INTRODUCTION

Securitization has been one of the most important developments in the financial markets
in the developed countries. The historical use of financial intermediaries to gather
deposits and lend them to those seeking funds was supplemented and even replaced by
securitization processes that bypass traditional intermediaries and link borrowers directly
to money and capital markets. Securitization began in early seventies in the United States
with residential mortgages. Restrictions with regard to lending by mortgage banks across
States within America created a lot of regional imbalances with some States being short
of funds to meet the housing needs and some others having surplus funds without an
attractive investment opportunity. Securitization corrected this imbalance by directly
linking the savers with the borrowers.

The experience in United States has shown that securitization aids disintermediation and
unleashes product and price competition leading to lower interest costs and higher
efficiency in the economy.

Traditionally, existing receivables, where the receivables are not contingent upon any
performance from the originator were securitized. Apart from mortgages, such assets
tended to be auto loans, credit card receivables, educational loan receivables, lease
receivables and industrial loan receivables.

Of late, however, future-flow securitization is gaining momentum leading to the

emergence of new and esoteric asset classes in the securitization market. Future flow

securitization refers to the sale of cash flows that would be earned/generated by the
originator by delivering product/services in the future. Remittances from overseas,
international telephone settlements, export receivables, vacation home loans, music
album sales, movie receivables, income tax revenues are finding favours with the
investors.

SECURITIZATION AN OVERVIEW
Definition
Securitization is a pooling of homogeneous, financial, cash flow producing, and
illiquid assets and issuing claims on those assets in the form of marketable securities.
The higher yield associated with these securities attracts investors who are willing to bear
incremental credit, prepayment and liquidity risk. The fundamental principle in
securitization is specific identification of risks and allocation of the same to various
parties who are best able to manage those risks.

As defined by the recent Ordinance:

Securitization means acquisition of financial assets by any securitization company or
reconstruction company from any originator, whether by raising of funds by such
Securitization company or reconstruction company from qualified institutional buyers by
issue of security receipts representing undivided interest in such financial assets or
otherwise.

Securitization is the process by which, financial assets such as household mortgages,

credit card balances, hire-purchase debtors and trade debtors, etc., are transformed into
securities. In present day capital market usage, the term is implied to include securities
created out of a pool of assets such as household mortgages, credit card balances, hirepurchase debtors and trade debtors, other receivables, etc., transferred, fully or partially,
which are put under the legal control of the investors by the owner (the Originator) in

return for an immediate cash payment and/or deferred consideration through a Special
Purpose Vehicle (SPV) created for this purpose.

The Special Purpose Vehicle finances the assets transferred to it by the issue of debt
securities such as loan notes or Pass Through Certificates, which are generally monitored
by trustees. Pass Through Certificates are certificates acknowledging a debt where the
payment of interest and/or the repayment of principal are directly or indirectly linked or
related to realizations from securitized assets.

Arrangements are made to protect the holders of the debt securities issued as above by
the Special Purpose Vehicle from losses occurring on the securitized assets by a process
termed as credit enhancement, which may take the form of a third party insurance, a
third party guarantee of the Special Purpose Vehicles obligations or an issue of
subordinated debt.

The Originator may continue to service the securitized assets (i.e., to collect amounts due
from borrowers, etc.) and receive servicing fees for the same.
The Originator may also securitize the future receivables, i.e., the receivables that do not
exist at the time of agreement but would be arising in future.

Purpose
Securitization is one way in which a company might go about financing its assets. There
are generally seven reasons why companies consider securitization:

to improve their return on capital, since securitization normally requires less

capital to support it than traditional on-balance sheet funding;

to raise finance when other forms of finance are unavailable (in a recession banks
are often unwilling to lend - and during a boom, banks often cannot keep up with
the demand for funds);

to improve return on assets - securitization can be a cheap source of funds, but

the attractiveness of securitization for this reason depends primarily on the costs
associated with alternative funding sources;

to diversify the sources of funding which can be accessed, so that dependence

upon banking or retail sources of funds is reduced;

to reduce credit exposure to particular assets (for instance, if a particular class of

lending becomes large in relation to the balance sheet as a whole, then
securitization can remove some of the assets from the balance sheet);

to match-fund certain classes of asset - mortgage assets are technically 25 year

assets, a proportion of which should be funded with long term finance;
securitization normally offers the ability to raise finance with a longer maturity
than is available in other funding markets;

to achieve a regulatory advantage, since securitization normally removes certain

risks which can cause regulators some concern, there can be a beneficial result in
terms of the availability of certain forms of finance (for example, in the UK
building societies consider securitization as a means of managing the restriction
on their wholesale funding abilities).

Establishing the primary rationale for the securitization activity, is a vital part of the
preparation for a securitization transaction, since it influences the sorts of administrative
tasks which need to be developed as well as the transaction structures themselves.

Securitization: The difference

Unlike a traditional bond issue, the repayment of funds raised through securitization is
not an obligation of the originator, or the finance company issuing the securitized
instrument. In a straight bond or debenture issue, in the event of the company going
bust, the investors would have a tough time getting their funds back, if at all. However, if
one invests in a securitized instrument, investors are assured of interest payments even if
the finance company goes bust, as the securitized loans are separated from the finance
companys books through a SPV which holds these assets. At the same time, as
securitized instruments can be traded, the investor is provided with liquidity as the
securitized bond can be sold in the market.

Features of Securitization
A securitized instrument, as compared to a direct claim on the issuer, will generally have
the following features:

Marketability:
The very purpose of securitization is to ensure marketability to financial claims.
Hence, the instrument is structured so as to be marketable. This is one of the most
important features of a securitized instrument, and the others that follow are
mostly imported only to ensure this one. The concept of marketability involves

two postulates: (a) the legal and systemic possibility of marketing the instrument;
(b) the existence of a market for the instrument.

As far as the legal possibility of marketing the instrument is concerned,

traditional mercantile law took a contemporaneous view of marketable
documents. In most jurisdictions of the world, laws dealing with marketable
instruments (also referred to as negotiable instruments) were mostly limited in
application to what were then in circulation as such. Besides, the corporate laws
mostly defined and sought to regulate issuance of very usual corporate financial
claims, such as shares, bonds and debentures. For any codified law, this is not
unexpected, since laws do not lead commerce: most often, they follow, as the
concern of the law-maker is mostly regulatory and not promotional.

Hence, in most jurisdictions of the world, well-coded laws exist to enable and
regulate the issuance of traditional forms of securitized claims, such as shares,
bonds, debentures and trade paper (negotiable instruments). Most countries lack
in legal systems pertaining to other securitized products, of recent or exotic origin,
such as securitization of receivables. On a policy plane, it is incumbent on the part
of the regulator to view any securitized instrument with the same concern as in
case of traditional instruments, for reasons of investor protection.
However, it needs to be noted that where a law does not exist to regulate issuance
of a securitized instrument, it is naive to believe that the law does not permit such
issuance. As regulation is a design by humanity itself, it would be ridiculous to

presume that everything that is not regulated is not even allowed. Regulation is an
exception and freedom is the rule.

The second issue is one of having or creating a market for the instrument.
Securitization is a fallacy unless the securitized product is marketable. The very
purpose of securitization will be defeated if the instrument is loaded on to a few
professional investors without any possibility of having a liquid market therein.
Liquidity to a securitized instrument is afforded either by introducing it into an
organized market (such as securities exchanges) or by one or more agencies
acting as market makers in it, that is, agreeing to buy and sell the instrument at
either pre-determined or market-determined prices.

Merchantable quality:
To be market-acceptable, a securitized product has to have a merchantable
quality. The concept of merchantable quality in case of physical goods is
something which is acceptable to merchants in normal trade. When applied to
financial products, it would mean the financial commitments embodied in the
instruments are secured to the investors' satisfaction. "To the investors'
satisfaction" is a relative term, and therefore, the originator of the securitized
instrument secures the instrument based on the needs of the investors. The general
rule is: the more broad the base of the investors, the less is the investors' ability to
absorb the risk, and hence, the more the need to securitize.

For widely distributed securitized instruments, evaluation of the quality, and its
certification by an independent expert, viz., rating is common. The rating serves
for the benefit of the lay investor, who is otherwise not expected to be in a
position to appraise the degree of risk involved.

In case of securitization of receivables, the concept of quality undergoes drastic

change making rating is a universal requirement for securitizations. As already
discussed, securitization is a case where a claim on the debtors of the originator is
being bought by the investors. Hence, the quality of the claim of the debtors
assumes significance, which at times enables to investors to rely purely on the
credit-rating of debtors (or a portfolio of debtors) and so, make the instrument
totally independent of the oringators' own rating.

Wide Distribution:
The basic purpose of securitization is to distribute the product. The extent of
distribution which the originator would like to achieve is based on a comparative
analysis of the costs and the benefits achieved thereby. Wider distribution leads to
a cost-benefit in the sense that the issuer is able to market the product with lower
return, and hence, lower financial cost to himself. But wide investor base involves
costs of distribution and servicing.

In practice, securitization issues are still difficult for retail investors to

understand. Hence, most securitizations have been privately placed with

professional investors. However, it is likely that in to come, retail investors could

be attracted into securitized products.

Homogeneity:
To serve as a marketable instrument, the instrument should be packaged as into
homogenous lots. Homogeneity, like the above features, is a function of retail
marketing. Most securitized instruments are broken into lots affordable to the
marginal investor, and hence, the minimum denomination becomes relative to the
needs of the smallest investor. Shares in companies may be broken into slices as
small as Rs. 10 each, but debentures and bonds are sliced into Rs. 100 each to Rs.
1000 each. Designed for larger investors, commercial paper may be in
denominations as high as Rs. 5 Lac. Other securitization applications may also
follow this logic.

The need to break the whole lot to be securitized into several homogenous lots
makes securitization an exercise of integration and differentiation: integration of
those several assets into one lump, and then the latter's differentiation into
uniform marketable lots. This often invites the next feature: an intermediary to
achieve this process

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Economic impact of securitization:

Securitization is as necessary to the economy as any organized markets are. While this
single line sums up the economic significance of securitization, the following can be seen
as the economic merits in securitization:

Facilitates creation of markets in financial claims:

By creating tradable securities out of financial claims, securitization helps to
create markets in claims which would, in its absence, have remained bilateral
deals. In the process, securitization makes financial markets more efficient, by
reducing transaction costs.

Disperses holding of financial assets:

The basic intent of securitization is to spread financial assets amidst as many
savers as possible. With this end in view, the security is designed in minimum size
marketable lots as necessary. Hence, it results into dispersion of financial assets.
One should not underrate the significance of this factor just because most of the
recently developed securitizations have been lapped up by institutional investors.
Lay investors need a certain cooling-off period before they understand a financial
innovation. Recent securitization applications, viz., mortgages, receivables, etc.
are, therefore, yet to become acceptable to lay investors. But given their attractive
features, there is no reason why they will not.

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Promotes savings:
The availability of financial claims in a marketable form, with proper assurance as
to quality in form of credit ratings, and with double safety-nets in form of trustees,
etc., securitization makes it possible for the lay investors to invest in direct
financial claims at attractive rates. This has salubrious effect on savings.

Reduces costs:
As discussed above, securitization tends to eliminate fund-based intermediaries,
and it leads to specialization in intermediation functions. This saves the end-user
company from intermediation costs, since the specialized-intermediary costs are
service-related, and generally lower.

Diversifies risks:
Financial intermediation is a case of diffusion of risk because of accumulation by
the intermediary of a portfolio of financial risks. Securitization further diffuses
such diversified risk to a wide base of investors, with the result that the risk
inherent in financial transactions gets very widely diffused.

Focuses on use of resources, and not their ownership:

Once an entity securitizes its financial claims, it ceases to be the owner of such
resources and becomes merely a trustee or custodian for the several investors who
thereafter acquire such claim. Imagine the idea of securitization being carried
further, and not only financial claims but claims in physical assets being

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securitized, in which case the entity needing the use of physical assets acquires
such use without owning the property. The property is diffused over an investor
crowd. In this sense, securitization carries Gandhi's idea of a capitalist being a
trustee of resources and not the owner. Securitization in its logical extension will
enable enterprises to use physical assets even without owning them, and to
disperse the ownership to the real owner thereof: the society.

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PARTIES INVOLVED
Securitization normally involves a wide variety of counterparties and advisers. On one
particularly complex transaction a few years ago there were 6 law firms, 3 firms of
accountants, 1 insurance broker, 1 investment bank, 1 consultant and 12 principals
(banks, originators, administrators, credit enhancers, underwriters and so on).
A transaction normally involves the following parties:

Originator and Administrator

Lead Underwriter who purchases the debt issued by the SPV (and sells it to
Eurobond investors)

Structuring Team either involving personnel from the lead underwriter and/or
other advisers

Two sets of lawyers, at least one of whom is a securitization specialist

Trustee and Trustee's lawyers representing the interests of the note holders in the
event that there is (a) an enforcement event (things go wrong) or (b) any
requirement to change or amend the documents or procedures after the transaction
completes;

Rating Agencies required to undertake an analysis of the risks associated with the
transaction and to award a credit rating to the debt issued

Originator's accountants to agree accounting treatment for the transaction, to

verify the analysis and existence of the assets involved and to confirm work
undertaken to show solvency

Credit Enhancement Providers and their lawyers transactions often involve a

third party fronting some of the risks associated with the assets

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Standby Servicer and their lawyers a third party prepared to administer the assets
in the event that the existing servicer fails or is incompetent; this is now becoming
a requirement for all transactions where the administrator does not already have at
least an A1/P1 short term rating

Clearing Bank and its lawyers running the originator's and the Issuer's bank
accounts, all of which normally require new mandates and a Bank Agreement is
also set up to regulate the operation of all aspects of the accounts

Banking Facility Providers and their lawyers often there are requirements for
additional banking facilities, e.g.: liquidity facilities or guaranteed deposit
arrangements ("GICs")

Hedging Providers and their lawyers

Paying Agents, Agent Banks, Common Depositary etc. a whole host of

organizations with Euro market responsibilities

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SPECIAL PUROSE VEHICLE

As opposed to a general purpose vehicle or a trading corporation, a Special purpose
vehicle, as the name suggests, is formed for a special purpose: therefore its powers are
limited to what might be required to attain that purpose and its life is destined to end
when the purpose is attained.

When a corporation, call it the sponsor of the SPV, wants to achieve a particular purpose,
for example, funding, by isolating an activity, asset or operation from the rest of
the sponsor's business, it hives off such asset, activity or operation into the vehicle by
forming it as a special purpose vehicle. This isolation is important for external investors
whose interest is backed by such hived-off assets, etc., but who are not affected by the
generic business risks of the entity of the originating entity. Thus SPVs are housing
devices - they house the assets etc transferred by the originating entity in a legal outfit,
which is legally distanced from the originator, and yet self-sustained as not to be treated
as the baby of the originator.

By its very nature, an SPV must be distanced from the sponsor both in terms of
management and ownership, because if the SPV were to be owned or controlled by the
sponsor, there is no difference between a subsidiary and an SPV.

Being an independent, an SPV is responsible for its own funding, risk capital and
management decisions. Most SPVs, for example, securitization SPVs, run on a

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prepunched program and do not have to take any management decision: they are almost
"brain dead".

Why create an SPV?

The creation of the trust serves to separate the risks of newly created securities from the
risk of the originating bank. This helps the investors in the new securities to clearly
identify and assess the risk of the securities. A common reason for the failure of an issue
of securities by an institution is that investors have difficulty in assessing the risk
attached to the security. This is because the risk attached to the security is closely
interwined with he overall risk of the issuing institution, which is complex and hard to
assess.

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SECURITIZATION PROCESS
Following are the steps typically involved in a securitization process:

Identify and/or accumulate assets:

These assets could include anything from airline ticket receivables, hire-purchase
rental receivables, sales cash flows of any commodity, et al.

Values are represented by future cash flows and it is essential to recognize a specific
timeframe for this purpose. The market for each security will define what investorrelevant information is. This information is normally checked through credit-rating
agencies that verify the credibility of the projected cash flows and the stability of their
sources.

Transfer or insulate assets from transferors creditors:

Assets are isolated usually through a true sale or clean transfer by the originator to
a bankruptcy-remote SPV that will issue the securitized bonds.

The issuing SPV may be either a limited purpose company, or a trust established
under a restrictive deed. In both cases the SPV will be managed by an independent
trustee, so that the issuer has no conflict of interest with the security.

Also acceptable is the assignor retaining legal title to the underlying asset but holding
such a title subject to the equitable interest of the assignee. This effectively means

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that the title to the asset will be held by the borrower (assignor) subject to the first
change in favour of the lender (assignee).

Issuing bonds:
The issue of debt bonds is how the anticipated cash flows from the assets are
transformed into cash in hand either by an SPV offering bonds to the public or the
private investor market.

The FI as an underwriter will take an initial investment position in the debt and later
offload it in the market, thus making a margin. This creates a huge market for term
lending and improves the performance of the FIs.

Every securitization requires the appointment of a servicer or administrator to collect

and distribute obligor payments from the assets performance, manage the collection
of recoveries for defaulted monitor and report on receivables.

The administrator is entitled to receive a fee for the services, paid out of the
collections on the assets. This fee represents one of the methods to compensate an
originator for transferring its rights to the assets.

Enhance and support assets and/or securities

The advantages of isolating cash flows and using them to service issued debt
obligations may justify securitization. Nevertheless, ABS and MBS investors may

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prefer structures to contain explicit enhancements that may improve the assets
performance. Others may boost the performance of the structure, or guarantee
payments to investors.

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SECURITIZATION STRUCTURE
Figure 1 below presents a typical Securitization Structure.

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Figure 1: A typical Securitization Structure

Rating Agency

Lender
(Originator /
Servicer)

Borrowers

Consideration

Assigns Loans
Trustee

SPV
Issuer
Consideration

ABS
Investors

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Flows at the time of Securitization

Periodic Cash flows post Securitization (repayment by borrowers passed
on to investors)
1. Assets are originated by a company, and funded on that company's balance sheet.
This company is normally referred to as the Originator".
2. Once a suitably large portfolio of assets has been originated, the assets are
analyzed as a portfolio, and then sold or assigned to a third party which is
normally a special purpose vehicle company (an " SPV") formed for the specific
purpose of funding the assets. The SPV is sometimes owned by a trust, or even,
on occasions, by the Originator.
3. Administration of the assets is then sub-contracted back to the Originator by the
SPV.
4. The SPV issues tradable "securities" to fund the purchase of the assets. The
performance of these securities is directly linked to the performance of the assets and there is no recourse (other than in the event of breach of contract) back to the
Originator.
5. Investors purchase the securities, because they are satisfied (normally by relying
upon a rating) that the securities will be paid in full and on time from the cash
flows available in the asset pool. A considerable amount of time is spent
considering the different likely performances of the asset pool, and the
implications of defaults by borrowers on the corresponding performance of the
securities. The proceeds upon the sale of the securities are used to pay the
Originator.

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6. The SPV agrees to pay any surpluses which arise during its funding of the assets
back to the Originator - which means that the Originator, for all practical
purposes, retains its existing relationships with the borrowers and all of the
economics of funding the assets (i.e.: the Originator continues to administer the
portfolio, and continues to receive the economic benefits (profits) of owning the
assets).
7. As cash flows arise on the assets, these are used by the SPV to repay funds to the
investors in the securities.

The original concept of securitization was to create securities based on financial assets,
say, receivables on mortgage loans, auto loans, credit cards, etc. However, later
innovation has extended application of securitization to cover non-financial assets such as
aircraft, buildings, and on the other hand, the same device has also been applied to
securitize risk, such as insurance risk, weather risk, etc.

