Buying and Selling of Stressed Loans by Banks

Earlier notifications and guidelines were not there at one place for the buying / selling of stressed loans, Now RBI came with the fresh guideline for these transactions with the notification RBI/DOR/2021-22/86 dated 24^th September, 2021.

Definitions

• Stressed Asset: Loans that are classified as NPA (Non-performing Asset) or SMA (Special Mention Accounts) by Transferor / Seller of the loan.
• Transfer: Transfer must be in the form of assignment or Novation and it should be not in the form of participation.
• Loan Participation: Loan Participation means a transaction through which the transferor transfers all or part of its economic interest in a loan exposure to transferee(s) without the actual transfer of the loan.

1. There has to be a Board Approved Policy for transfer / acquisition of Stressed Loans and it should contain;

1. Norms and Procedure for transfer / acquisition.
2. Valuation methodology
3. Delegation of Power to various level authorities
4. Stated objective of Stressed asset for Transfer / acquisition
5. Risk premium to be used for valuation
6. Process of Identification of Stressed Loans and it should be a Top-Down approach where Head Office should be involved for transfer / acquisition of Loans.
7. Clear guideline for the Board committee to review the Stressed loans periodically and based on review to decide its’s transferability.

2. Valuation: Transferor may go for the internal / external valuation method, but policy should have documented method. In Internal Method, they can use cost of equity (Ke) or Average cost of Fund (Ko) or Opportunity Cost etc. However, in case of credit exposure of Rs. 100 Crore or more (Gross Exposure i.e., Loan without netting off provision) transferor has to obtain at least two external valuation reports and cost for the report will be borne by transferor.

3. Transfer of loans should be made by auction through “Swiss Challenge Method” where exposure to Borrower whose loan (including investment exposure) is being transferred is 100 crore or more. In other cases, bilateral negotiations are enough subject to price discovery and value maximization.

4. After Transfer of stressed loans, transferor should not assume any operational, legal or any other type of risks relating to transferred loans including additional funding or commitments to the borrower.

5. Transferor can’t issue fresh exposure to the borrower (whose stressed loan has been transferred) for higher period of followings

• 12 months or
• Period mentioned in transferor’s documented policy

6. No transaction should be made at contingent price, price should be in absolute term.

7. Transfer should be on cash basis only to the transferee (other than Asset Reconstruction Company ARC).

8. Lender cannot buy the loan from the ARC, the loan exposure they have themselves earlier transferred to the ARC.

9. Once a Stressed Loan is acquired, it cannot be sold within 6 months form the date of acquisition.

10. Lenders are permitted to sale the pool of Stressed loans of personal loans on the basis of homogeneous portfolio. Homogeneity should be assessed on the basis of common risk drivers, including similar risk factor and risk profiles. In all other cases, the stressed loans acquired shall be treated as separate assets for the purpose of prudential requirements such as asset classification, capital computation, income recognition etc.

11. The reporting obligation, if any, to credit information companies such as CIBIL, Equifax etc. in respect of the stressed loans acquired will be with the transferee.

Accounting

In the books of Transferor/seller (other than ARC) to whom Accounting Standard (AS) is applicable

1. Loan transferred below the book value of Stressed Asset

Cash / Bank A/c - - - - - - - - -Dr. XXX
Profit / Loss Ac - - - - - - - - - - -Dr. xxxx
Provision on Loan Asset-- - - - Dr. XXX
To Loan Asset A/C (Cr.) xxx

the short amount has been treated as loss and debited to profit and loss A/C

2. Loan transferred above the book value of Stressed Asset

a. Reversal of Excess provision

Provision on loan Asset A/c - - - - - - - Dr XXX
To Profit and Loss A/c (cr.)- xxx

b. Sale of Asset

Cash / Bank A/c - - - - - -- - - - - - - - Dr. XXX
Provision on loan asset A/c---- - -- - ---Dr. XXX
Loan Asset A/c (Cr.) XXX

