Regulation of Bank Finance^405
relatively easier for an investor to compare the risk-return profile of asset
backed securities with other investible instruments and make an informed choice.l In a securitisation exercise the credit risk is shifted partially, or even completely
from the issuer of securities to the securitised asset and/or third parties depending
on the structure of the transaction. The security, thus, is insulated from other
risks associated with the originator or the issuer.
The recent RBI directive that Banks shall extend 40% of the maximum permissible
bank finance (MPBF) for amounts above Rs. 20 crores, by way of short-term loans
repayable within one year, makes them an ideal asset for debt securitisation.
Loan transfers
This type of transaction, where loans are transferred to an existing third party without
the creation of a new company, the issuer, as a vehicle for the deal. Technically loans
cannot be sold in the same way as tangible assets, but there are three main ways in
which the benefits and risks under the loan agreement can be sold to a third party.
l Novation : The rights and obligations attached to the loan are cancelled and
replaced by new ones whose main effect is to change the identity of the lender.
l Assignment: Loans may be assigned by either a statutory or equitable
assignment.
l Sub-participation: Rights and obligations are not transferred, but the lender
enters into a non-recourse, back to back agreement with a third party, the sub-
participant whereby the latter pays the lender some or all of the amount of the
loan in return for a share of the cash flows.
In this type of transaction the original lender:
l has no residual beneficial interest in the principal of the loan and that the sub-
participant has
no formal recourse to the lender for losses.
l has no obligation to provide further finance.
l does not intentionally bear any losses from interest rate changes.
Hedging approach to working capital financing
Under hedging approach to financing working capital requirements of a firm, each
asset in the balance sheet assets side would be offset with a financing instrument of the
same approximate maturity. The basic objective of this method of financing is that the
permanent component of current assets, and fixed assets would be met with long-term
funds and the short-term or seasonal variations in current assets would be financed
with short term debt. If the long term funds are used for short-term needs of the firm,
it can identify and take steps to correct the mismatch in financing.