Let us consider an example:

A finance company with a portfolio of car loans can raise funds by selling these loans to
another entity. But this sale can also be done by securitizing its car loans portfolio into
instruments with a fixed return based on the maturity profile (the period for which the
loans are given). If the company has Rs 100 crore worth of car loans and is due to earn 17
per cent income on them, it can securitize these loans into instruments with 16 % return
with safeguards against defaults. These could be sold by the finance company to another
if it needs funds before these loan repayments are due. The principal and interest

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repayment on the securitized instruments are met from the assets which are securitized, in
this case, the car loans.

Selling these securities in the market has a double impact. One, it will provide the
company with cash before the loans mature. Two, the assets (car loans) will go out of the
books of the finance company once they are securitized, a good thing as all risk is
removed.

Forms of Securitization Structures

The financial structure of the securitized product is a function of the type of the
instrument to be issued i.e. Pass Through Certificates (PTC) or Pay Through Certificates
(Bonds /Debentures). In both the cases, assets are sold to SPV for further sale to investors
in the form of a new instrument. However, the similarity ends here. In case of PTC,
investors get a direct undivided interest in the assets of SPV. The cash flows which
include principal, interest and pre-payments received from the financial asset are passed
on to investors on a pro rata basis after deducting the servicing fee etc. as and when
occurred without any reconfiguration. Therefore, the investor takes the reinvestment risk
on the payments received. The frequency of the payment is dependent on the frequency
of the payment from the financial assets. (Figure 2)

The PTC structure has a long life and unpredictable cash flows that inhibit participation
by some of the fixed income investors. The pay through structure reduces the term to
maturity and provides some certainty regarding timing of cash flows. It is issued as a debt

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security (bonds / debentures) and designed for variable maturities and yield so as to suit
the needs of different investors. The debt instrument is issued in the form of a tranche and
each tranche is redeemed one at a time. In this case, cash flows are to be reconfigured
since they have to match the maturity profile of the debt security. The payment to
investors is at different time intervals than the flows from the underlying assets.
Therefore, the reinvestment risk on the cash flows till they are passed on the investors is
carried by the SPV. (Figure 3)

The Act has named the securitized instrument as Security Receipt which has been added
as a security in The Securities Contract (Regulation) Act, 1956 and thereby makes it
available for trading through stock exchange mechanism. As per the definition of security
receipt in the Act (section 2(zg)) transfer of only an undivided interest in the financial
asset is allowed and thus the Act recognizes only pass-through certificates (PTC) as the
possible instrument for securitization. This has eliminated the possibility of issuing pay
through certificates in Indian markets which are more investor friendly and are the norm
in the international markets outside USA.

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Figure 2: Pass through Structure

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Figure 3: Pay Through Structure

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TYPES OF SECURITIZATION
To analyze the potential of securitization India, we split the securitization market into the
following four broad areas: Asset Backed Securities (ABS)
Asset backed Securities are the most general class of securitization transactions. The asset
in question could vary from Auto Loan/Lease/Hire Purchase, Credit Card, Consumer
Loan, student loan, healthcare receivables and ticket receivables to even future asset
receivables. The split of outstanding ABS in the US is given in Figure 4
Figure 4

In the Indian context, there has been moderate amount of activity on the Auto Loan
securitization front. Companies like TELCO, Ashok Leyland Finance, Kotak Mahindra
and Magma Leasing have been securitizing their portfolio of auto loans to buyers like

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ICICI and Citibank over the past 2-3 years, with several of the recent transactions rated
by rating agencies like CRISIL and ICRA. While many of the deals are bilateral portfolio
buyouts, ICICI has used the SPV structure * and placed the issuance privately to
corporate investors and banks.
In April last year, Global Tele-Systems Ltd. raised approximately USD 32 million by
securitizing the future receivables of its consumer telecom business to an SPV named
Integrated Call Management Centre. Tata Finance was the sole investor in the pass
through certificates issued by the SPV.

One of the first publicized structured finance transactions in India was the Rs. 4.09 billion
non convertible debenture program by India Infrastructure Developers Ltd (IIDL), an
SPV set up for building and operating a 90 MW captive co-generation power plant for
IPCL (March, 1999). IIDL raised finances on the BOLT (Build Operate Lease Transfer)
model on the strength of its future cash flows from IPCL and limited support from L&T.
The transaction was rated AA- (SO) by CRISIL.

ICICI has done several bilateral asset backed securitization deals including securitizing
DOT (Department of Telegraph) receivables from Sterlite Industries and Usha Beltron.
While the activity in the ABS market is picking up in India, the number of investors for
securitized paper is very limited. In the absence of a Securitization Act, there are taxation
and legal uncertainties with the securitization vehicle. In India, transfer of secured assets
as required for securitization, can attract a stamp duty as high as 10% in some states

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precluding transaction possibilities. With favorable legislation and taxation regime, the
ABS market in India can hope to see a lot of activity in future.

Future Cash Flow Receivables

Asset securitization processes have been structured not only based on the collateral of
existing assets but also on the collateral of future cash flow receivables. Such a structure
enables asset securitization to be used as a corporate finance tool or as a tool for
financing future projects. The securitization process works as follows. The trust or the
SPV that is set up to carry out the securitization buys the rights to a specified stream of
cash flows that is expected to be generated by the company or the planned project. The
SPV will issue bonds against the collateral of the cash flow receivables. Principal and
interest payments on the bonds will be met from the project receivables. Any surplus
from the receivables will be passed back to the company.

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TYPES OF ASSETS
All assets that generate funds over time can be securitized. These include repayments
under car loans, money due from owners of credit cards, airline ticket sales, toll
collections from roads or bridges, and sales of petroleum-based products from oil
refineries. In fact, artists have even raised funds by securitizing the royalty they will get
out of future sales of their records.

Securitization works well if the securitized asset (say, the pool of car loans) is
homogenous (the same kind) with regard to credit risk (how sound the borrower is) and
maturity. Ideally, there should be historical data on the portfolios performance and that of
the issuing company with regard to credit quality and repayment speed.

Asset Characteristics
Assets which can be securitized easily have a number of characteristics:

Cash-flow
A principal part of the asset is the right to receive a cash flow from a debtor in
certain amounts (or amounts defined by reference to a market or administered
rate) on certain dates i.e.: the asset can be analyzed as a series of cash flows.

Security
If the security available to collateralize the cash flows is valuable, then this
security can be realized by the SPV. For instance, for a mortgage loan, there is
security over the property and other collateral, which will make a significant
contribution towards recovering any losses which might otherwise arise.

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Consequently, if there is a default, an effective method of ensuring that the SPV

can gain the benefit of the security will be required (otherwise securitization will
be an uneconomic way of arranging funding).

Distributed risk
Assets either have to have a distributed risk characteristic or be backed by a
suitably-rated credit support. For instance: a single retail loan is relatively small in
value in the context of the available supply of retail loans to a single transaction
(normally in the region of 4,000 mortgage accounts or 100,000 personal loans or
small leases); in this way, the performance of one single asset is not likely to
distort the performance of the entire portfolio. Consequently, the entire portfolio
can be considered as a single asset, with a predictable performance.

Concentrations of risk do not have this characteristic. If individual assets were to

have a significant value in relation to the whole (e.g.: suppose only 100 mortgages
were to be securitized) then a different approach has to be taken, and these
individual assets have to be analyzed individually and specific enhancement
arranged.

Homogeneity
Assets have to be relatively homogeneous - this means that there are not wide
variations in documentation, product type or origination methodology. Otherwise,
it again becomes more difficult to consider the assets as a single portfolio.

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No executory clauses
The contracts to be securitized must work, even if the Originator goes bankrupt.
Certain clauses are therefore difficult to include in a securitisable contract -e.g.: in
a photocopier lease, the inclusion of a clause stating that the Originator will
maintain the photocopier would make that lease difficult to securitize. These sorts
of contract are normally referred to as "executory contracts".

Capacity
It must be possible for the necessary transactions which are needed for the
securitization to take place in relation to the assets concerned - for instance, if the
assets contain specific prohibitions against assignment, then they will not be
securitisable in the traditional sense.

Independence from Originator

The on-going performance of the assets must be independent of the existence of
the Originator. This tends to be a wider restriction than the example given above
about executory contracts. A number of technical matters can arise, for instance, if
asset yields are quoted only by reference to the Originator (e.g.; as the
Originator's rate), then this will cause a structural difficulty in the event of the
Originator's insolvency (i.e.: what now is the rate that the assets yield?).

Home equity loans

Meaning of home equity loans:
Home equity is basically a second loan against the mortgage of a house. The possibility
of such a loan arises when the value of a house is more than the outstanding value of a

34

mortgage - quite likely situation after the first mortgage has been partly amortized. The
second lender takes a second mortgage over the house, normally secondary in priority
over the rights of the first lender, and provides funding. Normally, the home equity loans
do not find its application in the same house: application of the money borrowed is
normally not controlled.
A home equity loan could either be a close-end loan: meaning the loan is paid off over a
stated period, or it may be a line of credit, that is, one where the borrower pays regular
interest but continues to enjoy the line of credit as an overdraft against the value of the
house.
In the US securitization market, home equity loans forms a significant portion of nonRMBS transactions.
Data for year 2000 reveals home equity loan securitization forms approximately 25% of
the total ABS market. In contrast sub prime mortgage loans form less than 10%, some
estimates say only 6%, of the European mortgage-backed market.

Auto loans
Auto loans securitization market:
Ever since the emergence of the ABS market, auto loans have formed an important
segment. The interesting features of auto loan markets are high asset quality and ease in
liquidation of delinquent receivables. The emergence of an alternative in form of assetbacked commercial paper has reduced the significance of auto loan securitizations, but
the activity in this segment is still important.

35

Product structure
The quality of auto loans depends upon the quality of the underlying collateral, lending
terms (loan to value ratio), and tenure. Recent years have seen tremendous competition in
auto loan financing segment with concomitant deterioration in the quality of the loans there is an increased proportion of used car loans versus new car loans, the loan to value
ratio has worsened and the financings are for a longer period now.
Hence, increased importance is attached today to the quality of the originator.
Typical features:
The payment structure of auto loans normally ranges between 3 to 6 years which is ideal
for direct pass throughs as well as collateralized bonds.
An important legal issue for auto loan securitization is whether the assignment of
receivables achieves a "true sale" recognized by law. Here the understanding of the legal
features of the concerned market becomes important.

Bank securitization
Collateralized Debt Obligations (CDO, CLO, CBO)
There is no basic distinction between generic securitizations and the CBO/ CLO issuance
at the instance of banks, except that here, the originating bank is trying to parcel out a
pool of loans or bonds held by the bank. There could also be a difference of motivation:
while for usual securitizations, the stronger motivation is liquidity, in case of CBO/
CLOs, the motivations could rank from capital relief, to risk transfer, to arbitraging
profits, to balance sheet optimization, etc.

36

Where the originating bank transfers a pool of loans, the bonds that emerge are called
collateralized loan obligations or CLOs. Where the bank transfers a portfolio of bonds
and securitizes the same, the resulting securitized bonds could be called collateralized
bond obligations or CBOs. A generic name given to the two is collateralized debt
obligations or CDOs, as in a number of cases, the portfolio transferred by the bank could
consist of loans as well as bonds, and at times, even ABS.

At a recent meeting of securitization professionals at Arizona in Feb., 2000, some

participants even reported the emergence of a new bank securitization instrument:
collateralized investment obligations (CIOs) where a bank securitizes its equity
investments.

Difference between normal securitizations and CDO structures:

Though there is no basic difference in terms of the essential structure, some differences
arise by the very nature of the collateral and the motives of the issuer. The important
points of difference are:

The number of obligors in the collateral pool are not many: unlike mortgage
portfolios or auto loans portfolios having thousands of obligors, CDO pools will
have 100 -200 loans.

The loans/ bonds are mostly heterogeneous. The originator might try to bunch
together loans which do not exhibit any mutual correlation, to provide benefits of
a diversified portfolio.

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Most CDO structures use a tranched, multi-layered structure with a substantial

amount of residual interest retained by the originator.

Generally, CDO issues will use a reinvestment period and an amortization period.
Some tranches might have a "soft bullet" repayment (meaning a bullet repayment
that is not guaranteed by any third party).

A common practice in CDO market is arbitraging, where larger banks buy out
loans from smaller ones and securitize them, making arbitrage revenues in the
process.

Motives in CBO/ CLO issuance:

Banks would resort to securitization essentially with 4 motives, in different combinations:
sourcing cheaper funds, attaining higher regulatory capital, better asset-liability
management, and reduced non-performing or under-performing assets.
There is yet another class of CDOs is called arbitrage CDOs where the originating bank
buys loans/bonds from the market and securitizes the same for gaining an advantage on
the rates. Since the motive of such securitizations is arbitraging, such CDOs are called
arbitrage CLOs/ CBOs. To distinguish these from the ones where a bank securitizes its
own receivables, the latter are called balance sheet CLOs/ CBOs.

Yet another variety of CLOs is developing fast: synthetic CLOs. Here the originating
bank retains the loans on its balance sheet but merely securitizes the inherent credit risk.
Synthetic CLOs repackage the underlying loans into cash flows that suit the needs of the
investors and are not dependant on the repayment structure of the underlying loans.

38

Types of CDOs:
As the above discussion reveals, CDOs could basically be of two types: balance sheet
CDOs and arbitrage CDOs. Balance sheet CDOs are those which result into transfer of
loans from the balance sheet and hence, which impact the balance sheet of the originator.
Arbitrage CDOs are those where the originator is merely a repackager: buying loans or
bonds or ABS from the market, pooling them together and securitizing the same. The
prime objective in balance sheet CDOs is the reduction of regulatory capital, while the
evident purpose in arbitrage CDOs is making arbitraging profits.
Balance sheet CLOs could be further classed into two: cash flow CDOs, and synthetic
CDOs.

Cash flow CDOs are the usual CDO tranches where the originating bank transfers a
portfolio of loans into an SPV. Master trust structures are commonly employed in CDOs
to enable the bank to keep transferring loans into the pool on a regular basis without
having to do complex documentation everytime.

Commercial loans are not regular-repaying in the sense of mortgage loans or auto loans.
Hence, there is no question of regular retirement of CDOs like pass throughs in the
mortgage market. Most of the cash flow CDOs repay by way of bullet repayments, and
hence they need to have a reinvestment period during which the cash collected will be
reinvested.

39

Synthetic CDOs do not intend to raise cash by transferring loans, but instead merely
transfer the risk inherent in the loans. In a synthetic CLO, the originating bank does not
transfer the loans off its books but merely transfers the credit risk in the loans by issue of
credit linked notes. The reference asset is the loans held by the bank - as the credit risk in
the loans is transferred to the SPV and from there on to the investors, the originating bank
achieves regulatory capital relief.

The technique in a synthetic CDO consists of an SPV issuing credit linked notes to
investors. The proceeds of the securities do not come to the originator, but are instead
invested in AAA rated securities, to ensure that the repayment of principal to the
investors is secured. The SPV in turn writes a credit default swap with the originating
bank. For more on credit default swaps and other credit derivatives. The loans remain on
the books of the originating bank. The bank keeps paying credit default swap premium to
the SPV. Should there be any default event with the originating bank, the bank would
seek a payment from the SPV, in which case the investors of the SPV would suffer losses.
As long as the default event does not take place, investors get returns equal to (a) returns
from the AAA-rated investments and (b) the default swap premium.

Synthetic CLOs have a very substantial advantage over traditional CLOs - as there is no
transfer of the loans itself, the legal issues associated with notice to obligors and
perfection of legal transfer are all completely avoided.

40

As regards regulatory capital relief on synthetic CLOs, the US FRB issued a supervisory
statement no. 99 -32 dated 15th Nov., 1999. The said circular provides that for the
purposes of risk-based capital, the originator may treat the cash proceeds from the sale of
credit linked notes that provide protection against underlying reference assets as cash
collateralizing these assets. This would permit the reference assets, if carried on the
sponsoring institutions books, to be assigned to the zero percent risk category to the
extent that their notional amount is fully collateralized by cash. This treatment may be
applied even if the cash collateral is transferred directly into the general operating funds
of the institution and is not deposited in a segregated account. The synthetic CLO would
not confer any benefits to the sponsoring banking organization for purposes of calculating
its Tier 1 leverage ratio because the reference assets remain on the organizations balance
sheet.

In this era of bank consolidations, CDOs can help banks to proactively manage their
portfolio. CDOs can also help banks in restructuring their stressed assets. ICICI made an
aborted attempt to do a CBO issuance in August 2000. The CDO market in India is,
however, likely to grow slowly owing to its complexities. The taxation and accounting
treatment for CDOs needs to be clarified.

Mortgage Backed Securities (MBS, RMBS, CMBS)

Securitization of residential mortgages is the mother of all securitizations. Residential
mortgage-backed securities (RMBS) are generally pass through securities or bonds based
on cash flows from residential home loans, as opposed to commercial real estate loans.

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Evidently enough, the residential mortgage market was one of the most appropriate
applications of securitization. That is why, for good reasons, some or the other way of
refinancing mortgages has been found in most parts of the world. If in USA, it was
securitization, in Europe, a traditional mortgage funding instrument, Pfrandbriefe has
been in vogue for almost 200 years.
There are two very strong reasons for RMBS being tuned to securitization: one, the long
maturities of residential mortgages, and two, the fact that mortgage lending is backed by
charge over real estate, which is a strong asset-backing enabling the investors to take an
independent exposure on the receivables. The govt. support to development of secondary
markets in mortgages has also been a strong reason, and the governments easily took this
as one of their major welfare activities.
Typical features:

Most of the mortgage funding is for very long maturities: say, 15 years to 30
years.

If the securitization is a pass-through, the investors will get paid over such a long
period, say 20 years. As that is too long a period for most investors, it is common
for mortgage securitizations to adopt the bond method (collateralized mortgage
obligations) which are repayable in different maturities.

RMBS could be either agency-backed or non-agency-backed. Agency-backed

refers to the transactions pooled and bought by specialized securitization agencies
such as FNMA (Federal National Mortgage Association) and GNMA
(Government National Mortgage Association). Outside the USA also, several
countries have put up their own models of FNMA as entities that buy mortgages

42

and securitize them. Mortgages securitized by the agencies normally provide the
guarantee of the agency to the investors.

If the mortgages are secured by the guarantee of the government or the

securitization agency (such as GNMA or FNMA in the USA), the only risk that
the investors carry is the risk of prepayment.

Depending on the level of development of securitization, mortgage securitization

market can be a highly commoditized market where mortgage origination,
servicing and administration can all be viewed by the market as independent
commodities and be regularly traded.

As we discussed above, MBS constitutes about 76% of the securitized debt market in the
US. In contrast, the MBS market in India is nascent - National Housing Bank (NHB), in
partnership with HDFC and LIC Housing Finance, issued Indias first MBS issuance in
August 2000.

In traditional mortgages, prior to securitization, home buyers obtain loans from mortgage
originators. Typically, originators lend to many home buyers; thus, they end up with a
loan portfolio. Such loan portfolios may either be held by the originator or sold to other
investors. The demand for credit, therefore, comes from home buyers, and the mortgage
originators supply the necessary credit. When the demand exceeds the supply in a region,
thrifts will sell their loan portfolio (which they originated) in order to supply additional
credit. When the supply exceeds the demand in a region, thrifts will buy portfolios from
other regions. Often, redistribution of mortgage credit from capital-surplus to capital-

43

deficit regions is necessary, and to accomplish this, usually the loans are sold and bought
by thrifts and mortgage banks around the country. When the overall demand for credit
grows at a rate that cannot be sustained by suppliers of credit, the deposit base of lenders
may simply be unable to support the demand for credit. For a liquid secondary market in
mortgage loans to develop, it is necessary that some of the following conditions are met:

The originators must continue to service the loans.

The loans must be standardized with respect to maturity, coupons and so on.

There must be a credible guarantee regarding the performance of home buyers in

paying the loan back.

