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The RBI has implemented some of the recommendations of the Nair Committee report, resulting in a lot more clarity on priority sector treatment, both in case of securitisation and direct assignments
The priority sector lending norms were announced on 1 July 2012 and were changed on 20 July 2012 (http://rbidocs.rbi.org.in/rdocs/notification/PDFs/19072012RG.pdf), to implement the recommendations of the Nair Committee.
The Nair Committee, in its report (http://rbidocs.rbi.org.in/rdocs/PublicationReport/Pdfs/FRNC210212F.pdf), had made several recommendations, primarily putting a limit to the extent to which banks can fulfil their priority sector lending (PSL) requirements by buying portfolios generated by others. PSL requirements are one of the central themes of banking in India, built on the ideals of financial inclusion. PSL requirements treat certain sectors, such as agriculture, small industry, housing, etc, as priorities for banks, and require banks to extend a part of their banking credit to these sectors. While the idea of PSL norms is healthy, most banks neither have the bandwidth nor the organisational focus to lend to these segments—therefore they buy out the portfolios generated by other banks, or NBFCs, to meet their PSL requirements. This has had several implications—first, that there is only a perfunctory service to the priority sector, as NBFCs may cleverly structure a gold loan or a commercial vehicle loan as a priority sector loan and sell the same off to a bank. Secondly, the PSL market led to the buoyant growth of the NBFC sector which would lend to the so-called priority sector at completely non-priority rates, and yet sell the same to banks with high spreads.
Against this background, the Nair Committee had made recommendations which were quite drastic.
The Reserve Bank of India (RBI) has implemented some of these with immediate effect. Several of the recommendations of the Committee, which were unpleasant, have been dropped. The result is a lot more clarity on priority sector treatment, both in case of securitisation and direct assignments. In addition, some of the recommendations, such as a new structure of transferable participation structures, have been discarded.
There was uncertainty whether portfolios originated by banks or NBFCs, and acquired by other banks, would qualify as PSL portfolio. The new norms state that they will so qualify. By itself, this would have been a great booster for non-banking finance companies, which are the prime originators of such pools, but there is still a hitch in form of the securitisation guidelines.
The securitisation guidelines were implemented by the Reserve Bank of India (RBI) in May this year in case of banks. In case of NBFCs, they have not been implemented as yet, but since the buyer of the pool in the instant case is a bank, the guidelines will still apply. The securitisation guidelines classify a transaction into (a) an SPV-structure; and (b) a bilateral or direct assignment structure. There is a diametrically opposite treatment in case of SPV structures and direct assignments. While in case of SPV structures, a minimum risk retention by the seller is a must, the risk retention is completely prohibited in case of direct assignments. In case of SPV-based transactions, there are other requirements—that the originator must have held each asset in the pool for a minimum seasoning period ranging between six months and nine months.
The SPV structures have other issues too—there has been a raging tax issue as regards taxability of the SPV. The income-tax (I-T) department claims that the transactions have not been properly structured to comply with the basic requirements of a pass-through vehicle. The matter is currently being debated in judicial forums.
While the market may still learn to handle securitisation guidelines, the Nair Committee report is still a welcome measure.
However, there is lot of confusion left behind. For example, in case of securitisation, one of the preconditions for PSL treatment is that the rate of interest on the underlying assets charged by the originating entity should not be higher than 8% over the base lending rate of the investing bank. In case of securitisation, one wonders, how could one ever identify, at the time of either origination or pooling, as to which investing banks are, and what are their base lending rates. By definition, a securitisation transaction may have multiple investors. Nay, these investors may also change over time. While it is impossible to identify the investors at the time of origination, even if this is one of the filters applied in selection of the loans, it would be impossible to find the base lending rates of each of the banks that ultimately buy the securities.
But is this the idea of financial inclusion?
Regrettably, however, the priority sector treatment still remains a perfunctory chase for what would, on paper, qualify as priority sector. More often than not, the borrower in question is not a farmer at all—based on some holding of farm land, the borrower buying a truck would say that he intends to carry his farm produce in the truck and seek loan as a farmer.
Unsurprisingly, gold loan companies were doing the same thing—taking a certificate of being a farmer from each borrower, and contending that every gold loan is a farming loan—before the RBI disqualified gold loan companies from PSL treatment altogether.
Some wise people say that the whole approach of the RBI to priority sector assets is flawed. Directing bank credit into certain sectors by mandatory lending norms leads to perfunctory compliances of the sort noted above. Instead, the RBI should have envisaged credit enhancement or cost absorption devices—taking out the primary risks of financial inclusion lending. The present directed lending approach creates biggest challenges for foreign banks doing business in India which don’t have any bandwidth at all to do such lending, and therefore, are left with the only option of buying out portfolios originated by others. Thereby, the cost to the ultimate target of priority sector, the borrowers, does not come down; intermediaries such as NBFCs pick up neat spreads while the buying banks are exposed to the risks of the portfolios they have no clues about.
(The writer is a chartered accountant, trainer and author. He is an expert in such specialised areas of finance as securitisation, asset-based finance, credit derivatives, accounting for derivatives and financial instruments and microfinance. He has written a book titled “Securitisation, Asset Reconstruction and Enforcement of Security Interests”, published by Butterworths Lexis-Nexis Wadhwa. He can be contacted at [email protected]. Visit his financial services website at www.vinodkothari.com.)