Chapter-1

Factoring &
forfeiting
 Factoring services started in US in early 1920s
and were introduced to other parts in 1960s.

 Factoring is a financial service covering the

financing and collection of accounts receivables in
domestic as well as in international trade.

 Basically, factoring is an arrangement in which

receivables on account of sale of goods or
services are sold to the factor at a certain
discount. As the factor gets the title to the
receivables on account of the factoring contract,
factor becomes responsible for all credit control,
sales ledger administration and debt collection
from the customers.
 Factoring is of recent origin in Indian Context.

 Kalyana Sundaram Committee recommended

introduction of factoring in 1989.

 Banking Regulation Act, 1949, was amended in 1991 for

Banks setting up factoring services.

 SBI/Canara Bank have set up their Factoring

Subsidiaries:-
 SBI Factors Ltd., (April, 1991)
 CanBank Factors Ltd., (August, 1991).

 RBI has permitted Banks to undertake factoring services

through subsidiaries.
Factoring is the Sale of Book Debts by a firm (Client) to a financial institution
(Factor) on the understanding that the Factor will pay for the Book Debts as
and when they are collected or on a guaranteed payment date. Normally, the
Factor makes a part payment (usually upto 80%) immediately after the debts
are purchased thereby providing immediate liquidity to the Client.

PROCESS OF FACTORING

CLIENT CUSTOMER

FACTOR
 A study group appointed by
International Institute for the
Unification of Private Law (UNIDROIT),
Rome 1988 defines
 “factoring means an arrangement
between a factor and his client which
includes at least two of the following
services to be provided by the factor;
i) finance,
(ii) maintenance of accounts,
(iii) collection of debts and
(iv) protection against credit risk
(v) consultancy services
 Deliver of goods

Client Customer
Order placed

Client submits invoice

Customer pays
Factor-Prepayment

Monthly statements

Factor
 Buyer
 Buyer negotiates terms of purchasing the
material with the seller.

 Buyer receives delivery of goods with

invoice and instructions by the seller to
make payment to factor on due date.

 Buyermakes payment to factor in time or

gets extension of time or in the case of
default is subject to legal process at the
hands of the factor.
 Seller
 MoU with the buyer in the form of letter
exchanged between them or agreement
 Sells goods to the buyer as per
MoU/agreement
 Delvers copies of invoice, delivery challan,
MoU, instructions to make payment to
factor given to buyer
 Seller receives 80 percent or more
payment in advance from factor on selling
the receivables from buyer to factor
 Seller receives balance payment from
factor after deduction of facto’s service
charges etc.
 Factor
 Factor enters into agreement with seller for
rendering factoring services.

 On receipt of copies of sale documents as

referred to above makes payment to seller
of the 80 percent of the price of the debt.

 Factorreceives payment from the buyer on

due dates and remits money to seller after
usual deductions.
 Factoralso ensures that the following
conditions met to give full effect to
factoring arrangements.

 Invoice, bills or other documents drawn

by the seller should contain a clause that
these payments arising out of transaction
as referred to or mentioned in might be
factored.
 Seller should confirm in writing to the
factor that all the payments arising out of
these bills are free from any, pledge,
hypothecation or mortgage or right of
set-off or counter claim from another.
 Seller should execute a deed of
assignment in favor of the factor to
enable him to recover the payment at the
time or after default.
 Seller should confirm that all conditions
to sell-buy contract between him and
the buyer have been complied with and
the transactions complete.
 Seller should procure a letter of waiver
from a bank in favor of factor in case the
bank has a charge over the assets sold
to buyer and the sale proceeds are to be
deposited in the account of the bank
 Credit administartion

 Credit collection & protection

 Financial assistance

 Other services
 Full service non recourse factoring

 Full service recourse factoring

 Bulk/agency factoring

 Notified and non notified factoring

 Export and import factoring

 Advance and maturity factoring

- It is the most comprehensive type of
factoring arrangement offering all
types of services namely:
 Finance
 Sales Ledger Administration
 Collection
 Debt Protection
 Advisory Services
 It gives protection against bad debts to
the client. In other words, in case the
customer fails to pay, the factor will
have ‘no recourse’ to the client and will
have to absorb the bad debts himself.
 In this type of factoring arrangement,
the factor provides all types of facilities
except debt protection. In other words,
the client is responsible for any bad
debts incurred.
 It is basically used as a method of
financing book debts where client
continues to administer credit and
operates sales ledger.

 The factor finances the book debts

against bulk either on recourse or
without recourse.
 The factor does not follow up or collect
payment from the customer. The
customer may not be aware of the
factoring arrangement and pays the
client directly. The factor receives
payment of invoices through the client.
 Name of the factor is disclosed in the
invoice by the supplier/client asking the
customer to make payment to the factor
 In the sphere of international trade a
two factor system is used export factor
& import factor
 Advance paid against invoice where as in
maturity factoring payment is made against
guarantee or collection of receivables.

