General Awareness for RBI Grade ‘B’ Officer Exam: Securitisation in India
Securitisation is the financial practice of pooling various types of contractual debt and selling their related cash flows to third party investors as securities. It diversifies credit markets as it breaks the process of lending and funding into several discrete steps, leading to specialisation and economies of scale.
Financial sector’s primary role is intermediation between ultimate savers and ultimate investors. Primarily, it was only banks which were the intermediaries. As the financial sector evolved, other types of financial institutions came on the scene to undertake such intermediation directly, or between and among other intermediaries. A parallel development is the emergence of varieties of financial products, far removed from simple deposits and advances, delivering such intermediation. Securitisation is among the latest of such intermediating product.
Meaning of Securitisation:
Securitisation is the financial practice of pooling various types of contractual debt such as residential mortgages, commercial mortgages, auto loans or credit card debt obligations (or other non-debt assets which generate receivables) and selling their related cash flows to third party investors as securities, which may be described as bonds, pass-through securities, or collateralized debt obligations (CDOs). Securitisation diversifies credit markets as it breaks the process of lending and funding into several discrete steps, leading to specialisation and economies of scale.
Advantages of Securitisation
Securitisation can offer a number of advantages for the stakeholders.
- It frees up an originator’s capital by removing the assets from the balance sheet. This way, capital is now available for origination of fresh assets with profitability potential.
- It improves the liquidity position of the originator as the future receivables are replaced by cash.
- It provides another option for diversifying their debt portfolio.
- It facilitates participation in relatively lower or higher risk portion of the cash flows.
- The presence of the ‘Pool Servicer” provides certain additional assurance and safety.
- It allows flexibility in structuring the timing of cash flows to one’s needs.
For Servicers, Trustees, Credit Rating Agencies and Brokers
- It offers added business opportunities and increased fee income.
For Financial Markets
- It provides alternate debt instruments in the financial markets and improves market liquidity. It widens the markets and allows entry to new players. It enhances return on capital, diversifies financial markets, and serves as an alternate route of funding.
- It improves efficiencies in financial markets through risk diversification as the risks can be bundled and hived off and distributed among counterparties better equipped to manage these risks.
Role of the RBI in regulation of Securitisation:
The RBI is the regulator of the Indian banking system and has to ensure that financial intermediaries engage in Securitisation prudently. RBI issued the first set of comprehensive guidelines applicable to banks, financial institutions and NBFCs on Securitisation in India way back in February 2006.
Based on the lessons learnt from the global financial crisis on Securitisation and with a view to develop an orderly and healthy securitisation market, the RBI guidelines of February 2006 were reviewed and enhancements to the guidelines issued in May 2012.
Regulation of Securitisation - Global initiatives
Securitisation emerged in the developed nations in 1970s as a financial innovation. However, the lessons from the great financial crisis of 2008 activated a number of initiatives by the international standard setting bodies, regulators and governments for re-building investor confidence in the securitisation market.
Indian Securitisation market and transaction volumes:
The Indian market is still at a nascent stage driven as it is by the needs for meeting priority sector lending targets by banks. The band of originators and investors is narrow with NBFCs as the main originators and banks as investors. Public Sector Banks are mostly absent. Insurance, Pension and Mutual Funds can play an important role in the Indian securitisation market as they can invest long term and at the same time have the risk appetite, capacity and expertise for taking exposures to the lower tranches. However, the Pension Funds are not allowed to invest in securitisation while Insurance companies are allowed to invest in high investment grade securities only.
The appetite for Securitisation in India has been on the lower side; it is used largely to meet priority sector lending targets by banks as investors, NBFCs being the originators. This low appetite can be ascribed to several factors, including legal, taxation and stamp duty issues.