The Reserve Bank of India (RBI) has recently constituted a task force to work on the development of a secondary market for corporate loans in India. Another panel has been appointed to work on the subject of housing finance securitisation in an effort to strengthen the capital market in India. The central bank is expected to release reports with policy recommendations on both matters by the end of August 2019.
A secondary market is a financial market where investors trade in pre-existing securities. Secondary market transactions only represent a change in ownership of the securities and do not involve any capital formation. Banks in India currently lack access to an evolved secondary market for the sale of stressed assets. These are either sold to asset reconstruction companies or to other banks through an ad-hoc process.
In recent times, the banking sector in India has been fraught with a significant Non-Performing Asset (NPA) problem. The current liquidity crunch in the economy can be attributed to the banks’ hesitation to lend due to the ongoing NPA crisis. The development of a loan transaction platform for stressed assets is one of the main agendas for the appointed committee apart from the creation of a loan contract registry and its ownership structure. The presence of an efficient secondary market will provide a smooth mechanism for banks to de-stress their balance sheets, allocate risk and improve liquidity in the economy.
Further, secondary markets can also alleviate much of the moral hazard problem with regard to the banks’ lending practices by promoting risk transparency through the standardisation of loan information and data access. As mentioned in the RBI press release dated May 29, 2019, the secondary market will lead to innovations in the securitisation market and the reinstatement of instruments like Credit Default Swaps (CDS) which will serve as “early warning signals regarding the riskiness of the debt being held by the banks which would incentivise improving the underwriting and origination standards.”
Housing Finance Securitisation refers to a process of bundling residential mortgages and selling these asset pools as derivative securities based on cash flows from the underlying mortgage. Mortgage securitisation in India is currently dominated by direct assignments among a restricted group of participants.
Prof. (Dr.) Sitangshu Khatua, Heritage Business School Finance, commenting on the upcoming report by the task force, informed BE, “These guidelines are expected to have a far-reaching impact on several issues and facilitate the develop-ment of a vibrant and robust securitisation market in India.”
The Indian securitisation market jumped by 56% on year-on-year basis to reach an all-time high in terms of volume in June, 2019. Vibhor Mittal from ICRA, an Indian rating agency said that Non-Banking Financial Companies (NBFCs) and Housing Finance Companies (HFCs) are some of the most reliant on the securitisation market for funds in the midst of the liquidity crisis in their respective sectors. Mortgage loans continue to be one of the major asset classes of the securitisation market in India.
In April 2019, RBI Governor Shaktikanta Das had stated, “We are aware that well-functioning securitisation markets can enable better management of credit and liquidity risks in the balance sheet of banks as well as non-bank mortgage originators, and, in turn, help lower costs of mortgage finance in the economy.”
The real estate sector in India has been under immense stress due to a combination of liquidity issues in addition to legal issues for industry leaders like the Amrapali Group and Jaypee Infratech. The National Housing Bank has injected `10,000 crore into the housing finance sector in order to revive the market and fight the recent slowdown in loans being churned out by NBFCs and HFCs. It can be expected that the housing finance securitisation initiative will improve matters.
The committee has also been asked to pay close attention to the impact of housing finance securitisation as it has been identified as one of the factors that led to the global financial crisis of 2008. Once the real estate bubble burst, the collapse of the mortgage backed securities in the United States due to the rampant malpractice of subprime lending sent shockwaves throughout the world economy and contributed to the global economic meltdown.
The current deceleration of the Indian economy and a 45-year high unemployment rate may expose banks to loan defaults as retail borrowers find themselves in a tight squeeze to repay their debt obligations. Retail borrowing has increased by almost 17% over the past year and according to RBI sources, the unsecured loan exposure for banks is at an all-time high. These are potential red flags with regard to the securitisation of mortgage loans in the economy. If these concerns are adequately addressed, the housing finance securitisation initiative may emerge as a game-changer for the real estate sector in India.