In the books of Transferor / seller (Other than ARC) to whom Indian Accounting Standard (IndAS) is applicable

1. Loan transferred below the book value of Stressed Asset

a. Loan accounted at amortised cost

Cash / Bank A/c - - - - - - -- Dr. XXX
Provision for Impairment - - - - Dr. XXX
Profit and Loss A/c - - - - - - - - Dr. XXX
To Loan Asset A/c XXX

b. Loan accounted at FVOCI

(i) Loss which is not there in OCI
Cash / Bank A/c - - - - - - -- Dr. XXX
Provision for Impairment - - - - Dr. XXX
Profit and Loss A/c - - - - - - - - Dr. XXX
To Loan Asset A/c XXX

(ii) Loss which is parked in OCI
Profit and loss A/c Dr. - -- - - - - - - Dr XXX
To OCI (cr) XXX

c. Loan accounted at FVTPL

Cash / Bank A/c - - - - Dr. XXX
Profit & Loss A/c- - - - Dr XXX
To Loan Asset (Cr.) XXX

In case of IndAS applicability losses to be transferred in Profit & loss A/c whether there were in OCI or provisions.

3. Loan transferred above the book value of Stressed Asset

a. Loan accounted at amortised cost

i) Reverse the excess provision
Impairment Provision A/c - - - - - - Dr. XXX
To Profit and Loss A/c(Cr) XXX

ii) Sale Entry
Cash / Bank A/c - - - - - -- - - - - Dr. XXX
Impairment Provision A/c --------Dr. XXX
To Loan Asset A/c (Cr) XXX

b. Loan Accounted at FVOCI

i. Reverse the Excess Provision

Impairment provisions A/c--------Dr. XXX
To OCI (Cr.) XXX

ii. Sale Entry

​​​​​​​Cash / Bank A/c - - -- - - - - - - - - - Dr. XXX
Impairment Provisions - - - - - - - -Dr. XXX

To Loan Asset A/c (Cr.) XXX
To Profit & Loss A/c (Cr.) XXX

c. Loan accounted at FVTPL

Cash / Bank A/c.- - - - - - - - - - - - Dr. XXX
To Loan Asset A/c(Cr.) XXX
To Profit and Loss A/c (Cr.) XXX

In the books of Buyer / Transferee

1. Stressed Loan Asset will be recognized at the consideration value and if Net present value of estimated cash flow is less than consideration then a provision should be made for the difference. Cashflow realized from borrower, will be to used to amortise the acquisition cost and excess cash flow, if any, will be treated as profit.

a. At the time of Acquisition

(i) Consideration < Net present value of estimated cashflows

Loan Asset A/c Dr. -- - - - - - Dr. XXX
To Cash / Bank A/c (Cr) XXX

(ii) Consideration >= Net present value of estimated cashflows

I) Loan Asset A/c - -.- - - - - - - Dr. XXX
To Cash / Bank A/c (Cr) XXX

II) Profit & Loss A/c -- - - - - - - Dr. XXX
To provision for Acquisition (Cr) XXX

b. Cash Flow Received

Cash / Bank /c-----------------Dr. XXX
To Loan Asset A/c (Cr.) XXX

c. In case the transferee except ARC, has NO existing exposure to the borrower whose stressed asset acquired will be treated as “Standard Asset” in the books of Transferee and its classification will be according to the recoverability of the transferee. However, Lender shall assign 100% risk weight to acquired asset till it is classified as “Standard Asset” in its Books of accounts.

d. In case the transferee, except ARC, has existing exposure to the borrower whose stressed asset acquired will be treated same as existing asset classification of the borrower with the transferee.

Disclosures

Following disclosure should be made to the notes of accounts for stressed loans

*The transferor should also make appropriate disclosure with regard to the quantum of excess provisions reversed in the profit and loss A/c.

Mohit Mishra is a practicing chartered accountant have more than 3 years of experience