria (e-Naira) and 8 countries in the Eastern Caribbean Union (DCash) having a digital currency backed by a Central Bank8 .
Although the Government has deferred the introduction of a bill in parliament to regulate cryptocurrency, it plans to introduce Standard Operating Procedures (SOPs) for global regulation of cryptocurrencies during India's G20 presidency, from Dec. 1, 2022, to Nov. 30, 20239 . A side event for the 1st International Financial Architecture Working Group Meeting of the G20 Finance Track, titled 'Central Bank Digital Currencies (CBDCs): Opportunities and Challenges' was held in Chandigarh recently indicating that further developments can expected for CBDCs as well10 .
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Footnotes
1. RBI Directions: https://rbi.org.in/Scripts/BS_ViewMasDirections.aspx?id=12439#1
2. https://www.rbi.org.in/Scripts/BS_SpeechesView.aspx?Id=1111
3. Section 2 (aiv) of the Reserve Bank of India Act, 1934
4. https://www.rbi.org.in/Scripts/BS_PressReleaseDisplay.aspx?prid=54773
6. Supra
8. https://www.atlanticcouncil.org/cbdctracker/
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