The potential of MBS in India, however, is huge. With NHB actively looking towards the
development of a Secondary Mortgage Market (SMM) in the country, the MBS market in
India could soon overtake the other securitization transactions in the country. An MBS
market can help small HFCs with good origination capabilities and limited balance sheet
strength in staying profitable and concentrate on the housing loan origination. The most
important roadblocks for MBS in India are lack of mortgage foreclosure norms and the
high incidence of stamp duty for assignment of mortgage necessary for securitization.

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CALCULATION OF MONTHLY CASH FLOWS

Now we shall see how the monthly cash flows are calculated for a fixed rate mortgage
(FRM). The traditional mortgage is the 30-year FRM with level monthly scheduled
payments. This is an amortizing loan, wherein level monthly payments are scheduled
over 360 months so that the loan is retired at the end of 360 months.

We illustrate the calculation of monthly payments, interest components and principal

components for a standard 30-year FRM. Let Fo be the face value of the loan that was
taken, let n be the original term of the loan in months, and let R be the annualized interest
that is specified in the FRM. Then, the monthly payments x are computed as shown in
equation 1 where r= R/12.
x = Fo x r (1 + r)n
[(1 + r)n 1]

...(1)

Then the principal payments will be simply,

Ft-1 Ft

.(2)

The interest payments for the month t are given by

(R/12) x Ft-1

.....(3)

The figure 5 shows the pattern of scheduled interest and principal payments over the life
of the mortgage. Note that in the early life of the mortgage, most of the monthly
payments x are applied towards repaying the interest component of the loan. It is toward
the end of the life of the mortgage that the payments towards principal constitute a major
part of the monthly payments. As the mortgage gets older, the outstanding principal
balance declines and, as a consequence, the interest payments decline. Since the monthly

45

scheduled payments are fixed, this means that the scheduled principal payments will
increase.
Figure 5

Interest Payment

Principal Payment

Time (months)

Prepayments
Mortgages permit the homeowners to prepay their loans. This prepayment provision
introduces timing uncertainty into the originating banks cash flows from its loan
portfolio. For example, if the bank originates a pool of mortgages with a weighted
average rate of 8% and six months later the mortgage rates drop significantly below 8%,
say to 7%, then the loan portfolio is certain to experience significant prepayments as
borrowers rush to refinance their mortgages with less costly loans. The lender has a long
position in the mortgage loan that entitles him or her to monthly scheduled payments, but
has also sold an option to the homeowners that gives them the right to repay the loan
when the circumstances demand it. This means that the bank cannot predict the

46

future cash flows from its loan portfolio with certainty. Clearly, the option to prepay
will be priced into the loan by the bank, and the borrower will pay a higher interest rate
on the loan as a consequence.

Constant Monthly Mortality: This is a measure of payment that assumes that there is a
constant probability that the mortgage will be prepaid following the next months
scheduled payments. For instance, consider the assumption that there is a 0.50%
probability that the mortgage will be prepaid following the first month.

This 0.5% probability is referred to as the single monthly mortality rate or SMM. Using
the SMM, we can compute the probability that the mortgage will be retired in the next
month. It depends on two factors: (a) the probability that the mortgage will survive the
first month, 1-0.5% = 99.5%; and (b) the mortality rate for the month 2 (given that it
survived the first month), which is 0.5%. so the probability that the mortgage will be
retired in month 2 is 0.5% x 99.5% = 0.4975%. using this, we can say that the probability
that the mortgage will be retired in month 3 is (1- 0.4975%) x 0.5% = 0.25125 and so on.

Usually, an annual prepayment known as the conditional prepayments rate (CPR) is used
to measure the speed of the prepayments. Given an annual CPR, we can estimate the
SMM. Remember that the probability the mortgage will survive a month is (1-SMM). For
a period of one year, the probability of survival is (1-SMM)12. this is set equal to (1
CPR). So we get:
(1-SMM)12 = 1 CPR

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or,
CPR = 1 (1-SMM)12
If SMM is 1%, it implies that 1% of the outstanding principal is paid down each month.
The Public Securities Association (PSA) assumes that 0.2% of the principal is paid in the
first month and will increase by 0.2% in each of the following months., finally leveling
out at 6% until maturity. This convention is referred to as the 100% PSA. The PSA
benchmark is not a model of prepayments but used as a benchmark in the industry.
Mathematically, the PSA benchmark can be expressed as follows:
Months 1 to 30: CPR = 6% x t/30,
Where t is the number of months since the origination of the loan, or
Months > 30: CPR = 6%

Mortgage cash flows with prepayments:

We can construct future cash flows from a single loan with a face value of Rs. 100,000
and a rate of 9%. The mortgage loan has a life of 30 years. Prepayments are assumed to
occur at a rate of 100% PSA. We detail the calculations next:

First, using the prepayment rate assumption, we can compute the SMM for
month t = 1 as follows:
CPR = 6% x 1/30 = 0.06/30 = 0.002
SMM = 1 (1 CPR)1/12 = 1 (1- 0.002)1/12 = 0.00167
As noted earlier, the method of calculating SMM is the same until t = 30. After t =
30, CPR = 6% until the loan is retired. Note that SMM = 0.005143 after t = 30
until end.

48

Second, total mortgage payments at t = 1 are obtained by applying equation (1)

with Fo = 100,000, n = 360 and r = 0.09/12. we get the payment x at t = 1 to be
804.62. we calculate the interest payment by multiplying the outstanding balance
with the monthly interest rate. For t = 1, we get 100,000x 0.09/12 = 750.

The scheduled principal payment at t = 1 is obtained by subtracting the interest

payments from the total mortgage payments: 804.62 750 = 54.62.

Finally prepayments at t=1 are computed by applying SMM to the remaining

principal:
= 0.000167 x [100,000 54.62]
= 16.67

Total principal outstanding at t = 2 is obtained by subtracting the total principal

payments at t = 1 from 100,000 to get:
100,000 [54.62 + 16.67] = 99,928.70

We then apply the procedure each time to get the projected future cash flows of
the mortgage loan.

49

RISKS INVOLVED IN SECURITIZATION

The inherent nature of the securitized instrument makes it less risky. The cash flow from
the securitized instrument is backed by tangible identified financial assets earmarked
exclusively for an instrument and is independent of the originator. Dependability of these
cash flows is further strengthened as signified by the ageing of the portfolio. This means,
an asset having a cash flow for three years would be monitored for the first 8 to 10
months to determine its historic loss profile. Earmarking a specific pool of aged assets is
the core feature contributing to lowering the risk associated with securitized product.
Further, the pool of borrowers creates a natural diversification in terms of capacity to pay,
geography, type of the loan etc and thereby lowers the variability of cash flows in
comparison to cash flows from a single loan. So, lower the variability, lower is the risk
associated with the resulting securitized instrument.

With such multiple options for risk reduction and natural diversification inherent in the
product, can a securitized instrument be presumed to be risk free? No. Primary risks
associated with securitized product are pre-payment risk and credit risk. The pre-payment
means refinancing at lower rate of interest or early repayment of the loan amount in part
or in full. This risk is associated with mortgaged backed products using the pass through
structure (PTC). Generally, loan agreements allow the borrower to make an early
payment of the principal amount. The risk originates from the possibility of obligor
making such early payment of principal amount and thereby disturbing the yield and the
investment horizon of the investors. For premium securities, accelerated pre-payment
reduces the average life and yield since the principal is received at par which is less than

50

the initial price. Opposite is the case of securities purchased at a discount. Consequently,
investors have to predict the average life of such securities and may have to look for
alternate investment opportunities in a changed interest rate scenario.

The Act provides for PTC as the securitized instrument and so the pre-payment risk will
exist in Indian market. Factors affecting pre-payment and corresponding pre-payment
models to evaluate this risk will have to be developed in order to make investment
decisions.

Credit risk reflects the risk that the obligor may not be able to make timely payments on
the loans or may even default on the loans. In case of defaults, internal and external risk
enhancement measures will come into play.

Finally, the mortgaged backed securitized product in the foreign markets are backed by a
guarantor who guarantee to the investors the timely payment of interest and principal. As
of now, such guarantees do not exist in Indian market. However, National Housing Board
(NHB) is working in this direction to guarantee securitization of housing loan mortgages.

CREDIT RISK
Rating Agencies really only deal with credit risk as a commercial matter (i.e.: they will
make an assessment of credit risk). All other risks have to be structured out, dealt with
beyond doubt or shown to be sufficiently remote. Sufficiently remote normally means

51

inconceivable. Any residual concerns which are not specifically analyzable as credit risks
will involve serious costs for the structure (e.g.: corporation tax and VAT risks).

SOLVENCY
Both rating agencies need to feel comfortable that the seller of the assets is solvent and is
expected to remain solvent for a period of two years from the date of the transaction.
Proving solvency to this standard is not a straightforward exercise. The legal definition of
solvency is a 20 page paper, and the tests which are necessary to show that a company is
solvent can be tortuous. A true solvency analysis will also take into account contingent
assets and liabilities (including deferred tax) which are not normally shown on the face of
a balance sheet, and will require a comprehensive and detailed analysis of the balance
sheet and projected cash flows.

TAX RISKS
The rating agencies require tax, accounting and actual cash surpluses to be in step (or to
the extent out of step, so that it does not matter) throughout the transaction and in a
variety of tax, interest rate and credit environments.

CORPORATION TAX
Since the Inland Revenue does not give advance rulings on the likely tax treatment of
different structures, the rating agencies normally require the structures to be analyzed
across all potential tax treatments.

52

On the Anglo transaction, for instance, it was determined that there were 9 different
potential tax treatments for the transaction. Each had to be analyzed, and the 3 principal
tax treatments had to be modeled in detail.

STAMP DUTY
If stampable transfers are involved, then it would be normal for the transfers to be
completed offshore. However, the rating agencies normally consider that the assets could
be repatriated (if the trustee was required to enforce the security) and therefore provision
has to be made to pay any stamp duty which COULD then become payable. If more than
one transfer has been made, then double, or even triple stamp duty provision can be
needed. This is a real capital cost to the transaction, but careful management and
structuring can enable the capital so required to be used efficiently.

SPECIFIC LEGAL RISKS

This is an area which the lawyers specializing in securitization will be able to advise on
more fully. These are normally dealt with by either investigation or by the production of
an opinion. However, a thumbnail sketch follows:
Title
Nothing must be capable of upsetting the title to the assets which the Issuer is acquiring.
Dealing with these concerns is often not straightforward. No charges (actual or implied)
must be capable of operating so as to restrict the originator's ability to sell the assets, in
particular in existing banking facilities. This means a thorough review of any likely
source of implied right to the assets is required.

53

Consequently, if the assets have passed through a number of hands prior to the
securitization, then each transfer has to be considered. Portfolios purchased from other
companies raise particular problems.
The question as to the solvency or insolvency of any company involved at any stage with
the receivables has to be addressed.
Contractual
All of the agreements must be binding upon all of the parties. The Issuer must be properly
constituted etc....
Statutory
CCA regulated agreements in particular cause problems of their own. A full CCA review
of the documents is normal practice. Similarly, product liability issues need to be
analyzed out or shown to be the minimum.

SPECIAL RISKS
Each structure has to address different problems. Sometimes the answer to these
problems is empirical (i.e.: the risk is included in the analysis of the transaction and
quantified). However, some points can only be dealt with by legal analysis and an
opinion. The extent to which the law firm involved is prepared (on occasions) to be
slightly "sporting" can be critical.
Set off and related risks
Set off can occur in a variety of ways for instance: lessees could have deposited money
with an originator of the assets (who then becomes insolvent), or lessees could have paid

54

for maintenance of equipment (which is then not carried out). Even if there is no legal
justification for the set off (i.e.: the lessor is wrong), it may still have to be taken into
account in the structure.

Similar risks relate to the position of the Issuer in the event that there is a liquidation of
the administrator. A critical aspect of the structure will be the consideration of the
liquidator's rights in this circumstance can the collection of the Issuer's receivables (and
their payment to the Issuer) be interrupted or stopped?
Executory contracts
Contracts which impose obligations upon the lessor are not generally securitisable. An
example of an obligation would be procuring that maintenance is carried out, or agreeing
to collect funds on behalf of a third party. The concern arises from a view that, were these
obligations to be carried out poorly, then the lessor would be in default, which could then
permit the lessee to avoid his obligations. A lessee may also have the right to reject the
replacement of the lessor with a third party. Essentially the problem is that the contract
becomes personal to the particular lessor and not generic.

However, there are certain techniques and credit enhancement structures which could be
used in these circumstances.
Unsecured creditors
The rating agencies are also concerned to ensure that either the Inland Revenue or HM
Customs do not become unsecured creditors to any part of the transaction structure in
other words, that there are known liabilities to either body which might not be met at any

55

future point. This is considered to give an excuse to "go after" the Issuer or the structure
as a whole to try to recover assets which have been sold to the Issuer and unravel the
deal.

A detailed investigation of the deferred tax positions of the originator and any group
companies is therefore required. Plans have to be made to show how any resulting
liabilities are proposed to be paid, given certain assumptions about origination levels and
credit losses.
Contractual failure
Even if a party has committed in contract to do XYZ, will they actually do it? On the
Anglo transaction, officers of both the trustee and the clearing bank were required to
confirm separately to Moodys that if their respective organizations agreed in contract to
do something, then they would actually do it.

56

CREDIT RATING MECHANISM

The rating agencies will wish to visit the originator/administrator to assess the quality of
the management, the way that the company is set up and to review the administrative
procedures.

Prior to the visit, it is normal practice to prepare a file on the company including financial
information, procedures, company history, senior staff biographies and example
contracts. Collating and preparing this information normally takes several weeks.

Asset analysis
This is the one risk which the rating agencies are prepared to take a commercial view on.
This view is based upon an analysis of the asset pool proposed to be securitized, and a
review of the historical performance of the originator's assets based upon certain
assumptions. Generally the golden rules are:

present your data appropriately (detailed advice is required on this point, since the
exact approach should be closely linked to the way that the transaction is to be
structured), and

generate as much data as possible irrelevant data can be discarded, but data
which is missing is impossible to replace; rating agencies, in the absence of data,
make conservative guesses (e.g.: 100% default rates, no recoveries etc..).

Once they have reviewed this information, the rating agencies will make an assessment of
their worst case expectations as to the performance of the portfolio (normally absolutely

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dismal, of course). The structure then has to be designed to ensure that, should these
losses appear, the rated debt is paid in full and on time.

Transaction analysis
This involves the production of detailed computer models of the transaction, which are
then used to determine the way in which the structure will behave in different
stress environments. Typical variables are: credit loss levels, delinquency levels,
interest rates, corporation tax rates, VAT rates etc. Each rating level normally has
associated with it a certain combination of stress assumptions, becoming more
stressful for higher ratings.
Models are used differently by the two rating agencies: S & P require that the model
demonstrates that note holders will receive all amounts due on time using the appropriate
stress assumptions for that rating. The model normally has to be audited, and S & P
require a copy of it which they review in detail.

Moody's will not normally rely on models produced by third parties, and would seek to
write their own. However, lease transactions are too complex to permit them to take this
approach. On the Anglo transaction, for instance, they used our model, but treated its
results with some circumspection. Their view seemed to be not that the structure had to
meet certain minimum levels of stress (as S & P) but that the structure should be set up to
deal with a variety of combinations of assumption, and that in certain circumstances,
these assumptions could show a default.

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S & P's approach means that, once the structure and the model is agreed, it is possible to
be reasonably certain as to the required levels of credit enhancement for each rating level.
Moody's approach is less empirical, and this means that there can be no certainty that the
credit enhancement levels are appropriate.

Legal and tax

It is now normal for the rating agencies to require detailed opinions on the transaction
addressing both legal and tax risks. These opinions are extremely difficult documents for
lawyers to write, since the levels of comfort required are higher than those which would
be necessary from a commercial perspective. This is one of the expensive elements of a
transaction.

For the ALPS transaction (aircraft leases), for instance, a separate legal opinion had to be
procured for each jurisdiction in which an aircraft could land result: 118 legal opinions.
From a rating perspective, the intrinsic value of the aircraft was a key part of the credit
analysis and therefore the aircraft have to be demonstrated to be recoverable if there is a
default on the lease.

On the Anglo transaction, the tax analysis was so complex that the only way that
sufficient comfort could be given was to offer nine alternative tax treatments for the
transaction. The relevant partner of Clifford Chance was fairly happy (at a commercial
level) as to the likely tax treatment of the transaction

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but at a rating level (100%

certainty), he could only be certain that it would be one of the nine. This meant that the
tax opinion ended up the wrong side of 80 pages.

The rating process is complicated, but not too mysterious. Managing the rating process is
a key element in the control of the transaction. Our advice is always that it is the
originator who should control this process. As a result, the selection of the originator's
advisers is a crucial element in ensuring a successful and controlled transaction - since it
is through the assistance of these persons that the rating agency relationship is
maintained. Several transactions which we have worked upon have changed radically as a
result of the mismanagement of the rating process by third parties over whom the
originator had no control.

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CREDIT ENHANCEMENT TECHNIQUES

Unlike in plain vanilla instruments, in securitization transactions it is possible to work
towards a target credit rating, which could be much higher than the originators own
credit rating. This is possible through a mechanism called Credit Enhancement. The
purpose of credit enhancement is to ensure timely payment to the investors, if the actual
collections from the pool of receivables securitized for a given period are short of the
contractual payouts on Asset Backed Securitization (ABS). ABS are normally nonrecourse instruments and therefore, the repayment on ABS would have to come from the
underlying assets and the credit enhancement, with no further recourse to the originator.

Understanding of risk enhancement measures, which at times are used in combination, is

also necessary to analyze the risk profile of securitized product. Normally, these risks
enhancement measures are provided to cover the historic risk profile (first level risk) of
the financial assets and some percentage of losses which may be higher than the historic
risk profile (second level risk). Internal risk enhancement measures like overcollateralization, liquidity reserve, corporate undertaking, senior / sub-ordinate structure,
spread account etc. cover the first level risk. External risk enhancement measures like
insurance, guarantee, letter of credit are used to cover the second level risk.

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splitting the Issuer liabilities into different classes: senior, mezzanine and
junior (for instance), and arranging to pay them in that order, so that the
i)

Overcollateralisation
senior liabilities are effectively protected by the existence of the
subordinated liabilities
insuring the credit performance of the assets (so that, from the Issuer's

ii)

Insurance
perspective, losses do not occur)
arranging for the Issuer's obligations under the rated notes to be

iii)

Financial Guarantee

guaranteed (so that if the Issuer is unable to make a payment, then

someone else will make it for him)
arranging for a bank facility which the SPV can draw down in the event

iv)

Letter of Credit
that it suffers significant credit losses.

When asset-backed securities are purchased by investors, the investment risk they
undertake directly relates to the credit quality of the original borrowers whose loan
contracts are offered as collateral for the securities. In order to offer the purchasers a
further enhancement to the credit quality, the issuer of the securities may wish to provide
further payment guarantees obtained from a third party insurer or through a process of
what is termed as over-collateralization.

Over-collateralization works when there are several classes of securities being issued. In
an over-collateralization, a subordinated class of securities absorbs the losses due to
payment defaults of the original loan borrowers first. The senior class of securities, is
therefore, shielded from default risk. The senior class of securities is now overcollateralized and will attract an enhanced credit rating. Over-collateralization means for

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servicing an instrument of Rs. 100/- cash flow from underlying asset valuing Rs. 110/are earmarked. Similarly, cash worth Rs. 5/- called Liquidity Reserve may be separately
earmarked for servicing an instrument of Rs. 100/-. These features cover investors against
the likely default in cash flow from the borrower to the extent of Over-collateralization /
Liquidity Reserve.

