In its most basic sense, securitization is the process of turning assets into securities. It is the process by which an issuer creates a financial instrument by combining other financial assets and then marketing different tiers of the packaged instruments to investors.
Securitization is a process by which a company clubs its different financial assets or debts to form a consolidated financial instrument which is issued to investors. In return, the investors in such securities get interest. This process enhances liquidity in the market and serves as a useful tool especially for financial companies to help raise funds. If such a company has already issued a large number of loans to its customers and wants to further add to the number, then the practice of securitization can come to its rescue.
An example of securitization is a Mortgage – Backed Security which is an investment that is made up of a bundle of home loans bought from the banks that issued them.
Although, Securitization is an American concept, it is no longer bound to only one nation. Presently, almost every country has its own Securitization scheme in its financial system. In India, the first securitization deal dates back to 1990 when Citibank secured auto loans and sold them to the GIC Mutual Fund. Securitization markets began to grow post globalization and the integration of capital markets in India when financial players in India adopted innovative strategies to promote liquidity in the then illiquid mortgage markets.
The Securitization Process
A few terms that need to be defied before the process is explained are:
- Special Purpose Vehicle (SPV): An SPV is a distinct entity that has been formed absolutely for the purpose of facilitating the securitization process and provides funds to the originator.
- Originators: They are the parties, such as mortgage lenders and banks, that initially create the assets to be securitized.
- Asset Reconstruction: It refers to the conversion of non-performing assets into performing assets.
- Asset reconstruction companies (ARC): ARCs are government owned companies who acquire bad loans from banks at a reduced price thus helping them to focus on their primary activities and cleaning their balance sheets.
The whole process consists of two major steps:
- Segregation of selected homogenous assets: The process begins with the segregation of assets and pooling up of receivables by a financial institution. A regulated institution identifies mortgage based securities which are backed by similar type of mortgages. Then, a large number of homogenous loans are aggregated or packaged into a pool.
- Transfer to SPV and sale of bonds to investors: After pooling of assets, the owner or the originator sells those assets to a Special Purpose Vehicle (SPV). The SPV further sells the bonds to investors. These bonds are backed up by claims against mortgaged assets. The SPV uses the proceeds received from those sales to pay the originator for the assets taken over. The assets constitute collateral for the bonds issued. The bonds thus issued are liquid and can be sold in the secondary market easily.
Under the true sale mechanism, the assets move from the balance sheet of the originator to the balance sheet of a special purpose vehicle (“SPV”) or asset reconstruction company, and are pooled, sub-divided, repackaged as tradable securities backed by such pooled assets and sold to investors either as pass through certificates (“PTCs”) or security receipts (“SRs”), which represent claims on incoming cash flows from such pooled assets. Banks and financial institutions in India also often enter into direct assignments of non-stressed financial assets under the provisions of the RBI Guidelines. Such direct assignment structures would not involve an SPV, the pooling of assets or the issuance of PTCs, and are often preferred in the Indian market by banks and financial institutions when selling down to other banks or financial institutions.
Securitization under the SARFAESI Act
The enactment of the Securitization and Reconstruction of Financial Assets & enforcement of Securities Interest (SARFAESI) Act, 2002 marked the first legal framework for Securitization in India. The Act elaborates on securitization of financial assets, reconstruction of financial assets, and recognition to any security interest created for due repayment of a loan as security interest under the Securitization Act, irrespective of its form.
The SARFAESI Act allows banks and financial institutions to auction properties when its borrowers fail to repay their loans. It enables banks to reduce their non-performing assets by adopting measures for recovery or reconstruction. Upon loan default, banks can seize the securities without intervention of the court. SARFAESI is effective only for secured loans where bank can enforce the underlying security like mortgages. Generally, court intervention is not necessary, unless the security is void or fraudulent. However, if the asset in question is an unsecured asset, the bank would have to consult the Court to sue the defaulter.
Section 13 of the Act states that a secured creditor can enforce his interest in case of default by the borrower in repayment of loan without the intervention of court. The borrower who defaults in payment of the loan in a whole or installments, his account is held as a non-performing asset.
As per the Act, in case the borrower fails to repay the loan, the secured creditor can give a notice in writing to the defaulting borrower requiring it to discharge its liabilities within 60 days. If the borrower fails to comply with the notice, the secured creditor may take recourse to one or more of the following measures:
- Take possession of the security for the loan;
- Sale or lease or assign the right over the security;
- Manage the same or appoint any person to manage the same
- ITC Limited v. Blue Coast Hotels Ltd. & Ors.: the Supreme Court, in this case, held that non compliance of Section 13 (3-A) is of no avail to a debtor who uses it merely to seek extension of time for repayment and still defaults. The debtor did not receive any discretionary equitable relief under Article 226 or Article 32 of the Constitution of India.
- M/s Mardia Chemical Ltd. v. Union of India and others: The Supreme Court declared that SARFAESI Act 2002 was not unconstitutional, solely because it was an Act that favored the lender that is the banks and financial institutions and provided limited relief and remedies to the borrowers. The Court also struck down section 17 (2) and laid down that the borrower’s objections regarding the notice should be considered and not rejected ritually. The reasons for such refusal of the borrower’s objections shall be communicated to him.
- Pandurang Ganpati Chaugale v. Vishwasrao Patil Murgud Sahakari Bank Ltd.: in this case, the SC held that ‘banking’ relating to cooperatives can be included within the purview of Entry 45 of List I, and it cannot be said to be over inclusion to cover provisions of recovery by cooperative banks in the SARFAESI Act.
 Definition of Securitization, The Economic Times, available at: https://economictimes.indiatimes.com/definition/securitization
 Securitization 2020: Trends And Developments In India, Mondaq available at: https://www.mondaq.com/india/securitization-structured-finance/885822/securitisation-2020-trends-and-developments-in-india
 Highlights of SARFAESI Act, TaxGuru available at: https://taxguru.in/corporate-law/highlights-of-sarfaesi-act-2002.html
 (2018) 143 CLA 0339
 (2004) 4 SCC 311
 2020 SCC OnLine SC 431