 The factor not only offers sales accounting,

debt collection and credit control but also but
also offers money in advance of the date on
which client could expect to receive the
payment from his customer

 The factor usually pays 80-90% of the total

invoice as soon as invoice is issued by the
client.
 In this type of factoring arrangement,
only finance is provided and no other
service is offered.
 There are usually four parties to a
cross-border factoring transactions
 Exporter (client)
 Importer (customer)
 Export Factor
 Import Factor
 Two factor system results in two
separate but inter-linked agreements
 Between exporter and export factor
 Between export factor import factor
 Usually export and import factors belong
to a formal chain of factors with well-
defined rules governing the conduct of
business.
 Import factor provides a link between
export factor and the importer and
serves to solve the international barriers
like language problem, legal formalities
and so on. He also underwrites customer
trade credit risks, collects receivables
and transfers funds to the export factor
in the currency of the invoice
 Functions of factors are divided between
export factor and import factor
 Steps
 Exporter informs the export factor about the
export of goods to a particular import-client
domiciled in a specified country.

 Exportfactor writes to import factor

(domiciled in the country of the importer)
enquiring about the credit-worthiness,
reputation and so on of the importer.

 On getting satisfactory information from the

import factor, exporter delivers the goods to
the importer and the relevant invoices, bills of
landing and other supporting documents are
delivered to the export factor. Export
receivables on a non-recourse basis are
factored.
 Export factor does credit checking, sales
ledgering and collection to the import
factor.

 Importfactor collects the payment from

the importer and effects payments to the
export factor on
assignment/maturity/collection as per the
terms of assignment in the currency of
the invoice.

 Finally,
the export factor makes payment
to the exporter upon assignment or
maturity or collection depending upon the
factoring agreement between them
 Country A Country B
Goods and invoices – Stage I
Exporter Importer

Copy Invoice Stage II Payments

Stage VI

Prepayments Stage III

Statements Stage V

Export Factor Copy Invoices Stage IV Import Factor

Payments Stage VII

Payment of Commission Stage VIII

 Finance Charge - It represents the
interest on funds made available to the
client by way of prepayment against
purchase of approved invoices.
 Service Charge - The charge levied for
rendering non-funding services such as
collection, sales ledger maintenance
and other advisory services.
 Provide service of credit management

 Save cost of credit administartion due to

economies of scale and specialization

 Firm can improve their cash flow

through prepayment facilities
 Forfaiting is a form of financing of
(export) receivables pertaining to
international trade. It denotes the
purchase of trade bills/promissory
notes by a bank/financial institution
without recourse to the seller. The
purchase is in the form of discounting
the documents covering the entire risk
of non-payment in collection. All risks
and collection problems are fully the
responsibility of the purchaser
(Forfaiter) who pays cash to seller
after discounting the bills/notes.
 Exporter under Forfaiting surrenders his right
for claiming payment for services rendered or
goods supplied to Importer in favour of
Forefaiter.

 Bank (Forefaiter) assumes default risk possessed

by the Importer.

 Credit Sale gets converted as Cash Sale.

 Forfaiting is arrangement without recourse to

the Exporter (seller)
 Operated on fixed rate basis (discount)

 Finance available upto 100% of value (unlike in

Factoring)

 Introduced in the country in 1992.

1. Exporter (India)
2. Importer (Abroad)
3. Exporter’s Bank (India)
4. Importer’s/Avalising Bank (Abroad)
5. EXIM Bank (India )
6. Forfaiter (Abroad)
EXPORTER IMPORTER

FORFAITER AVALLING BANK

HELD TILL MATURITY

SELL TO GROUPS OF INVESTORS

TRADE IN SECONDARY MARKET

 Exporter to extend credit to Customers for periods above 6
months.

 Exporter to raise Bill of Exchange covering deferred

receivables from 6 months to 5 years.

 Repayment of debts will have to be avallised or guaranteed

by another Bank, unless the Exporter is a Government
Agency or a Multi National Company.

 Co-acceptance acts as the yard stick for the Forefaiter to

credit quality and marketability of instruments accepted.
IN FORFAITING:-

 Promissory notes are sent for avalling to the Importer’s

Bank.

 Avalled notes are returned to the Importer.

 Avalled notes sent to Exporter.

 Avalled notes sold at a discount to a Forefaiter on a NON-

RECOURSE basis.

 Exporter obtains finance.

 Forfaiter holds the notes till maturity or securitises these

notes and sells the Short Term Paper either to a group of
investors or to investors at large in the secondary market.
 Commitment Fee:- Payable to Forfaiter by Exporter in
consideration of forefaiting services.