In case of Senior / sub-ordinate debt, cash flows from two groups of borrowers are
independently used to bundle two set of securities. These two trenches of securities are
issued with a pre-determined priority in their servicing. This means the senior trench has
prior claim on the cash flows from the underlying assets so that all losses will accrue first
to the junior securities up to a pre-determined level. Thereby, the losses of the senior debt
are borne by the holders of the sub-ordinate debt, normally the originator.

The difference between yield on the assets and yield to investors is the spread which is
the gain to the originator. A portion of the amount earned out of this spread is kept aside
in a spread account to service investors. This amount is taken back by the originator only
after the payment of principal and interest to investors.

In a third party insurance scheme, an independent insurer would guarantee payment of

interest and principal of the securities in the event of default by the original borrowers.
Such credit enhancement will raise the credit quality of the securities above that of the
underlying loans offered as collateral and increase the marketability of the securities.

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Other third party credit enhancement measures such as insurance, guarantee and letter of
credit are also used by originator to get a better credit rating for the instruments.

Figure 6:Profile of credit enhancement in retail securitization transaction in India

(Source: The Chartered Accountant May 2002)

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RBI REGULATIONS AND GUIDELINES

(1) Acquisition of Financial Assets
The Asset Acquisition Policy shall provide that the transactions take place in a
transparent manner and at a true price in a well informed market, and the transactions are
executed at arms length in exercise of due diligence;

ii. The Policy so framed should provide for checks in the matter of acquiring assets
from a single Bank/FI, own sponsors and any single entity upto a desirable level of
ceiling so that possible departures from desirable practices are avoided;

iii. The percentage of financial assets to be acquired should be appropriately and

objectively worked out keeping in view the fact that the percentage of ownership stake
has a bearing on the speed with which security interest rights can be enforced in
accordance with the provisions of the Ordinance;

iv. For easy and faster realisability, financial assets due from a single debtor to various
banks / FIs may be considered for acquisition. Similarly, financial assets having linkages
to the same collateral may be considered for acquisition to ensure relatively faster and
easy realization;

v. Both fund and non-fund based financial assets may be included in the list of assets for
acquisition. Standard Assets likely to face distress prospectively may also be acquired;

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vi. Acquisition of funded assets should not include takeover of outstanding commitments,
if any, of bank / FI to lend further. Terms of acquisition of security interest in non-fund
transactions, should provide for the relative commitments to continue with bank/FI, till
demand for funding arises;

vii. Loans not backed by proper documentation should be avoided;

viii. The valuation process should be uniform for assets of same profile and a standard
valuation method should be adopted to ensure that the valuation of the financial assets is
done in scientific and objective manner. Valuation may be done internally and or by
engaging an independent agency, depending upon the value of the assets. Ideally,
valuation may be entrusted to an asset acquisition committee, which shall carry out the
task in line with an Asset Acquisition Policy laid down by the Board in this regard;

ix. A record indicating therein the details of deviations made from the prescriptions of the
Board in the matter of asset acquisition, pricing, etc. should be maintained;

x. To ensure functioning of Securitization Companies/ Reconstruction Companies on

healthy lines, the operations and activities of such companies may be subjected to
periodic audit and checks by internal / external agencies.

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(2) Engagement of Outside Agency

Securitization Companies/ Reconstruction Companies may engage the services of reputed
specialized external agencies to handle the task of taking possession of secured assets in
pursuance of its right to enforce security interest.

(3) Sale Committee

It is desirable that the Sale Committee authorizes in case of joint / consortium financing,
the secured creditor with the highest outstanding, or more preferably, the Securitization
Company/ Reconstruction Company as the designated secured creditor to arrange for the
sale of secured assets.

(4) Issue of security receipts

(i)The parties in question may finalize the price at which security receipt will be issued as
per the mutually agreed terms and on assessment of the risks involved;

(ii) In cases where security receipts are issued involving transfer of risks to the full extent
and rewards to a limited extent, there could be a possibility of sharing of surplus between
the issuer and the investors;

(iii) The issuer may consider obtaining credit rating from any of the recognized credit
rating agencies. The matters relating to charging of management fee by the

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Securitization Company/ Reconstruction Company, for managing schemes floated by it,

may be as per the mutually agreed terms.

As per Amendment ( 29.03.2004)

Every Securitization company or Reconstruction company seeking the Banks
registration under Section 3, or carrying on business on commencement of the
Securitization Companies and Reconstruction Companies (Reserve Bank)
(Amendment) Guidelines and Directions, 2204, hall have a minimum Owned fund
not less than fifteen percent of the total financial assets acquired or to be acquired
by the securitization Company or Reconstruction Company on an aggregate basis
or Rs. 100 crore, whichever is less; irrespective of whether the assets are
transferred to a trust set up for the purpose of securitization or not.
Further the Securitization Company or Reconstruction Company should continue
to hold this owned fund level until the realization of the assets and redemption of
security receipts issued against such assets.
The Securitization Company or Reconstruction Company can utilize this amount
towards the Security Receipts issued by the trust under each scheme. This will
ensure the stake of the Securitization Company or Reconstruction Company in the
assets acquired.
No subsidiaries of the Bank: Some of the ARCs are currently being promoted by
Ban and FIs. The shareholding of such ARCs are dispersed in such a manner that
they do not become subsidiaries of any of the promoting institutions.

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 NPA to be taken over at proper price: Care has to be taken in constituting the
management structure and operations of the ARC such that even if the promoting
Bank or FIs transfer their NPA portfolio, then it will treated as transfer to an
independent or non-subsidiary ARC. Valuation of the NPA portfolio will have to
be negotiated at arms length and upsides on recovery can be even shared with
ARC.
NPA acquisition based on properly framed policies: Every ARC is required to
have a financial asset acquisition policy which interalia must lay down policies
and guidelines for the valuation of NPAs acquired by the ARC (having realizable
value and capable of being reasonably estimated and independently valued).
True sale and not adjustment: The acquisition of financial assets by an ARC must
conform to the principles of a true sale.

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SECURITIZATION IN ASIA
Hong Kong
Hong Kongs English law based legal system is probably the most securitization-friendly
in Asia and makes it quite straight-forward to structure true sale transactions from a
legal, regulatory and accounting perspective. Bankruptcy law is well developed and the
regulatory environment, with guidelines for regulatory off-balance-sheet treatment, which
largely follow the Bank of England model, is sophisticated. There is no withholding tax
on interest payments to a non-resident, simplifying the securitization offshore of interestbearing receivables. Rating agencies, monocline insurers and investors have now become
increasingly comfortable with Hong Kong.

In addition to consumer-related assets such as mortgages, more innovative structures,

such as those used in the Queens Funding and Pacific Palisades residential property
transactions and the Wharf commercial property transaction, have also been used in Hong
Kong. We have also seen the development of the Hong Kong Mortgage Corp., which has
now acquired its first pools of residential mortgages and will likely look to securitization
as one of its funding strategies.

Thailand
Putting a transaction together under the Thai civil law system has historically been legally
more complex than in Hong Kong. Thai law does not generally recognize the concept of
a trust, which causes the SPV to run commingling risk if the debtors continue to pay
into the originators normal collection account. As a result, if notice has not been given to

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debtors, on the bankruptcy of the originator, the SPV will not be entitled to claim the
payments belonging to it, but instead will have a claim as an unsecured creditor. In
addition, although the auto lease and hire purchase receivables in the Thai cars type
structure were assignable as a matter of Thai law, a true sale could not be achieved
economically due to the imposition of tax on the purchase price of the receivables. VAT
was also imposed on any servicing fee. In addition, withholding tax was payable on
payments of interest offshore.

In 1997, the Thai government passed a new securitization law which helped to alleviate
some of the concerns by:

Setting up a structure for onshore SPVs.

Clarifying that the SPV does not require a license as it not a finance or a credit
foncier business.

Allowing the SPV to charge interest in excess of 15% p.a.

Removing the originator bankruptcy risk if the transfer of the receivables to the
SPV satisfied certain conditions.

Korea
Historically, the transfer of receivables by a Korean resident to a non-resident required
the consent of the Ministry of Finance and Economy (MoFE), which had not been
forthcoming until 1997. the original transactions dominating the Korean market in 1997
involved Korean merchant banks as sellers of US dollar denominated equipment lease
receivables owned by Korean corporations. None of these transactions closed.

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Receivables can be assigned although notice to the debtor (which must be notarized with
a fixed date) has to be given, which may lead to customer confidentiality issues for
banks.

The issue of withholding tax payable on interest payments to a non-resident remains a

problem, but this can be mitigated by using the double tax treaty with Ireland which
reduces the withholding tax rate to zero.

Korea has also passed a Securitization law which will require some amendments before
the full benefit for foreign investors can be realized.

The Philippines
The Philippine legal environment is friendly towards securitization although only a few
securitization transactions have closed. Receivables can be assigned and a true sale can
be achieved to remove the bankruptcy risk of the seller.

Although securitization was contemplated some time ago it has had little use as a
financing tool. There has been frequent talk about the securitization of overseas workers
remittances, although no transaction appears to have closed. In addition to a lack of
regulatory and accounting off-balance-sheet guidelines as well as the typical tax
problems, banks wishing to sell assets require Central banks approval.

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China
The size of China and its economy make it an obvious candidate for securitization.
However, attempts to securitize PRC cash flows have, in general, so far failed. The issue
is complicate further the lack of certainty in the bankruptcy and security laws, which are
still developing and the requirement that the consent of debtors is needed to achieve a
true sale of assets, such as loan or trade receivables. This may prove logically difficult
where the asset pool size is very large. Regulatory approvals continue to cause arrangers
and investors much agonizing in trying to structure securitizations. Taxes, particularly
withholding tax, also provide some problems.

Singapore and Malaysia

Although it is still early days, changes in the official regulatory and government policy in
Singapore and Malaysia could pave the way for securitization deals in both the
jurisdictions. Although taxes remain an issue, the common law system (historically based
on English law) provides a sound legal platform for such transactions and originators in
both the countries seem keen to proceed.

As economic, currency and political stability begin to return to the region, originators
will once again look to securitization as one of their financing tool. The current trend of
looking further afield for securitization opportunities, in respect of both countries and
assets, should help ensure the future long-term growth of securitization business in Asia.

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SECURITIZATION IN INDIA
Securitization as a financial instrument has been in the practiced in India since the early
1990s essentially as a device of bilateral acquisitions of portfolios of finance
companies. As would be the case elsewhere too, securitization finds its way of loan sales.
There were quasi-securitizations for quite a while where creation of any form of security
was rare and the portfolios simply ended from balance sheet of one originator over to that
of another. CRISIL rated the first securitization programme in India in 1991 when
Citibank securitized a pool from its auto loan portfolio and placed the paper with GIC
Mutual fund. The volume involved was about Rs. 16 crore. Since then, over 225 asset
backed structure transactions aggregating to a volume of about Rs. 37,500 crore have
been rated by CRISIL. The volume of securitization transactions rated by CRISIL
between 2001-2003 amounted to over Rs. 28,000 crore indicating the upsurge in activity
in this segment during this period. The spurt in the issuance of securitized paper has been
led by the CLO/CBO segment, wherein, loan and bond receivables are packaged and sold
in the form of pass through certificates. CRISIL has so far rated CLO/CBO of about Rs.
8,000 crore till 2003.

Form of security:
In the later part of 1990s, creation of transferable securities in the form of pass-through
certificates (PTCs) became common. The word PTC has almost become synonymous
with securitization in India and most market practitioners do not envisage issuance of
notes or bonds as a securitized product. A typical Indian PTC does not abide by any
specific structural features there are PTCs which have a specific coupon rate, there are

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structured PTCs and PTCs have different payback periods. In other words, many such
PTCs are essentially debt instruments it is only that they are not called as such.

The issuance of PTC has so intensely been associated with the market that even for
completely bilateral deals which are really speaking loan sales, people have used trusts
and PTCs.

Asset classes:
Over time, the market has spread into several asset classes while auto loans and
residential housing loans are still the mainstay, there are corporate loans, commercial
mortgage receivables, future flow, project receivables, toll revenues, etc that have been
securitized. Securitization of Housing loan receivables took off in India in 2000 with
National Housing Bank issuing mortgage backed securities (MBS) backed by housing
loan receivables of HDFC and LIC housing finance limited (LICHFL). Both the issued
were rated by CRISIL resulting in LICHFL and HDFC going in for second tranches of
MBS.

Since January 2001 there has been emergence of new types of securitization transactions
in India rated by CRISIL like an offshore securitization transaction backed by aircraft
hire purchase receivables in January, 2001 for Jet Airways. CRISIL also rated the first
education bond in the country and there is a growing interest among other educational
institutions to raise funds through issue of bonds. These bonds are backed by an escrow
of future fee receivables.

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Figure 7: Asset Class distribution involving receivables backed by existing assets as at

February 2002
(Source: The Chartered Accountant May 2002)

Nature and form of credit enhancements:

Subordination is a commonly used form of credit enhancement. Since asset backed
securities are still new, investors have a preference for AAA or AA rated instruments.
Most transactions in the market, therefore, end up with a couple of senior classes. Multiclass issuances with several rated tranches are uncommon.

Apart from subordination, over-collateralization, guarantees, recourse, cash reserves are

used as other forms of enhancement. The extent of enhancements is relatively very high
and not very painful, as there are no capital consequences of providing such
enhancement.

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Legal structure:
In 2002, India enacted a law that reads Securitization and Reconstruction of Financial
Assets and Enforcement of Security Interests Act, 2002 (SARFAESI) (See Annexure I).
Though masquerading as a securitization-related law, this law does very little for
securitization transactions and has been viewed as a law relating to enforcement of
security interests, as a very narrow avatar of personal property security laws of North
America. In commercial practice, the SARFAESI has been very irrelevant for real life
securitizations.

Most securitizations in India adopt a trust structure with the underlying assets being
transferred by way of a sale to a trustee, who holds it in trust for the investors. A trust is
not a legal entity is law but a trustee is entitled to hold property which is distinct from
the property of the trustee or other trust properties held by him. Thus, there is isolation,
both from the property of the seller, as also from the property of the trustee. The trust law
has its foundations in UK trust law and is practically the same.

Therefore, the trust is the special purpose vehicle. Most transactions to date use discrete
SPVs master trusts are still not seen. The trustee typically issues PTCs. A PTC is a
certificate of proportional beneficial interest. Beneficial property and legal property is
distinct in law the issuance of the PTCs does not imply transfer of property by the SPV
but certification of beneficial interest.

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The stamp duty unclarity and illogicality has in a way shaped the market players have
limited transactions to such receivables as may be transferred without unbearable stamp
duty costs. The SARFAESI law intended to resolve the stamp duty problem, but owing to
its flawed language, did not succeed.

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BENEFITS OF SECURITIZATION
Economic benefits:
Securitization benefits the economy as a whole by bringing financial markets and capital
markets together. Financial assets are created in the financial markets, e.g., banks or
mortgage financing companies. These assets are traditionally refinanced on on-balance
sheet means of funding of the respective banks.

Securitization connects the capital markets and financial markets by converting these
financial assets into capital market commodities. The agency and intermediation costs are
thereby reduced.

Securitization converts loan relationships into capital market commodities and therefore,
increases the power of the capital market. The shift to marketable from non-marketable
assets brought about by securitization has stretched credit creation. It tends to sustain
borrowers longer in economic expansion and probably to expose them more in
contractions. It also has had the important side effect of removing the illusion of price
stability for non-marketable assets. Some of the new securitized instruments have
therefore magnified the volatility of financial asset prices.

Securitization and cost of funding

It is a clear proposition that the stronger the security rights of the creditor, the lesser is
the risk he faces, and the lower, therefore, is the risk premium he translates into cost of

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lending. If securitization means lesser credit risks for the originator, obviously this should
lead to lower funding costs.
Benefits to the Originator
1. Alternative funding
Securitization offers an effective and relatively quick alternative funding source.

2. 100% Financing
Bank and financial Institution (FI) funding have margins of around 25%. Securitization
has no margins. Even if one considers collateral as margin money, it will be lower than
25% in most cases.

3. Balance Sheet Management

Securitization is an off-balance sheet funding alternative. It generates cash for the
originator without any addition to borrowings thus without increasing the debt to equity
ratios. Companies that have capital adequacy pressures can undertake securitization to
raise funds.

4. Profit & Loss Account Management

Securitization helps in up fronting profits. In case of high yielding portfolios like car
loans and truck loans, there is a profit on sale, as the inherent yield in the portfolio is
typically higher than the coupon rate on ABS. Hence there is a boost to bottom line and
EPS in the year of securitization.

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5. Lower Interest Rates

As securitized papers are highly rated, cost of borrowing is relatively lower. Even for
originators rated in the AA category, there is likely to be a price advantage in
securitization as AAA has a price premium. This is all the more attractive for investors
whose own credit ratings are lower.

6. Improvement of Financial Ratios

Since securitization helps to undertake larger business with the same capital, profitability
and return on investment ratios improve post-securitization.

7. Asset-Liability Management
After securitization, medium term assets are replaced by cash lending to mitigation of
tenor mismatch.

8. Exposure Management
Banks, FIs, NBFCs who are fully exposed to certain industries, corporates or groups can
do further business without violating exposure norms by securitizing a part of he existing
exposure.

9. Elimination of credit and prepayment risk

After securitization, both these risks are passed on to the investors.

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10. Wider Investor Base

With the advantage of a high rating, there is access to wider base of investors.

Benefits to investors
Traditionally, investors look at safety, liquidity, and yield before making any investment
decisions. ABS is relatively more safe as they are typically highly rated. ABS could be
listed in stock exchanges like any other debt instruments. Typically, yields in ABS are
more than that of other instruments with the same rating. This is to compensate for the
prepayment risk and the novelty of the instrument.

Another advantage of the instrument is the flexibility to structure the instrument to suit
the investors needs, I terms of tenor or periodicity of payment. In developed markets,
several classes of securities are issued from one asset pool to suit the varying investor
preferences. Essentially these classes of securities differ in structure, tenure, priority of
payment and yield so that the investors could choose the class that fits their requirement
best. For example, money market mutual funds would be interested in short term paper
whereas; pension funds would be interested in long term paper. In some issues interest
and principal components are split and placed with different investors. In case of variable
rate loans, the interest-only securities would appreciate in value when interest rates go up,
whereas, principal-only securities depreciate in value.
Besides, in ABS, the investors get the benefit of a payment structure closely monitored on
a monthly basis by the rating agency and the trustees, which is not available in other
instruments.

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While the foregoing paragraph outlines the benefits to the investors, one important aspect
of most ABS, which investors need to understand, is the prepayment risk. In conventional
instruments, there is a schedule of repayment of interest and principal. In ABS, however,
while there is a schedule of payments in the beginning, this could undergo a substantial
change depending on the prepayment by the underlying borrowers in the pool. In a
declining interest rate scenario, this risk could be considerable when the underlying
borrowers in the pool would tend to repay loans with high cost to replace the same with
low cost loans.

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ISSUES IN SECURITIZATION
Lack of appropriate legislation
As we discussed earlier, there are no laws specially governing securitization transactions
in India. The Government of India constituted a Working Group on Asset Securitization
in July 2000. This Working Group submitted a comprehensive draft Securitization Bill to
the Government. However, the bill has not been tabled in the parliament yet. A
comprehensive securitization Act can give a much-needed thrust to securitization activity
in India. The following are the key areas where legislation is required: -

a) True Sale (Isolation from bankruptcy of the Originator)

The central idea of a securitization transaction is to isolate the assets of the Originator
from Originators balance sheet and seek a higher credit rating than the Originators own
rating. A key requirement for that is to achieve a "true sale" of the assets to the Special
Purpose Entity.

b) Tax neutral bankruptcy remote SPE

The special purpose entity that buys assets from the Originator should be a bankruptcy
remote conduit for distributing the income from the assets to the investors. While banks
have experimented with company revocable trust and mutual fund structures, no clear
vehicle has emerged for performing securitization. This should be addressed by the
Securitization act.

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c) Stamp Duties
Stamp Duty is a state subject in India. Stamp Duties on transfer of assets in securitization
can often make a transaction unviable. While five Indian states have recognized the
special nature of securitization transactions and have reduced the stamp duties for them,
other states still operate at stamp duties as high as 10% for transfer of secured
receivables. The Working Group of RBI has recommended a uniform rate of 0.1% duty
on all transactions. The acceptance of these recommendations by other states can boost
the securitization activity in India especially in the MBS area.

d) Taxation
The tax laws have no specific provision dealing with securitization. Hence, the market
practice is entirely based on generic tax principles, and since these were never crafted for
securitizations, experts opinions differ.

The generic tax rule is that a trustee is liable to tax in a representative capacity on behalf
of the beneficiaries therefore, there is a prima facie taxation of the SPV as a
representative of all end investors. However, the representative tax is not applicable in
case of non-discretionary trusts where the share of the beneficiaries is ascertainable. The
share of the beneficiaries is ascertainable in all securitizations through the amount of
PTCs held by the investors. Though the PTCs might be multi-class, and a large part might
be residual income certificates in effect, the market believes, though with no reliable
precedent, that there will be no tax at the SPV level and the investors will be taxed on

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their share of income. The scenario is, however, far from clear and the current thinking
may be short lived.

e) Accounting
The Institute of Chartered Accountants of India has come out with a guidance note on
accounting for securitization. Guidance notes are issued by the Research Committee of
the Institute and are recommendatory rather than mandatory. But where a method is
recommended, it is expected to be followed, unless there are reasons not to.

The guidance note is a mix of FAS 140 and FRS 5 approach. Generally, off balance sheet
treatment is allowed, if risks and rewards are transferred. Gain on sales is computed
based on the components approach underlying the US accounting standard. Originators
are required to estimate the fair value of retained interests, and retained liabilities and
apportion the carrying value of the asset in proportion of such retained and transferred
interests.

The guidance note also makes a reference to accounting for SPVs without caring for
whether the issuance of securities by the SPV leads to a transfer of beneficial interest.
Literally interpreted, assets transferred to SPVs should stay on the balance sheet of the
SPV in all cases.

86

f) Eligibility
Only recently Mutual funds have been allowed to invest in PTCs. The government should
lay down norms governing investment eligibility for various securitization instruments.

Debt market
Lack of a sophisticated debt market is always a drawback for securitization for lack of
benchmark yield curve for pricing. The appetite for long ended exposures (above 10
years) is very low in the Indian debt market requiring the Originator to subscribe to the
bulk of the long ended portion of the financial flows. The development of the Indian debt
market would naturally increase the securitization activity in India.

Lack of Investor Appetite

Investor awareness and understanding of securitization is very low. RBI, key drivers of
securitization in India like ICICI and Citibank and rating agencies like CRISIL and ICRA
should actively educate corporate investors about securitization. Mandatory rating of all
structured obligations would also give investors much needed assurance about
transactions. Once the private placement market for securitized paper gathers momentum,
public retail securitization issuances would become a possibility.

87

FUTURE OF SECURITIZATION IN INDIA

Since the late eighties, when securitization made its beginning in India, the number as
well as the size of transactions has grown over the years. This trend is likely to continue
and the market would witness considerable growth in the coming years.

It would help in the development of ABS market particularly the mortgage backed
securities (MBS) market, if incentives are given to these instruments. For example, MBS
could be declared as eligible investments by provident fund and pension funds and the
concessions available to infrastructure bonds could be extended to MBS.

So far, companies securitized assets to raise funds without adding to borrowings. This
helped companies which had high gearing levels. The motivating factor in some
securitization transaction in the past was the ability to book profits upfront. While these
would continue to be demand drivers for securitization, securitization is likely to be
increasingly used for better asset liability management. As securitization replaces long to
medium-tem assets by cash, the weighted average maturity of assets for the company
comes down. This is a big comfort, as typically, NBFCs were funding three year assets
with one year fixed deposits.

Traditionally, in the fund-based business segment of the financial services sector in India,
a single entity was engaged in the entire gamut of activities which are raising funds,
locating borrowers, credit appraisal of borrowers, servicing of loans and recovery. Owing
to the rapidly changing environment, realignment is likely to happen in this sector. One

88

could see specializations emerging in the market. In developed markets like USA,
particularly in the mortgage market, there is a considerable amount of specialization.
Typically in these markets a single entity does not perform more than one or two of the
activities mentioned earlier. The trend of specialization is also in line with the increasing
emphasis on core-competence. Instead of an entity engaged in all the activities, it would
make sense to focus on a few areas where it has competitive advantage. The trend is
already visible in the auto loan sector. Owing to the regulatory changes with respect to
the quantums of fixed deposits that NBFCs could mobilize and the linking of the same
with credit rating a number of NBFCs are finding it difficult to raise funds at competitive
rates. These NBFCs however have a relatively low cost distribution network in place to
originate and service loans. On the other hand, large companies and foreign banks find
that it is not economical to create a large distribution network in terms of extensive
branch network across the country due to their high cost structure. However, these
companies given their size, parent support, managerial talent and a high credit rating have
a much stronger funding capability.

Securitization could be effectively used to combine these two complementary pools of

resources. NBFCs could originate loans and securitize them and sell to large companies.
And they could use the proceeds of the sale to originate more loans and the process could
go on. The small NBFCs could continue to service the loans which would ensure a steady
flow of fee income.

89

While many transactions are underway in the auto loan sector, this trend is likely to
extend to housing finance sector. As regards housing finance the funding required is of a
much longer tenure and thus far more difficult to raise.

90

CASE STUDY
The impact of Securitization in the books of the originator and SPV can be explained
with the help of the following example.

The Originator, X bank has issued home loans worth Rs.150 lakhs with an effective
finance charge of 16.5%p.a and average maturity of seven years. The home loans are
received in equal monthly installments. X bank has financed this entirely from deposits
raise on an average @ 14.5% p.a. now it needs money to repay the deposit.

The amount of principal collected by the bank is generally recycled to maintain the level
of operation. Either there should be ploughed back profit or new flow to match retirement
of deposits.

In case the bank is able to maintain the principal outstanding, it would have Rs. 150 lakhs
outstanding principal on home loan stock at any point of time (assuming a no growth
situation). If the bank receives home loan in equal monthly installment, its cash flow
structure would be as shown in Table 1. Equal Monthly Installment (EMI) is determined
in the following manner:
150/49.63299 = 3.02 lakh
49.63299 is the annuity factor of Re.1 @ 16.5% interest monthly payable at the end of
each month for 84 months.

91

Cash flow Structure of a Home loan Pool

Table 1
1

Month
1
2
3
4
5
6
7
8
9
10
11
12
13
14
15
16
17
18
19
20
21
22
23
24
25
26
27
28
29
30
31
32
33
34
35
36
37
38
39
40
41
42

Discount
Factor

EMI

0.9864365
0.97305696
0.9598589
0.94683986
0.93399739
0.92132912
0.90883267
0.89650571
0.88434596
0.87235113
0.86051899
0.84884734
0.837334
0.82597682
0.81477368
0.8037225
0.7928212
0.78206777
0.7714602
0.76099649
0.75067472
0.74049294
0.73044926
0.72054181
0.71076874
0.70112823
0.69161847
0.68223771
0.67298417
0.66385615
0.65485194
0.64596985
0.63720824
0.62856546
0.62003991
0.61163
0.60333416
0.59515083
0.5870785
0.57911566
0.57126083
0.56351253

3.02
3.02
3.02
3.02
3.02
3.02
3.02
3.02
3.02
3.02
3.02
3.02
3.02
3.02
3.02
3.02
3.02
3.02
3.02
3.02
3.02
3.02
3.02
3.02
3.02
3.02
3.02
3.02
3.02
3.02
3.02
3.02
3.02
3.02
3.02
3.02
3.02
3.02
3.02
3.02
3.02
3.02

Principal Finance
Recovery Charge

Remaining
Principal Balance
(RPB)

0.96
0.97
0.99
1.00
1.01
1.03
1.04
1.06
1.07
1.09
1.10
1.12
1.13
1.15
1.16
1.18
1.19
1.21
1.23
1.24
1.26
1.28
1.30
1.31
1.33
1.35
1.37
1.39
1.41
1.43
1.45
1.47
1.49
1.51
1.53
1.55
1.57
1.59
1.61
1.63
1.66
1.68

92

2.06
2.05
2.04
2.02
2.01
1.99
1.98
1.97
1.95
1.94
1.92
1.91
1.89
1.88
1.86
1.84
1.83
1.81
1.80
1.78
1.76
1.74
1.73
1.71
1.69
1.67
1.65
1.63
1.62
1.60
1.58
1.56
1.54
1.52
1.50
1.47
1.45
1.43
1.41
1.39
1.37
1.34

149.04
148.07
147.08
146.08
145.07
144.04
143.00
141.94
140.87
139.79
138.69
137.57
136.44
135.30
134.13
132.96
131.76
130.55
129.32
128.08
126.82
125.54
124.24
122.93
121.60
120.25
118.88
117.49
116.09
114.66
113.21
111.75
110.26
108.76
107.23
105.68
104.11
102.52
100.91
99.27
97.62
95.94

43
44
45
46
47
48
49
50
51
52
53
54
55
56
57
58
59
60
61
62
63
64
65
66
67
68
69
70
71
72
73
74
75
76
77
78
79
80
81
82
83
84
Total

Notes:

0.55586933
0.54832979
0.54089252
0.53355612
0.52631923
0.5191805
0.5121386
0.5051922
0.49834003
0.49158079
0.48491323
0.47833611
0.4718482
0.46544829
0.45913518
0.4529077
0.44676468
0.44070499
0.43472749
0.42883106
0.42301461
0.41727705
0.41161731
0.40603434
0.40052709
0.39509454
0.38973568
0.38444949
0.37923501
0.37409126
0.36901727
0.3640121
0.35907483
0.35420451
0.34940026
0.34466117
0.33998636
0.33537495
0.33082609
0.32633893
0.32191263
0.31754637
49.63299

3.02
3.02
3.02
3.02
3.02
3.02
3.02
3.02
3.02
3.02
3.02
3.02
3.02
3.02
3.02
3.02
3.02
3.02
3.02
3.02
3.02
3.02
3.02
3.02
3.02
3.02
3.02
3.02
3.02
3.02
3.02
3.02
3.02
3.02
3.02
3.02
3.02
3.02
3.02
3.02
3.02
3.02
253.86

1.70
1.73
1.75
1.77
1.80
1.82
1.85
1.87
1.90
1.93
1.95
1.98
2.01
2.03
2.06
2.09
2.12
2.15
2.18
2.21
2.24
2.27
2.30
2.33
2.36
2.40
2.43
2.46
2.50
2.53
2.57
2.60
2.64
2.67
2.71
2.75
2.78
2.82
2.86
2.90
2.94
2.98
150.00

1.32
1.30
1.27
1.25
1.22
1.20
1.17
1.15
1.12
1.10
1.07
1.04
1.02
0.99
0.96
0.93
0.90
0.87
0.84
0.81
0.78
0.75
0.72
0.69
0.66
0.63
0.59
0.56
0.53
0.49
0.46
0.42
0.39
0.35
0.31
0.28
0.24
0.20
0.16
0.12
0.08
0.04
103.86

94.23
92.51
90.76
88.98
87.19
85.36
83.51
81.64
79.74
77.81
75.86
73.88
71.88
69.84
67.78
65.69
63.57
61.42
59.25
57.04
54.80
52.53
50.23
47.90
45.54
43.14
40.71
38.25
35.75
33.22
30.66
28.06
25.42
22.75
20.04
17.29
14.51
11.68
8.82
5.92
2.98
0.00

(1) Column 4 = Column (3) - Column (5)

(2) Column 6 = RPB of last month - Principal recovery of current month

93

X bank may sell this future flow to the buyer institution to the extent an agreed Loan to
Value (LTV). Agreed LTV depends on the
1.

Quality of the customers from the future cash flow to be derived.

2.

Seasoning of cash flows i.e. payment records in the past and

3.

Usual banking margin to cover possible downfall in the value of collateral and
unexpected bad debts.

Generally, a twenty-four months seasoning of the assets is demanded for inclusion in a

pool to be securitized. For example, the Bank may be having various large number of
home loan clients. For choosing a pool the following principles are followed
1. Select home loan which are entered during the same month with similar maturity
pattern and implicit interest rate;
2. Other income loans which may have different aging but having identical maturity
and implicit interest rate can also be included in the pool;
3. All such home loans should be at least of twenty-four months old.

Passing the cash flow to the SPV

The originator retains a margin of finance charge while selling the future cash flow to the
SPV and the SPV in turn retains a margin while retailing the same. For example, X bank
sells the cash flows with effective finance charge of 15.5%, retaining a margin of 1% p.a.,
whereas the SPV may retail it @ 14.5% p.a. retaining a margin of 1% p.a. at the end of
24months. RPB is Rs.81.95 lakhs. If LTV were 80%, X bank would get Rs. 65.56 lakhs
by securitization of the pool. Table 2 shows cash flow that will go to the SPV for onward
payment to the retail investors.

94

Table 2
Cash Flow Split for Securitized Assets Pool
1

Month
24
25
26
27
28
29
30
31
32
33
34
35
36
37
38
39
40
41
42
43
44
45
46
47
48
49
50
51
52
53
54
55
56
57
58
59
60
61
62
63
64
65

EMI
3.02
3.02
3.02
3.02
3.02
3.02
3.02
3.02
3.02
3.02
3.02
3.02
3.02
3.02
3.02
3.02
3.02
3.02
3.02
3.02
3.02
3.02
3.02
3.02
3.02
3.02
3.02
3.02
3.02
3.02
3.02
3.02
3.02
3.02
3.02
3.02
3.02
3.02
3.02
3.02
3.02
3.02

RPB
122.93
121.60
120.25
118.88
117.49
116.09
114.66
113.21
111.75
110.26
108.76
107.23
105.68
104.11
102.52
100.91
99.27
97.62
95.94
94.23
92.51
90.76
88.98
87.19
85.36
83.51
81.64
79.74
77.81
75.86
73.88
71.88
69.84
67.78
65.69
63.57
61.42
59.25
57.04
54.80
52.53
50.23

Securitized
Debt
98.34
97.28
96.20
95.10
93.99
92.87
91.73
90.57
89.40
88.21
87.01
85.78
84.55
83.29
82.02
80.73
79.42
78.09
76.75
75.39
74.01
72.61
71.19
69.75
68.29
66.81
65.31
63.79
62.25
60.69
59.11
57.50
55.87
54.22
52.55
50.86
49.14
47.40
45.63
43.84
42.03
40.19

Discount
factor
1
0.987248
0.974659
0.96223
0.94996
0.937846
0.925886
0.91408
0.902423
0.890916
0.879555
0.868339
0.857266
0.846334
0.835541
0.824887
0.814368
0.803983
0.793731
0.783609
0.773616
0.763751
0.754012
0.744397
0.734904
0.725533
0.716281
0.707147
0.698129
0.689227
0.680438
0.671761
0.663195
0.654738
0.646388
0.638146
0.630008
0.621974
0.614043
0.606213
0.598482
0.59085

Proportionate
EMI @ 15.5%

Interest on
Securitized
Debt

Principal
Repayment

2.37
2.37
2.37
2.37
2.37
2.37
2.37
2.37
2.37
2.37
2.37
2.37
2.37
2.37
2.37
2.37
2.37
2.37
2.37
2.37
2.37
2.37
2.37
2.37
2.37
2.37
2.37
2.37
2.37
2.37
2.37
2.37
2.37
2.37
2.37
2.37
2.37
2.37
2.37
2.37
2.37

1.27
1.26
1.24
1.23
1.21
1.20
1.18
1.17
1.15
1.14
1.12
1.11
1.09
1.08
1.06
1.04
1.03
1.01
0.99
0.97
0.96
0.94
0.92
0.90
0.88
0.86
0.84
0.82
0.80
0.78
0.76
0.74
0.72
0.70
0.68
0.66
0.63
0.61
0.59
0.57
0.54

1.10
1.11
1.12
1.14
1.15
1.17
1.18
1.20
1.21
1.23
1.24
1.26
1.27
1.29
1.31
1.32
1.34
1.36
1.37
1.39
1.41
1.43
1.45
1.46
1.48
1.50
1.52
1.54
1.56
1.58
1.60
1.62
1.64
1.67
1.69
1.71
1.73
1.75
1.78
1.80
1.82

95

66
67
68
69
70
71
72
73
74
75
76
77
78
79
80
81
82
83
84
Total

3.02
3.02
3.02
3.02
3.02
3.02
3.02
3.02
3.02
3.02
3.02
3.02
3.02
3.02
3.02
3.02
3.02
3.02
3.02

47.90
45.54
43.14
40.71
38.25
35.75
33.22
30.66
28.06
25.42
22.75
20.04
17.29
14.51
11.68
8.82
5.92
2.98
0.00

38.32
36.43
34.51
32.57
30.60
28.60
26.58
24.53
22.45
20.34
18.20
16.03
13.83
11.61
9.35
7.06
4.74
2.38
0.00

0.583316
0.575878
0.568534
0.561284
0.554127
0.54706
0.540084
0.533197
0.526398
0.519685
0.513058
0.506516
0.500057
0.49368
0.487385
0.48117
0.475034
0.468976
0.462996
41.57453

2.37
2.37
2.37
2.37
2.37
2.37
2.37
2.37
2.37
2.37
2.37
2.37
2.37
2.37
2.37
2.37
2.37
2.37
2.37
141.93

0.52
0.49
0.47
0.45
0.42
0.40
0.37
0.34
0.32
0.29
0.26
0.24
0.21
0.18
0.15
0.12
0.09
0.06
0.03
43.89

1.85
1.87
1.89
1.92
1.94
1.97
2.00
2.02
2.05
2.08
2.10
2.13
2.16
2.19
2.22
2.24
2.27
2.30
2.33
98.04

Mechanism of cash flow split on securitized pool is explained below:

Find out the RPB of the pool after seasoning at the point of securitization. In this example
end of 24 months has been taken as securitization point, when RPB is Rs.122.93 lakhs.
Taking Loan to value (LTV) as 80% securitized asset pool amounts to Rs.98.34 lakhs.
Work out the annuity factor as the pass through rate to the SPV. In this example pass
through rate to the SPV is 15.5% and the interest is payable on monthly basis. So the
annuity factor is 41.57453.

Work out the EMI for the securitized asset pool which comes out to be Rs. 2.37 lakhs.
Interest element of the securitized pool is shown in column 7 of table 2 which is
calculated on the balance amount of the securitized asset @ 15.5% on monthly basis.

96

Servicing Spread This is spread enjoyed by the servicer and the SPV. In the given
example, servicing spread is 0.2% shared equally between the servicer X bank and the
SPV. Table 3 explains the servicing spread enjoyed by the originator, X bank.

Table 3
Spread of the Originator in Securitization Process
1

Month
24
25
26
27
28
29
30
31
32
33
34
35
36
37
38
39
40
41
42
43
44
45
46
47
48
49
50
51
52
53
54
55
56
57

RPB
24.59
24.32
24.05
23.78
23.50
23.22
22.93
22.64
22.35
22.05
21.75
21.45
21.14
20.82
20.50
20.18
19.85
19.52
19.19
18.85
18.50
18.15
17.80
17.44
17.07
16.70
16.33
15.95
15.56
15.17
14.78
14.38
13.97
13.56

3
Balance
of EMI
0.66
0.66
0.66
0.66
0.66
0.66
0.66
0.66
0.66
0.66
0.66
0.66
0.66
0.66
0.66
0.66
0.66
0.66
0.66
0.66
0.66
0.66
0.66
0.66
0.66
0.66
0.66
0.66
0.66
0.66
0.66
0.66
0.66

4
Interest

5
Principal
Recovery

Spread

0.338
0.334
0.331
0.327
0.323
0.319
0.315
0.311
0.307
0.303
0.299
0.295
0.291
0.286
0.282
0.278
0.273
0.268
0.264
0.259
0.254
0.250
0.245
0.240
0.235
0.230
0.225
0.219
0.214
0.209
0.203
0.198
0.192

0.196
0.201
0.206
0.211
0.216
0.221
0.227
0.232
0.238
0.243
0.249
0.255
0.260
0.266
0.272
0.278
0.284
0.291
0.297
0.303
0.310
0.316
0.323
0.330
0.337
0.344
0.351
0.358
0.365
0.372
0.380
0.387
0.395

0.123
0.122
0.120
0.119
0.117
0.116
0.115
0.113
0.112
0.110
0.109
0.107
0.106
0.104
0.103
0.101
0.099
0.098
0.096
0.094
0.093
0.091
0.089
0.087
0.085
0.084
0.082
0.080
0.078
0.076
0.074
0.072
0.070

97

58
59
60
61
62
63
64
65
66
67
68
69
70
71
72
73
74
75
76
77
78
79
80
81
82
83
84
Total

13.14
12.71
12.28
11.85
11.41
10.96
10.51
10.05
9.58
9.11
8.63
8.14
7.65
7.15
6.64
6.13
5.61
5.08
4.55
4.01
3.46
2.90
2.34
1.76
1.18
0.60
0.00

0.66
0.66
0.66
0.66
0.66
0.66
0.66
0.66
0.66
0.66
0.66
0.66
0.66
0.66
0.66
0.66
0.66
0.66
0.66
0.66
0.66
0.66
0.66
0.66
0.66
0.66
0.66
39.40

0.186
0.181
0.175
0.169
0.163
0.157
0.151
0.144
0.138
0.132
0.125
0.119
0.112
0.105
0.098
0.091
0.084
0.077
0.070
0.063
0.055
0.048
0.040
0.032
0.024
0.016
0.008
11.68

0.403
0.410
0.418
0.426
0.435
0.443
0.451
0.460
0.468
0.477
0.486
0.495
0.504
0.513
0.523
0.532
0.542
0.551
0.561
0.571
0.582
0.592
0.602
0.613
0.624
0.634
0.646
23.47

0.068
0.066
0.064
0.061
0.059
0.057
0.055
0.053
0.050
0.048
0.046
0.043
0.041
0.038
0.036
0.033
0.031
0.028
0.025
0.023
0.020
0.017
0.015
0.012
0.009
0.006
0.003
4.25

Explanation to the calculation of the Spread:

After securitization 20% of the RPB will remain with the originator, X bank. So during
25-84 months RPB will be calculated on the basis of Rs.24.59 lakhs.

In column 3 of Table 3 balance of EMI has been shown. This is the balance of EMI that
will remain with the originator after passing the cash flow to the SPV which is necessary
to service 80% LTV @ 15.5%. Balance of EMI is total EMI Rs. 3.02 pass through EMI
Rs. 2.37 lakhs = Rs. 0.66 lakhs.

98

Balance of EMI can be segregated into three elements (i) Column 4 of table 3 shows
interest element on a reduced level of RPB as shown in column 2 of table 3. Interest is
calculate @ 16.5% p.a. (ii) Column 6 shows 1% service spread enjoyed by the originator,
which is 1% of the original RPB as shown in column 3 of Table 2 and (iii) Repayment of
Principal as shown in column 5 of table 3; this is calculated as Column 3 column 4column 6.

In addition, the originator can deploy the funds raised in the securitization process. Table
3 simply explains that total spread to the securities is Rs. 4.25 lakhs on Rs.122.93 lakhs
pool with 80% LTV over 5 year period @ 0.1%.

Servicing spread of the SPV on the other hand, the SPV also enjoys a servicing spread.
In table 4, servicing spread enjoyed by the SPV has been calculated.

99

Table 4
Servicing spread to the SPV and distribution of cash flow of the Securitized asset
pool
1

Month
25
26
27
28
29
30
31
32
33
34
35
36
37
38
39
40
41
42
43
44
45
46
47
48
49
50
51
52
53
54
55
56
57
58
59
60
61
62

Cash Flow
from
underlying
asset pool
3.02
3.02
3.02
3.02
3.02
3.02
3.02
3.02
3.02
3.02
3.02
3.02
3.02
3.02
3.02
3.02
3.02
3.02
3.02
3.02
3.02
3.02
3.02
3.02
3.02
3.02
3.02
3.02
3.02
3.02
3.02
3.02
3.02
3.02
3.02
3.02
3.02
3.02

Cash
Flow to
SPV
2.37
2.37
2.37
2.37
2.37
2.37
2.37
2.37
2.37
2.37
2.37
2.37
2.37
2.37
2.37
2.37
2.37
2.37
2.37
2.37
2.37
2.37
2.37
2.37
2.37
2.37
2.37
2.37
2.37
2.37
2.37
2.37
2.37
2.37
2.37
2.37
2.37
2.37

Total
Interest
1.27
1.26
1.24
1.23
1.21
1.20
1.18
1.17
1.15
1.14
1.12
1.11
1.09
1.08
1.06
1.04
1.03
1.01
0.99
0.97
0.96
0.94
0.92
0.90
0.88
0.86
0.84
0.82
0.80
0.78
0.76
0.74
0.72
0.70
0.68
0.66
0.63
0.61

Spread
to SPV
0.082
0.081
0.080
0.079
0.078
0.077
0.076
0.075
0.074
0.074
0.073
0.071
0.070
0.069
0.068
0.067
0.066
0.065
0.064
0.063
0.062
0.061
0.059
0.058
0.057
0.056
0.054
0.053
0.052
0.051
0.049
0.048
0.047
0.045
0.044
0.042
0.041
0.039

100

6
Net
amount
to
Retail
Investor
2.284
2.284
2.285
2.286
2.287
2.288
2.289
2.290
2.291
2.292
2.293
2.294
2.295
2.296
2.297
2.298
2.299
2.300
2.302
2.303
2.304
2.305
2.306
2.307
2.309
2.310
2.311
2.312
2.314
2.315
2.316
2.318
2.319
2.320
2.322
2.323
2.325
2.326

Towards
Interest
1.188
1.175
1.162
1.149
1.136
1.122
1.108
1.094
1.080
1.066
1.051
1.037
1.022
1.006
0.991
0.975
0.960
0.944
0.927
0.911
0.894
0.877
0.860
0.843
0.825
0.807
0.789
0.771
0.752
0.733
0.714
0.695
0.675
0.655
0.635
0.615
0.594
0.573

Towards
Principal
1.095
1.109
1.123
1.137
1.151
1.166
1.181
1.196
1.211
1.226
1.242
1.257
1.273
1.290
1.306
1.323
1.340
1.357
1.374
1.392
1.410
1.428
1.446
1.465
1.483
1.503
1.522
1.542
1.561
1.582
1.602
1.623
1.644
1.665
1.687
1.709
1.731
1.753

63
64
65
66
67
68
69
70
71
72
73
74
75
76
77
78
79
80
81
82
83
84
Total

3.02
3.02
3.02
3.02
3.02
3.02
3.02
3.02
3.02
3.02
3.02
3.02
3.02
3.02
3.02
3.02
3.02
3.02
3.02
3.02
3.02
3.02
181.33

2.37
2.37
2.37
2.37
2.37
2.37
2.37
2.37
2.37
2.37
2.37
2.37
2.37
2.37
2.37
2.37
2.37
2.37
2.37
2.37
2.37
2.37
141.93

0.59
0.57
0.54
0.52
0.49
0.47
0.45
0.42
0.40
0.37
0.34
0.32
0.29
0.26
0.24
0.21
0.18
0.15
0.12
0.09
0.06
0.03
43.89

0.038
0.037
0.035
0.033
0.032
0.030
0.029
0.027
0.025
0.024
0.022
0.020
0.019
0.017
0.015
0.013
0.012
0.010
0.008
0.006
0.004
0.002
2.832

2.327
2.329
2.330
2.332
2.334
2.335
2.337
2.338
2.340
2.342
2.343
2.345
2.347
2.349
2.350
2.352
2.354
2.356
2.358
2.360
2.362
2.364
139.098

0.551
0.530
0.508
0.486
0.463
0.440
0.417
0.394
0.370
0.346
0.321
0.296
0.271
0.246
0.220
0.194
0.167
0.140
0.113
0.085
0.057
0.029
41.057

1.776
1.799
1.823
1.846
1.871
1.895
1.920
1.945
1.970
1.996
2.022
2.049
2.076
2.103
2.130
2.158
2.187
2.216
2.245
2.274
2.304
2.335
98.041

In this example, the securitiser earns a spread of Rs. 4.25 lakhs whereas the SPV earns a
spread of Rs.2.83 lakhs.

101

THE LAST WORD.

Securitization is time consuming, complicated and can be expensive. Avoiding some of
the costs, ensuring that timetables are adhered to and getting a transaction which meets
the originator's needs is a question of organization and preparation.

The variety of issues, and the amounts of work involved mean that it is inevitable that a
large number of advisers are needed to complete any transaction. Although there are both
high internal and external costs associated with any transaction on this scale
securitization does offer access to large amounts of funding, and once programmes are set
up, they can be repeated relatively cheaply and easily.

Select your advisers carefully - and ensure that the advice which is received covers all
aspects of the transaction, and includes systems, accounting, legal, tax, banking, rating
and general administration.

102

Annexure I
THE SECURITIZATION AND RECONSTRUCTION OF FINANCIAL ASSETS
AND ENFORCEMENT OF SECURITY INTEREST
BILL, 2002
A
BILL
to regulate securitization and reconstruction of financial assets and enforcement
of security interest and for matters connected therewith or incidental thereto.

BE it enacted by Parliament in the Fifty-third Year of the Republic of India as

follows:

CHAPTER I PRELIMINARY
CHAPTER

II

RECONSTRUCTION

REGULATION
OF

FINANCIAL

OF

SECURITIZATION

ASSETS

OF

FINANCIAL INSTITUTIONS
CHAPTER III - ENFORCEMENT OF SECURITY INTEREST
CHAPTER IV - CENTRAL REGISTRY
CHAPTER V - OFFENCES AND PENALTIES
CHAPTER VI - MISCELLANEOUS
THE SCHEDULE

103

BANKS

AND
AND

CHAPTER I
PRELIMINARY
1. Short title, extent and commencement.(1) This Act may be called the Securitization and Reconstruction of Financial Assets and
Enforcement of Security Interest Act, 2002.
(2) It extends to the whole of India.
(3) It shall be deemed to have come into force on the 21st day of June, 2002.
2. Definitions.-(1) In this Act, unless the context otherwise requires,
(a) "Appellate Tribunal" means a Debts Recovery Appellate Tribunal established under
sub-section (1) of section 8 of the Recovery of Debts Due to Banks and Financial
Institutions Act, 1993 (51 of 1993);
(b) "asset reconstruction" means acquisition by any securitization company or
reconstruction company of any right or interest of any bank or financial institution in any
financial assistance for the purpose of realization of such financial assistance;
(c) "bank" means
(i) a banking company; or
(ii) a corresponding new bank; or
(iii) the State Bank of India; or
(iv) a subsidiary bank; or
(v) such other bank which the Central Government may, by notification, specify for the
purposes of this Act;
(d) "banking company" shall have the meaning assigned to it in clause (c) of section 5 of
the Banking Regulation Act, 1949 (10 of 1949);

104

(e) "Board" means the Securities and Exchange Board of India established under section
3 of the Securities and Exchange Board of India Act, 1992 (15 of 1992);(f) "borrower" means any person who has been granted financial assistance by any bank
or financial institution or who has given any guarantee or created any mortgage or pledge
as security for the financial assistance granted by any bank or financial institution and
includes a person who becomes borrower of a securitization company or reconstruction
company consequent upon acquisition by it of any rights or interest of any bank or
financial institution in relation to such financial assistance;
(g) "Central Registry" means the registry set up or cause to be set up under sub-section
(1) of section 20;
(h) "corresponding new bank" shall have the meaning assigned to it in clause (da) of
section 5 of the Banking Regulation Act, 1949 (10 of 1949);
(i) "Debts Recovery Tribunal" means the Tribunal established under subsection (1) of
section 3 of the Recovery of Debts due to Banks and Financial Institutions Act, 1993 (51
of 1993);
(j) "default" means non-payment of any principal debt or interest thereon or any other
amount payable by a borrower to any secured creditor consequent upon which the
account of such borrower is classified as non-performing asset in the books of account of
the secured creditor in accordance with the directions or guidelines issued by the Reserve
Bank;
(k) "financial assistance" means any loan or advance granted or any debentures or bonds
subscribed or any guarantees given or letters of credit established or any other credit
facility extended by any bank or financial institution;

105

(l) "financial asset" means debt or receivables and includes

(i) a claim to any debt or receivables or part thereof, whether secured or unsecured; or
(ii) any debt or receivables secured by, mortgage of, or charge on, immovable property;
or
(iii) a mortgage, charge, hypothecation or pledge of movable property; or
(iv) any right or interest in the security, whether full or part underlying such debt or
receivables; or
(v) any beneficial interest in property, whether movable or immovable, or in such debt,
receivables, whether such interest is existing, future, accruing, conditional or contingent;
or
(vi) any financial assistance;
(m) "financial institution" means
(i) a public financial institution within the meaning of section 4A of the Companies Act,
1956 (1 of 1956);
(ii) any institution specified by the Central Government under subclause
(ii) of clause (h) of section 2 of the Recovery of Debts Due to Banks and Financial
Institutions Act, 1993 (51 of 1993);
(iii) the International Finance Corporation established under the International Finance
Corporation (Status, Immunities and Privileges ) Act, 1958 (42 of 1958);
(iv) any other institution or non-banking financial company as defined in clause (f) of
section 45-I of the Reserve Bank of India Act, 1934 (2 of 1934), which the Central
Government may, by notification, specify as financial institution for the purposes of this
Act;

106

(n) "hypothecation" means a charge in or upon any movable property, existing or future,
created by a borrower in favour of a secured creditor without delivery of possession of
the movable property to such creditor, as a security for financial assistance and includes
floating charge and crystallization of such charge into fixed charge on movable property;
(o) "non-performing asset" means an asset or account of a borrower, which has been
classified by a bank or financial institution as sub-standard, doubtful or loss asset, in
accordance with the directions or under guidelines relating to assets classifications issued
by the Reserve Bank;
(p) "notification" means a notification published in the Official Gazette;
(q) "obligor" means a person liable to the originator, whether under a contract or
otherwise, to pay a financial asset or to discharge any obligation in respect of a financial
asset, whether existing, future, conditional or contingent and includes the borrower;
(r) "originator" means the owner of a financial asset which is acquired by a securitization
company or reconstruction company for the purpose of securitization or asset
reconstruction;
(s) "prescribed" means prescribed by rules made under this Act;
(t) "property" means
(i) immovable property;
(ii) movable property;
(iii) any debt or any right to receive payment of money, whether secured or unsecured;
(iv) receivables, whether existing or future;
(v) intangible assets, being know-how, patent, copyright, trade mark, license, franchise or
any other business or commercial right of similar nature;

107

(u) "qualified institutional buyer" means a financial institution, insurance company, bank,
state financial corporation, state industrial development corporation, trustee or any asset
management company making investment on behalf of mutual fund or provident fund or
gratuity fund or pension fund or a foreign institutional investor registered under the
Securities and Exchange Board of India Act, 1992 (15 of 1992) or regulations made
thereunder, or any other body corporate as may be specified by the Board;
(v) "reconstruction company" means a company formed and registered under the
Companies Act, 1956 (1 of 1956) for the purpose of asset reconstruction;
(w) "Registrar of Companies" means the Registrar defined in clause (40) of section 2 of
the Companies Act, 1956 (1 of 1956);
(x) "Reserve Bank" means the Reserve Bank of India constituted under section 3 of the
Reserve Bank of India Act, 1934 (2 of 1934);
(y) "scheme" means a scheme inviting subscription to security receipts proposed to be
issued by a securitization company or reconstruction company under that scheme;
(z) "securitization" means acquisition of financial assets by any securitization company or
reconstruction company from any originator, whether by raising of funds by such
securitization company or reconstruction company from qualified institutional buyers by
issue of security receipts representing undivided interest in such financial assets or
otherwise;
(za) "securitization company" means any company formed and registered under the
Companies Act, 1956 (1 of 1956) for the purpose of securitization;

108

(zb) "security agreement" means an agreement, instrument or any other document or

arrangement under which security interest is created in favour of the secured creditor
including the creation of mortgage by deposit of title deeds with the secured creditor;
(zc) "secured asset" means the property on which security interest is created;
(zd) "secured creditor" means any bank or financial institution or any consortium or
group of banks or financial institutions and includes
(i) debenture trustee appointed by any bank or financial institution; or
(ii) securitization company or reconstruction company; or
(iii) any other trustee holding securities on behalf of a bank or financial institution;
in whose favour security interest is created for due repayment by any borrower of any
financial assistance;
(ze) "secured debt" means a debt which is secured by any security interest;
(zf) "security interest" means right, title and interest of any kind whatsoever upon
property, created in favour of any secured creditor and includes any mortgage, charge,
hypothecation, assignment other than those specified in section 31;
(zg) "security receipt" means a receipt or other security, issued by a securitization
company or reconstruction company to any qualified institutional buyer pursuant to a
scheme, evidencing the purchase or acquisition by the holder thereof, of an undivided
right, title or interest in the financial asset involved in securitization;
(zh) "sponsor" means any person holding not less than ten per cent. of the paid-up equity
capital of a securitization company or reconstruction company;
(zi) "State Bank of India" means the State Bank of India constituted under section 3 of the
State Bank of India Act, 1955 (23 of 1955);

109

(zj) "subsidiary bank" shall have the meaning assigned to it in clause (k) of section 2 of
the State Bank of India (Subsidiary Banks) Act, 1959 (38 of 1959).
(2) Words and expressions used and not defined in this Act but defined in the Indian
Contract Act, 1872 (9 of 1872) or the Transfer of Property Act, 1882 (4 of 1882) or the
Companies Act, 1956 (1 of 1956) or the Securities and Exchange Board of India Act,
1992 (15 of 1992) shall have the same meanings respectively assigned to them in those
Acts.

110

CHAPTER II
REGULATION OF SECURITIZATION AND RECONSTRUCTION OF FINANCIAL
ASSETS OF BANKS AND FINANCIAL INSTITUTIONS
3. Registration of securitization companies or reconstruction compnaies.-(1) No
securitization company or reconstruction company shall commence or carry on the
business of securitization or asset reconstruction without
(a) obtaining a certificate of registration granted under this section; and
(b) having the owned fund of not less than two crore rupees or such other amount not
exceeding fifteen per cent. of total financial assets acquired or to be acquired by the
Securitization Company or reconstruction company, as the Reserve Bank may, by
notification, specify:
Provided that the Reserve Bank may, by notification, specify different amounts of owned
fund for different class or classes of securitization companies or reconstruction
companies:
Provided further that a securitization company or reconstruction company, existing on the
commencement of this Act, shall make an application for registration to the Reserve Bank
before the expiry of six months from such commencement and notwithstanding anything
contained in this sub-section may continue to carry on the business of securitization or
asset reconstruction until a certificate of registration is granted to it or, as the case may
be, rejection of application for registration is communicated to it.
(2) Every securitization company or reconstruction company shall make an application
for registration to the Reserve Bank in such form and manner as it may specify.

111

(3) The Reserve Bank may, for the purpose of considering the application for registration
of a securitization company or reconstruction company to commence or carry on the
business of securitization or asset reconstruction, as the case may be, require to be
satisfied, by an inspection of records or books of such securitization company or
reconstruction company, or otherwise, that the following conditions are fulfilled, namely:

(a) that the securitization company or reconstruction company has not incurred losses in
any of the three preceding financial years;
(b) that such securitization company or reconstruction company has made adequate
arrangements for realization of the financial assets acquired for the purpose of
securitization or asset reconstruction and shall be able to pay periodical returns and
redeem on respective due dates on the investments made in the company by the qualified
institutional buyers or other persons;
(c) that the directors of securitization company or reconstruction company have adequate
professional experience in matters related to finance, securitization and reconstruction;
(d) that the board of directors of such securitization company or reconstruction company
does not consist of more than half of its total number of directors who are either
nominees of any sponsor or associated in any manner with the sponsor or any of its
subsidiaries;
(e) that any of its directors has not been convicted of any offence involving moral
turpitude;

112

(f) that a sponsor, is not a holding company of the securitization company or

reconstruction company, as the case may be, or, does not otherwise hold any controlling
interest in such securitization company or reconstruction company;
(g) that securitization company or reconstruction company has complied with or is in a
position to comply with prudential norms specified by the Reserve Bank.
(4) The Reserve Bank may, after being satisfied that the conditions specified in subsection (3) are fulfilled, grant a certificate of registration to the securitization company or
the reconstruction company to commence or carry on business of securitization or asset
reconstruction, subject to such conditions, which it may consider, fit to impose.
(5) The Reserve Bank may reject the application made under sub-section (2) if it is
satisfied that the conditions specified in sub-section (3) are not fulfilled: Provided that
before rejecting the application, the applicant shall be given a reasonable opportunity of
being heard.
(6) Every securitization company or reconstruction company, shall obtain prior approval
of the Reserve Bank for any substantial change in its management or change of location
of its registered office or change in its name:
Provided that the decision of the Reserve Bank, whether the change in management of a
securitization company or a reconstruction company is a substantial change in its
management or not, shall be final.
Explanation.For the purposes of this section, the expression "substantial change in
management" means the change in the management by way of transfer of shares or
amalgamation or transfer of the business of the company.

113

4. Cancellation of certificate of registration.-(1) The Reserve Bank may cancel a

certificate of registration granted to a securitization company or a reconstruction
company, if such company
(a) ceases to carry on the business of securitization or asset reconstruction; or
(b) ceases to receive or hold any investment from a qualified institutional buyer; or
(c) has failed to comply with any conditions subject to which the certificate of
registration has been granted to it; or
(d) at any time fails to fulfill any of the conditions referred to in clauses (a) to (g) of subsection (3) of section 3; or
(e) fails to
(i) comply with any direction issued by the Reserve Bank under the provisions of this
Act; or
(ii) maintain accounts in accordance with the requirements of any law or any direction or
order issued by the Reserve Bank under the provisions of this Act; or
(iii) submit or offer for inspection its books of account or other relevant documents when
so demanded by the Reserve Bank; or
(iv) obtain prior approval of the Reserve Bank required under subsection (6) of section 3:
Provided that before canceling a certificate of registration on the ground that the
securitization company or reconstruction company has failed to comply with the
provisions of clause (c) or has failed to fulfill any of the conditions referred to in
clause (d) or sub-clause (iv) of clause (e), the Reserve Bank, unless it is of the opinion
that the delay in canceling the certificate of registration granted under subsection (4) of
section 3 shall be prejudicial to the public interest or the interests of the investors or the

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securitization company or the reconstruction company, shall give an opportunity to such

company on such terms as the Reserve Bank may specify for taking necessary steps to
comply with such provisions or fulfillment of such conditions.
(2) A securitization company or reconstruction company aggrieved by the order of
rejection of application for registration or cancellation of certificate of registration may
prefer an appeal, within a period of thirty days from the date on which such order of
rejection or cancellation is communicated to it, to the Central Government:
Provided that before rejecting an appeal such company shall be given a reasonable
opportunity of being heard.
(3) A securitization company or reconstruction company, which is holding investments of
qualified institutional buyers and whose application for grant of certificate of registration
has been rejected or certificate of registration has been cancelled shall, notwithstanding
such rejection or cancellation, be deemed to be a securitization company or
reconstruction company until it repays the entire investments held by it (together with
interest, if any) within such period as the Reserve Bank may direct.
5. Acquisition of rights or interest in financial assets.-(1) Notwithstanding anything
contained in any agreement or any other law for the time being in force, any
securitization company or reconstruction company may acquire financial assets of any
bank or financial institution,
(a) by issuing a debenture or bond or any other security in the nature of debenture, for
consideration agreed upon between such company and the bank or financial institution,
incorporating therein such terms and conditions as may be agreed upon between them; or

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(b) By entering into an agreement with such bank or financial institution for the transfer
of such financial assets to such company on such terms and conditions as may be agreed
upon between them.
(2) If the bank or financial institution is a lender in relation to any financial assets
acquired under sub-section (1) by the securitization company or the reconstruction
company, such securitization company or reconstruction company shall, on such
acquisition, be deemed to be the lender and all the rights of such bank or financial
institution shall vest in such company in relation to such financial assets.
(3) Unless otherwise expressly provided by this Act, all contracts, deeds, bonds,
agreements, powers-of-attorney, grants of legal representation, permissions, approvals,
consents or no-objections under any law or otherwise and other instruments of whatever
nature which relate to the said financial asset and which are subsisting or having effect
immediately before the acquisition of financial asset under sub-section (1) and to which
the concerned bank or financial institution is a party or which are in favour of such bank
or financial institution shall, after the acquisition of the financial assets, be of as full force
and effect against or in favour of the securitization company or reconstruction company,
as the case may be, and may be enforced or acted upon as fully and effectually as if, in
the place of the said bank or financial institution, securitization company or
reconstruction company, as the case may be, had been a party thereto or as if they had
been issued in favour of securitization company or reconstruction company, as the case
may be.
(4) If, on the date of acquisition of financial asset under sub-section (1), any suit, appeal
or other proceeding of whatever nature relating to the said financial asset is pending by or

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against the bank or financial institution, save as provided in the third proviso to subsection (1) of section 15 of the Sick Industrial Companies (Special Provisions) Act, 1985
(1 of 1986) the same shall not abate, or be discontinued or be, in any way, prejudicially
affected by reason of the acquisition of financial asset by the securitization company or
reconstruction company, as the case may be, but the suit, appeal or other proceeding may
be continued, prosecuted and enforced by or against the securitization company or
reconstruction company, as the case may be.
6. Notice to obligor and discharge of obligation of such obligor.-(1) The bank or financial
institution may, if it considers appropriate, give a notice of acquisition of financial assets
by any securitization company or reconstruction company, to the concerned obligor and
any other concerned person and to the concerned registering authority (including
Registrar of Companies) in whose jurisdiction the mortgage, charge, hypothecation,
assignment or other interest created on the financial assets had been registered.
(2) Where a notice of acquisition of financial asset under sub-section (1) is given by a
bank or financial institution, the obligor, on receipt of such notice, shall make payment to
the concerned securitization company or reconstruction company, as the case may be, and
payment made to such company in discharge of any of the obligations in relation to the
financial asset specified in the notice shall be a full discharge to the obligor making the
payment from all liability in respect of such payment.
(3) Where no notice of acquisition of financial asset under sub-section (1) is given by any
bank or financial institution, any money or other properties subsequently received by the
bank or financial institution, shall constitute monies or properties held in trust for the
enefit of and on behalf of the securitization company or reconstruction company, as the

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case may be, and such bank or financial institution shall hold such payment or property
which shall forthwith be made over or delivered to such securitization company or
reconstruction company, as the case may be, or its agent duly authorized in this behalf.
7. Issue of security by raising of receipts or funds by securitization company or
reconstruction company.-(1) Without prejudice to the provisions contained in the
Companies Act, 1956 (1 of 1956), the Securities Contracts (Regulation) Act, 1956 (42 of
1956) and the Securities and Exchange Board of India Act, 1992 (15 of 1992), any
securitization company or reconstruction company, may, after acquisition of any financial
asset under sub-section (1) of section 5, offer security receipts to qualified institutional
buyers (other than by offer to public) for subscription in accordance with the provisions
of those Acts.
(2) A securitization company or reconstruction company may raise funds from the
qualified institutional buyers by formulating schemes for acquiring financial assets and
shall keep and maintain separate and distinct accounts in respect of each such scheme for
every financial asset acquired out of investments made by a qualified institutional buyer
and ensure that realizations of such financial asset is held and applied towards
redemption of investments and payment of returns assured on such investments under the
relevant scheme.
(3) In the event of non-realization under sub-section (2) of financial assets, the qualified
institutional buyers of a securitization company or reconstruction company, holding
security receipts of not less than seventy-five per cent. of the total value of the security
receipts issued by such company, shall be entitled to call a meeting of all the qualified

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institutional buyers and every resolution passed in such meeting shall be binding on the
company.
(4) The qualified institutional buyers shall, at a meeting called under sub-section (3),
follow the same procedure, as nearly as possible as is followed at meetings of the board
of directors of the securitization company or reconstruction company, as the case may be.
8. Exemption from registration of security receipt.-Notwithstanding anything contained
in sub-section (1) of section 17 of the Registration Act, 1908 (16 of 1908),
(a) any security receipt issued by the securitization company or reconstruction company,
as the case may be, under sub-section (1) of section 7, and not creating, declaring,
assigning, limiting or extinguishing any right, title or interest, to or in immovable
property except in so far as it entitles the holder of the security receipt to an undivided
interest afforded by a registered instrument; or
(b) any transfer of security receipts, shall not require compulsory registration.
9. Measures for assets reconstruction.-Without prejudice to the provisions contained in
any other law for the time being in force, a securitization company or reconstruction
company may, for the purposes of asset reconstruction, having regard to the guidelines
framed by the Reserve Bank in this behalf, provide for any one or more of the following
measures, namely:
(a) the proper management of the business of the borrower, by change in, or take over of,
the management of the business of the borrower;
(b) the sale or lease of a part or whole of the business of the borrower;
(c) rescheduling of payment of debts payable by the borrower;
(d) enforcement of security interest in accordance with the provisions of this Act;

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(e) settlement of dues payable by the borrower;

(f) taking possession of secured assets in accordance with the provisions of this Act.
10. Other functions of securitization company or reconstruction company.-(1) Any
securitization company or reconstruction company registered under section 3 may
(a) act as an agent for any bank or financial institution for the purpose of recovering their
dues from the borrower on payment of such fees or charges as may be mutually agreed
upon between the parties;
(b) act as a manager referred to in clause (c) of sub-section (4) of section 13 on such fee
as may be mutually agreed upon between the parties;
(c) act as receiver if appointed by any court or tribunal:
Provided that no securitization company or reconstruction company shall act as a
manager if acting as such gives rise to any pecuniary liability.
(2) Save as otherwise provided in sub-section (1), no securitization company or
reconstruction company which has been granted a certificate of registration under
sub-section (4) of section 3, shall commence or carry on, without prior approval of the
Reserve Bank, any business other than that of securitization or asset reconstruction:
Provided that a securitization company or reconstruction company which is carrying on,
on or before the commencement of this Act, any business other than the business of
securitization or asset reconstruction or business referred to in subsection (1), shall cease
to carry on any such business within one year from the date of commencement of this
Act.
ExplanationFor the purposes of this section, securitization company or
reconstruction company does not include its subsidiary.

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11. Resolution of disputes.-Where any dispute relating to securitization or reconstruction

or non-payment of any amount due including interest arises amongst any of the parties,
namely, the bank or financial institution or securitization company or reconstruction
company or qualified institutional buyer, such dispute shall be settled by conciliation or
arbitration as provided in the Arbitration and Conciliation Act, 1996 (26 of 1996), as if
the parties to the dispute have consented in writing for determination of such dispute by
conciliation or arbitration and the provisions of that Act shall apply accordingly.
12. Power of Reserve Bank to determine policy and issue directions.-(1) If the Reserve
Bank is satisfied that in the public interest or to regulate financial system of the country
to its advantage or to prevent the affairs of any securitization company or reconstruction
company from being conducted in a manner detrimental to the interest of investors or in
any manner prejudicial to the interest of such securitization company or reconstruction
companay, it is necessary or expedient so to do, it may determine the policy and give
directions to all or any securitization company or reconstruction company in matters
relating to income recognition, accounting standards, making provisions for bad and
doubtful debts, capital adequacy based on risk weights for assets and also relating to
deployment of funds by the securitization company or reconstruction company, as the
case may be, and such company shall be bound to follow the policy so determined and
the directions so issued.
(2) Without prejudice to the generality of the power vested under sub-section (1), the
Reserve Bank may give directions to any securitization company or reconstruction
company generally or to a class of securitization companies or reconstruction companies
or to any securitization company or reconstruction company in particular as to

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(a) the type of financial asset of a bank or financial institution which can be acquired and
procedure for acquisition of such assets and valuation thereof;
(b) the aggregate value of financial assets which may be acquired by any securitization
company or reconstruction company.

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CHAPTER III
ENFORCEMENT OF SECURITY INTEREST
13. Enforcement of security interest.-(1) Notwithstanding anything contained in section
69 or section 69A of the Transfer of Property Act, 1882 (4 of 1882), any security interest
created in favour of any secured creditor may be enforced, without the intervention of the
court or tribunal, by such creditor in accordance with the provisions of this Act.
(2) Where any borrower, who is under a liability to a secured creditor under a security
agreement, makes any default in repayment of secured debt or any installment thereof,
and his account in respect of such debt is classified by the secured creditor as nonperforming asset, then, the secured creditor may require the borrower by notice in writing
to discharge in full his liabilities to the secured creditor within sixty days from the date of
notice failing which the secured creditor shall be entitled to exercise all or any of the
rights under sub-section (4).
(3) The notice referred to in sub-section (2) shall give details of the amount payable by
the borrower and the secured assets intended to be enforced by the secured creditor in the
event of non-payment of secured debts by the borrower.
(4) In case the borrower fails to discharge his liability in full within the period
specified in sub-section (2), the secured creditor may take recourse to one or more of the
following measures to recover his secured debt, namely:
(a) take possession of the secured assets of the borrower including the right to transfer by
way of lease, assignment or sale for realizing the secured asset;
(b) take over the management of the secured assets of the borrower including the right to
transfer by way of lease, assignment or sale and realize the secured asset;

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(c) appoint any person (hereafter referred to as the manager), to manage the secured
assets the possession of which has been taken over by the secured creditor;
(d) require at any time by notice in writing, any person who has acquired any of the
secured assets from the borrower and from whom any money is due or may become due
to the borrower, to pay the secured creditor, so much of the money as is sufficient to pay
the secured debt.
(5) Any payment made by any person referred to in clause (d) of sub-section (4) to the
secured creditor shall give such person a valid discharge as if he has made payment to the
borrower.
(6) Any transfer of secured asset after taking possession thereof or take over of
management under sub-section (4), by the secured creditor or by the manager on behalf
of the secured creditor shall vest in the transferee all rights in, or in relation to, the
secured asset transferred as if the transfer had been made by the owner of such secured
asset.
(7) Where any action has been taken against a borrower under the provisions of subsection (4), all costs, charges and expenses which, in the opinion of the secured creditor,
have been properly incurred by him or any expenses incidental thereto, shall be
recoverable from the borrower and the money which is received by the secured creditor
shall, in the absence of any contract to the contrary, be held by him in trust, to be applied,
firstly, in payment of such costs, charges and expenses and secondly, in discharge of the
dues of the secured creditor and the residue of the money so received shall be paid to the
person entitled thereto in accordance with his rights and interests.

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(8) If the dues of the secured creditor together with all costs, charges and expenses
incurred by him are tendered to the secured creditor at any time before the date fixed for
sale or transfer, the secured asset shall not be sold or transferred by the secured creditor,
and no further step shall be taken by him for transfer or sale of that secured asset.
(9) In the case of financing of a financial asset by more than one secured creditors or joint
financing of a financial asset by secured creditors, no secured creditor shall be entitled to
exercise any or all of the rights conferred on him under or pursuant to sub-section (4)
unless exercise of such right is agreed upon by the secured creditors representing not less
than three-fourth in value of the amount outstanding as on a record date and such action
shall be binding on all the secured creditors:
Provided that in the case of a company in liquidation, the amount realized from the sale
of secured assets shall be distributed in accordance with the provisions of section 529A of
the Companies Act, 1956 (1 of 1956):
Provided further that in the case of a company being wound up on or after the
commencement of this Act, the secured creditor of such company, who opts to realize his
security instead of relinquishing his security and proving his debt under proviso to subsection (1) of section 529 of the Companies Act, 1956 (1 of 1956), may retain the sale
proceeds of his secured assets after depositing the workmens dues with the liquidator in
accordance with the provisions of section 529A of that Act:
Provided also that the liquidator referred to in the second proviso shall intimate the
secured creditors the workmens dues in accordance with the provisions of section 529A
of the Companies Act, 1956 (1 of 1956) and in case such workmens dues cannot be
ascertained, the liquidator shall intimate the estimated amount of workmens dues under

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that section to the secured creditor and in such case the secured creditor may retain the
sale proceeds of the secured assets after depositing the amount of such estimated dues
with the liquidator:
Provided also that in case the secured creditor deposits the estimated amount of
workmens dues, such creditor shall be liable to pay the balance of the workmens dues or
entitled to receive the excess amount, if any, deposited by the secured creditor with the
liquidator:
Provided also that the secured creditor shall furnish an undertaking to the liquidator to
pay the balance of the workmens dues, if any.
Explanation.For the purposes of this sub-section,
(a) record date means the date agreed upon by the secured creditors representing not
less than three-fourth in value of the amount outstanding on such date;
(b) amount outstanding shall include principal, interest and any other dues payable by
the borrower to the secured creditor in respect of secured asset as per the books of
account of the secured creditor.
(10) Where dues of the secured creditor are not fully satisfied with the sale proceeds of
the secured assets, the secured creditor may file an application in the form and manner as
may be prescribed to the Debts Recovery Tribunal having jurisdiction or a competent
court, as the case may be, for recovery of the balance amount from the borrower.
(11) Without prejudice to the rights conferred on the secured creditor under or by this
section the secured creditor shall be entitled to proceed against the guarantors or sell the
pledged assets without first taking any of the measures specified in clauses (a) to (d) of
sub-section (4) in relation to the secured assets under this Act.

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(12) The rights of a secured creditor under this Act may be exercised by one or more of is
officers authorized in this behalf in such manner as may be prescribed.
(13) No borrower shall, after receipt of notice referred to in sub-section (2), transfer by
way of sale, lease or otherwise (other than in the ordinary course of his business) any of
his secured assets referred to in the notice, without prior written consent of the secured
creditor.
14. Chief Metropolitan Magistrate or District Magistrate to assist secured creditor in
taking possession of secured asset.-(1) Where the possession of any secured asset is
required to be taken by the secured creditor or if any of the secured asset is required to be
sold or transferred by the secured creditor under the provisions of this Act, the secured
creditor may, for the purpose of taking possession or control of any such secured asset,
request, in writing, the Chief Metropolitan Magistrate or the District Magistrate within
whose jurisdiction any such secured asset or other documents relating thereto may be
situated or found, to take possession thereof, and the Chief Metropolitan Magistrate or, as
the case may be, the District Magistrate shall, on such request being made to him
(a) take possession of such asset and documents relating thereto; and
(b) forward such asset and documents to the secured creditor.
(2) For the purpose of securing compliance with the provisions of sub-section (1), the
Chief Metropolitan Magistrate or the District Magistrate may take or cause to be taken
such steps and use, or cause to be used, such force, as may, in his opinion, be necessary.
(3) No act of the Chief Metropolitan Magistrate or the District Magistrate done in
pursuance of this section shall be called in question in any court or before any authority.

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15. Manner and effect of takeover of management.-(1) When the management of business
of a borrower is taken over by a secured creditor, the secured creditor may, by publishing
a notice in a newspaper published in English language and in a newspaper published in
an Indian language in circulation in the place where the principal office of the borrower is
situated, appoint as many persons as it thinks fit
(a) in a case in which the borrower is a company as defined in the Companies Act, 1956
(1 of 1956), to be the directors of that borrower in accordance with the provisions of that
Act; or
(b) in any other case, to be the administrator of the business of the borrower.
(2) On publication of a notice under sub-section (1),
(a) in any case where the borrower is a company as defined in the Companies Act, 1956
(1 of 1956), all persons holding office as directors of the company and in any other case,
all persons holding any office having power of superintendence, direction and control of
the business of the borrower immediately before the publication of the notice under
subsection (1), shall be deemed to have vacated their offices as such;
(b) any contract of management between the borrower and any director or manager
thereof holding office as such immediately before publication of the notice under
subsection
(1), shall be deemed to be terminated;
(c) the directors or the administrators appointed under this section shall take such steps
as may be necessary to take into their custody or under their control all the property,
effects and actionable claims to which the business of the borrower is, or appears to be,
entitled and all the property and effects of the business of the borrower shall be deemed

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to be in the custody of the directors or administrators, as the case may be, as from the
date of the publication of the notice;
(d) the directors appointed under this section shall, for all purposes, be the directors of
the company of the borrower and such directors or as the case may be, the administrators
appointed under this section, shall alone be entitled to exercise all the powers of the
directors or as the case may be, of the persons exercising powers of superintendence,
direction and control, of the business of the borrower whether such powers are derived
from the memorandum or articles of association of the company of the borrower or from
any other source whatsoever.
(3) Where the management of the business of a borrower, being a company as defined in
the Companies Act, 1956 (1 of 1956), is taken over by the secured creditor, then,
notwithstanding anything contained in the said Act or in the memorandum or articles of
association of such borrower,
(a) it shall not be lawful for the shareholders of such company or any other person to
nominate or appoint any person to be a director of the company;
(b) no resolution passed at any meeting of the shareholders of such company shall be
given effect to unless approved by the secured creditor;
(c) no proceeding for the winding up of such company or for the appointment of a
receiver in respect thereof shall lie in any court, except with the consent of the secured
creditor.
(4) Where the management of the business of a borrower had been taken over by the
secured creditor, the secured creditor shall, on realization of his debt in full, restore the
management of the business of the borrower to him.

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16. No compensation to directors for loss of office.-(1) Notwithstanding anything to the

contrary contained in any contract or in any other law for the time being in force, no
managing director or any other director or a manager or any person in charge of
management of the business of the borrower shall be entitled to any compensation for the
loss of office or for the premature termination under this Act of any contract of
management entered into by him with the borrower.
(2) Nothing contained in sub-section (1) shall affect the right of any such managing
director or any other director or manager of any such person in charge of management to
recover from the business of the borrower, moneys recoverable otherwise than by way of
such compensation.
17. Right to appeal.-(1) Any person (including borrower), aggrieved by any of the
measures referred to in sub-section (4) of section 13 taken by the secured creditor or his
authorized officer under this Chapter, may prefer an appeal to the Debts Recovery
Tribunal having jurisdiction in the matter within forty-five days from the date on which
such measure had been taken.
(2) Where an appeal is preferred by a borrower, such appeal shall not be entertained by
the Debts Recovery Tribunal unless the borrower has deposited with the Debts Recovery
Tribunal seventy-five per cent. of the amount claimed in the notice referred to in subsection (2) of section 13:
Provided that the Debts Recovery Tribunal may, for reasons to be recorded in writing,
waive or reduce the amount to be deposited under this section.
(3) Save as otherwise provided in this Act, the Debts Recovery Tribunal shall, as far as
may be, dispose of the appeal in accordance with the provisions of the Recovery of Debts

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Due to Banks and Financial Institutions Act, 1993 (51 of 1993) and rules made there
under.
18. Appeal to Appellate Tribunal.-(1) Any person aggrieved, by any order made by the
Debts Recovery Tribunal under section 17, may prefer an appeal to an Appellate Tribunal
within thirty days from the date of receipt of the order of Debts Recovery Tribunal.
(2) Save as otherwise provided in this Act, the Appellate Tribunal shall, as far as may be,
dispose of the appeal in accordance with the provisions of the Recovery of Debts Due to
Banks and Financial Institutions Act, 1993 (51 of 1993) and rules made there under.
19. Right of borrower to receive compensation and costs in certain cases.-If the Debts
Recovery Tribunal or the Appellate Tribunal, as the case may be, on an appeal filed under
section 17 or section 18, holds the possession of secured assets by the secured creditor as
wrongful and directs the secured creditor to return such secured assets to the concerned
borrower, such borrower shall be entitled to payment of such compensation and costs as
may be determined by such Tribunal or Appellate Tribunal.

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CHAPTER IV
CENTRAL REGISTRY
20. Central Registry.-(1) The Central Government may, by notification, set up or cause to
be set up from such date as it may specify in such notification, a registry to be known as
the Central Registry with its own seal for the purposes of registration of transaction of
securitization and reconstruction of financial assets and creation of
security interest under this Act.
(2) The head office of the Central Registry shall be at such place as the Central
Government may specify and for the purpose of facilitating registration of transactions
referred to in sub-section (1), there may be established at such other
places as the Central Government may think fit, branch offices of the Central
Registry.
(3) The Central Government may, by notification, define the territorial limits within
which an office of the Central Registry may exercise its functions.
(4) The provisions of this Act pertaining to the Central Registry shall be in addition to
and not in derogation of any of the provisions contained in the Registration Act, 1908 (16
of 1908), the Companies Act, 1956 (1 of 1956), the Merchant Shipping Act, 1958 (44 of
1958), the Patents Act, 1970 (39 of 1970), the Motor Vehicles Act, 1988 (59 of 1988) and
the Designs Act, 2000 (16 of 2000) or any other law requiring registration of charges and
shall not affect the priority of charges or validity thereof under those Acts or laws.
21. Central Registrar.-(1) The Central Government may, by notification, appoint a
person for the purpose of registration of transactions relating to securitization,
reconstruction of financial assets and security interest created over properties, to be

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known as the Central Registrar.

(2) The Central Government may appoint such other officers with such designations
as it thinks fit for the purpose of discharging under the superintendence and
direction of the Central Registrar, such functions of the Central Registrar under this Act
as he may, from time to time, authorize them to discharge.
22. Register of securitization, reconstruction and security interest transactions.-(1) For the
purposes of this Act, a record called the Central Register shall be kept at the head office
of the Central Registry for entering the particulars of the transactions relating to
(a) securitization of financial assets;
(b) reconstruction of financial assets; and
(c) creation of security interest.
(2) Notwithstanding anything contained in sub-section (1), it shall be lawful for the
Central Registrar to keep the records wholly or partly in computer, floppies, diskettes or
in any other electronic form subject to such safeguards as may be prescribed.
(3) Where such register is maintained wholly or partly in computer, floppies, diskettes or
in any other electronic form, under sub-section (2), any reference in this Act to entry in
the Central Register shall be construed as a reference to any entry as maintained in
computer or in any other electronic form.
(4) The register shall be kept under the control and management of the Central Registrar.
23. Filing of transactions of securitization, reconstruction and creation of security
interest.-The particulars of every transaction of securitization, asset reconstruction or
creation of security interest shall be filed, with the Central Registrar in the manner and on
payment of such fee as may be prescribed, within thirty days after the date of such

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transaction or creation of security, by the securitization company or reconstruction

company or the secured creditor, as the case may be:
Provided that the Central Registrar may allow the filing of the particulars of such
transaction or creation of security interest within thirty days next following the expiry of
the said period of thirty days on payment of such additional fee not exceeding ten times
the amount of such fee.
24. Modification of security interest registered under this Act.-Whenever the terms or
conditions, or the extent or operation, of any security interest registered under this
Chapter, are, or is, modified, it shall be the duty of the securitization company or the
reconstruction company or the secured creditor, as the case may be, to send to the Central
Registrar, the particulars of such modification, and the provisions of this Chapter as to
registration of a security interest shall apply to such modification of such security
interest.
25. Securitization company or reconstruction company or secured creditors to report
satisfaction of security interest.-(1) The securitization company or reconstruction
company or the secured creditor as the case may be, shall give intimation to the Central
Registrar of the payment or satisfaction in full, of any security interest relating to the
securitization company or the reconstruction company or the secured creditor and
requiring registration under this Chapter, within thirty days from the date of such
payment or satisfaction.
(2) The Central Registrar shall, on receipt of such intimation, cause a notice to be sent to
the securitization company or reconstruction company or the secured creditor calling
upon it to show cause within a time not exceeding fourteen days specified in such notice,

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as to why payment or satisfaction should not be recorded as intimated to the Central

Registrar.
(3) If no cause is shown, the Central Registrar shall order that a memorandum of
satisfaction shall be entered in the Central Register.
(4) If cause is shown, the Central Registrar shall record a note to that effect in the Central
Register, and shall inform the borrower that he has done so.
26. Right to inspect particulars of securitization, reconstruction and security interest
transactions.-(1) The particulars of securitization or reconstruction or security interest
entered in the Central register of such transactions kept under section 22 shall be open
during the business hours for inspection by any person on payment of such fee as may be
prescribed.
(2) The Central Register referred to in sub-section (1) maintained in electronic form, shall
also be open during the business hours for the inspection by any person through
electronic media on payment of such fee as may be prescribed.

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CHAPTER V
OFFENCES AND PENALTIES
27. Penalties.-If a default is made
(a) in filing under section 23, the particulars of every transaction of any securitization or
asset reconstruction or security interest created by a securitization company or
reconstruction company or secured creditor; or
(b) in sending under section 24, the particulars of the modification referred to in that
section; or
(c) in giving intimation under section 25, every company and every officer of the
company or the secured creditor and every officer of the secured creditor who is in
default shall be punishable with fine which may extend to five thousand rupees for every
day during which the default continues.
28. Penalties for non-compliance of direction of Reserve Bank.-If any securitization
company or reconstruction company fails to comply with any direction issued by the
Reserve Bank under section 12, such company and every officer of the company who is
in default, shall be punishable with fine which may extend to five lakh rupees and in the
case of a continuing offence, with an additional fine which may extend to ten thousand
rupees for every day during which the default continues.
29. Offences.-If any person contravenes or attempts to contravene or abets the
contravention of the provisions of this Act or of any rules made there under, he shall be
punishable with imprisonment for a term which may extend to one year, or with fine, or
with both.

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30. Cognizance of offence.-No court inferior to that of a Metropolitan Magistrate or a

Judicial Magistrate of the First Class shall try any offence punishable under this Act.

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CHAPTER VI
MISCELLANEOUS
31. Provisions of this Act not to apply in certain cases.-The provisions of this Act shall
not apply to
(a) a lien on any goods, money or security given by or under the Indian Contract Act,
1872 (9 of 1872) or the Sale of Goods Act, 1930 (3 of 1930) or any other law for the
time being in force;
(b) a pledge of movables within the meaning of section 172 of the Indian Contract Act,
1872 (9 of 1872);
(c) creation of any security in any aircraft as defined in clause (1) of section 2 of the
Aircraft Act, 1934 (24 of 1934);
(d) creation of security interest in any vessel as defined in clause (55) of section 3 of the
Merchant Shipping Act, 1958 (44 of 1958);
(e) any conditional sale, hire-purchase or lease or any other contract in which no security
interest has been created;
(f) any rights of unpaid seller under section 47 of the Sale of Goods Act, 1930 (3 of
1930);
(g) any properties not liable to attachment or sale under the first proviso to sub-section
(1) of section 60 of the Code of Civil Procedure, 1908 (5 of 1908);
(h) any security interest for securing repayment of any financial asset not exceeding one
lakh rupees;
(i) any security interest created in agricultural land;

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(j) any case in which the amount due is less than twenty per cent. of the principal amount
and interest thereon.
32. Protection of action taken in good faith.-No suit, prosecution or other legal
proceedings shall lie against any secured creditor or any of his officers or manager
exercising any of the rights of the secured creditor or borrower for anything done or
omitted to be done in good faith under this Act.
33. Offences by companies.-(1) Where an offence under this Act has been committed by a
company, every person who at the time the offence was committed was in charge of, and
was responsible to, the company, for the conduct of the business of the company, as well
as the company, shall be deemed to be guilty of the offence and shall be liable to be
proceeded against and punished accordingly:
Provided that nothing contained in this sub-section shall render any such person liable to
any punishment provided in this Act, if he proves that the offence was committed without
his knowledge or that he had exercised all due diligence to prevent the commission of
such offence.
(2) Notwithstanding anything contained in sub-section (1), where an offence under this
Act has been committed by a company and it is proved that the offence has been
committed with the consent or connivance of, or is attributable to any neglect on the part
of, any director, manager, secretary or other officer of the company, such director,
manager, secretary or other officer shall also be deemed to be guilty of the offence and
shall be liable to be proceeded against and punished accordingly.
Explanation.For the purposes of this section,
(a) company means any body corporate and includes a firm or other association of

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individuals; and
(b) director, in relation to a firm, means a partner in the firm.
34. Civil court not to have jurisdiction.-No civil court shall have jurisdiction to entertain
any suit or proceeding in respect of any matter which a Debts Recovery Tribunal or the
Appellate Tribunal is empowered by or under this Act to determine and no injunction
shall be granted by any court or other authority in respect of any action taken or to be
taken in pursuance of any power conferred by or under this Act or under the Recovery of
Debts Due to Banks and Financial Institutions Act, 1993 (51 of 1993).
35. The provisions of this Act to override other laws.-The provisions of this Act shall
have effect, notwithstanding anything inconsistent therewith contained in any other law
for the time being in force or any instrument having effect by virtue of any such law.
36. Limitation.-No secured creditor shall be entitled to take all or any of the measures
under sub-section (4) of section 13, unless his claim in respect of the financial asset is
made within the period of limitation prescribed under the Limitation Act, 1963 (36 of
1963).
37. Application of other laws not barred.-The provisions of this Act or the rules made
there under shall be in addition to, and not in derogation of, the Companies Act, 1956 (1
of 1956), the Securities Contracts (Regulation) Act, 1956 (42 of 1956), the Securities and
Exchange Board of India Act, 1992 (15 of 1992), the Recovery of Debts Due to Banks
and Financial Institutions Act, 1993 (51 of 1993) or any other law for the time being in
force.
38. Power of Central Government to make rules.-(1) The Central Government may, by
notification and in the Electronic Gazette as defined in clause (s) of section 2 of the

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Information Technology Act, 2000 (21 od 2000), make rules for carrying out the
provisions of this Act.
(2) In particular, and without prejudice to the generality of the foregoing power, such
rules may provide for all or any of the following matters, namely:
(a) the form and manner in which an application may be filed under sub-section (10) of
section 13;
(b) the manner in which the rights of a secured creditor may be exercised by one or
more of his officers under sub-section (12) of section 13;
(c) the safeguards subject to which the records may be kept under sub-section (2) of
section 22;
(d) the manner in which the particulars of every transaction of securitization shall be filed
under section 23 and fee for filing such transaction;
(e) the fee for inspecting the particulars of transactions kept under section 22 and
entered in the Central Register under sub-section (1) of section 26;
(f) the fees for inspecting the Central Register maintained in electronic form under
subsection (2) of section 26;
(g) any other matter which is required to be, or may be, prescribed, in respect of which
provision is to be, or may be, made by rules.
(3) Every rule made under this Act shall be laid, as soon as may be after it is made, before
each House of Parliament, while it is in session, for a total period of thirty days which
may be comprised in one session or in two or more successive sessions, and if, before the
expiry of the session immediately following the session or the successive sessions
aforesaid, both Houses agree in making any modification in the rule or both Houses agree

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that the rule should not be made, the rule shall thereafter have effect only in such
modified form or be of no effect, as the case may be; so, however, that any such
modification or annulment shall be without prejudice to the validity of anything
previously done under that rule.
39. Certain provisions of this Act to apply after Central Registry is set-up or cause to be
setup.The provisions of sub-sections (2), (3) and (4) of section 20 and sections 21, 22, 23, 24,
25, 26 and 27 shall apply after the Central Registry is set up or cause to be set up under
subsection (1) of section 20.
40. Power to remove difficulties.-(1) If any difficulty arises in giving effect to the
provisions of this Act, the Central Government may, by order published in the Official
Gazette, make such provisions not inconsistent with the provisions of this Act as may
appear to be necessary for removing the difficulty:
Provided that no order shall be made under this section after the expiry of a period of two
years from the commencement of this Act.
(2) Every order made under this section shall be laid, as soon as may be after it is made,
before each House of Parliament.
41. Amendments of certain enactments.-The enactments specified in the Schedule shall
be amended in the manner specified therein.
42. Repeal and saving.-(1) The Securitization and Reconstruction of Financial Assets and
Enforcement of Security Interest Ordinance, 2002 (2 of 2002) is hereby repealed.

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(2) Notwithstanding such repeal, anything done or any action taken under the said
Ordinance shall be deemed to have been done or taken under the corresponding
provisions of this Act.

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THE SCHEDULE
(See section 41)

Year

Act No.

Short title

1956

42

The
Securities
Contracts
(Regulation)
Act, 1956.

1986

1956

Amendment

In section 4A, in sub-section (1), after clause (vi),

insert the following:
(vii) the securitization company or reconstruc-tion
company which has obtained a certificate of
registration under sub-section (4) of section 3 of the
Securitization and Reconstruction of Financial
Assets and Enforcement of Security Interest
Ordinance, 2002.
The
Sick In section 2, in clause (h), after sub-clause (ib),
Industrial
insert the following:
Companies
(ic) security receipt as defined in clause (zg) of
(Special
section 2 of the Securitization and Reconstruction
Provisions) Act, of Financial Assets and Enforcement of Security
1985.
Interest Act,
2002.
The companies In section 15, in sub-section (1), after the proviso,
Act, 1956
insert the following:
Provided further that no reference shall be made to
the Board for Industrial and Financial
Reconstruction after the commencement of the
Securitization and Reconstruction of Financial
Assets and Enforcement of Security Interest Act,
2002, where financial assets have been acquired by
any securitization company or reconstruction
company under sub-section (1) of section 5 of that
Act:
Provided also that on or after the commencement of
the Securitization and Reconstruction of Financial
Assets and Enforcement of Security Interest Act,
2002, where a reference is pending before the Board
for Industrial and Financial Reconstruction, such
reference shall abate if the secured creditors,
representing not less than three-fourth in value of
the amount outstanding against
financial assistance disbursed to the borrower of
such secured creditors, have taken any measures to
recover their secured debt under sub-section (4) of
section 13 of that Act..

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ANNEXURE II
AMENDMENT IN THE BUDGET 2005
In an effort to improve the corporate bond market and fuel the use of securitization, the
Finance Minister Mr. P.Chidambaram has made the following announcement in his
budget speech.

While Indias equity market has made progress, the corporate bond market still lags
behind. In order to address this gap, I propose to:

amend the definition of securities under the Securities Contracts (Regulation) Act,
1956 so as to provide a legal framework for trading of securitized debt including
mortgage backed debt; and

appoint a high level Expert Committee on corporate bonds and securitization to look
into the legal, regulatory, tax and market design issues in the development of the
corporate bond market.

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BIBLIOGRAPHY
Books:
Fixed Income Markets and their Derivatives Suresh Sundaresan

Articles:
1. Development of Securitized Debt Markets in Emerging Countries Management
Review, July98
2. Asset Securitization-Towards Transformation of Finance Function The
chartered Accountant, May02
3. Securitization- Position Paper CRISIL, April03
4. Securitization In Asia Asiamoney

Websites:
1. www.vinodkothari.com
2. www.securitization.net
3. www.arcil.co.in

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