 Commission:- Ranges from 0.5% to 1.5% per annum.

 Discount Fee:- Discount rate based on LIBOR for the

period concerned.

 Documentation Fee:- where elaborate legal formalities

are involved.

 Service Charges:- payable to Exim Bank.

 Full risk cover

 Cost effectiveness

 Increase in turnover

 Instant cash

 Additional source of funding

 Full finance

 Lesser prosedural formalities

 Benchmark rates
 Non-availability for short Periods
 Non-availability for financially weak
countries
 Dominance of western currencies
 Difficulty in procuring international
bank’s guarantee
[Link] for ongoing 1. Oriented towards
open account sales, not single transactions
backed by LC or backed by LC or bank
accepted bills or guarantee.
exchange. [Link] is usually
[Link] provides for medium to long-
financing for short-term term credit periods
credit period of upto 180 from 180 days upto 7
days. years though
shorterm credit of
30–180 days is also
available for large
transactions.
[Link] a 3. Seller need not
continuous route or commit
arrangements other business to
between factor and the forfaiter. Deals
client, whereby all are concluded
sales are routed transaction-wise.
through the factor. [Link]’s
[Link] assumes responsibility
extends to
responsibility for
collection of
collection, helps forfeited debt only.
client to reduce his Existing financing
own overheads. lines remains
unaffected.
 A lease is a contractual arrangement calling for
the lessee (user) to pay the lessor (owner) for use of an
asset

 Leasing is a process by which a firm can obtain the use

of a certain fixed assets for which it must pay a series
of contractual, periodic, tax deductible payments.

 According to European leasing association….

“leasing is a contract between lessor and lessee, for the
hire of a specific asset, selected from manufacturer or
vendor of such an asset by the lessee, the lessee has the
possession and the use of the asset on payment of
specified rentals over a period “
 Lessee is the receiver of the services or the
assets under the lease contract.
 Lessor is the owner of the assets.
 Tenancy is the relationship between the tenant
and the landlord.
 Term is the fixed or an indefinite period of time
involved in the lease contract.
 Rent is the consideration for the lease.
 Two parties : lessor & lessee..lessors
can be..
- Leasing company
- One-off lessors
- Manufacturer lessor
- Subsidiary of the banks
- Commercial banks
- Financial institutions
- In-house lessors
 Contract to hire a specific asset

 Specifications of asset by lessee

 Payment by lessor

 Useful possession

 Payment of specified rent

 Contract to be valid for a specific period

 Ownership & users

 Mode of termination
Operating lease: Short term, cancellable lease
agreements. The lessor is responsible for the
maintaince and insurance of the asset. Example:
Tourist renting a car, Hotel rooms, etc.
Financial Lease: Long term non cancellable
lease contract. Example: Plant, Machinery,
Building, Ships and aircraft.
Sale and Lease-back: Special financial
agreement in which the user may sell an asset
owned by him to the lessor and lease it back
from him. Example: shipping Industry.
 According to IAS 17.. “ a finance lease
is one where the lessor transfers to the
lessee, substantially all the risk &
rewards incidental to the ownership of
the asset whether or not the title is
eventually transferred”
 Non cancellable & present the value of
minimum lease payments
A Financial Lease is structured to include:
 The Lessee selects the equipment meeting his requirement
 The Lessee negotiates the price, delivery schedule,
installation, warranties, maintenance, etc.
 The Lessee informs the above details and Lessor makes
the payment directly to the Seller(manufacturer
/distributor).
 The equipment is directly delivered to the Lessee by
seller.
 The Lessee enjoys exclusive and peaceful possession and
use of the equipment.
 Enters in to the Lease agreement with Lessor.
 The Lessor pays the amount directly to
Seller(Manufacturer/supplier).
 Long-term, non-cancellable lease contracts are known as
financial leases.
 To record a lease as a capital lease, the lease must be
noncancelable.
 One or more of four criteria must be met:

1. Transfers ownership to the lessee.

2. Contains a bargain-purchase option.
3. Lease term is equal to or greater than 75 percent of the
estimated economic life of the leased property.
4. The present value of the minimum lease payments
(excluding executor costs) equals or exceeds 90 percent
of the fair value of the leased property.
 Under leveraged leasing arrangement, a
third party is involved beside lessor and
lessee.
 The lessor borrows a part of the purchase
cost (say 80%) of the asset from the third
party i.e., lender and the asset so
purchased is held as security against the
loan.
 The lender is paid off from the lease
rentals directly by the lessee and the
surplus after meeting the claims of the
lender goes to the lessor.
 The lessor, the owner of the asset is
entitled to depreciation allowance
associated with the asset.
 It is a lease in which the lessor aims not
only to recover the whole of initial
capital investments out of rental
payable under contractual agreement
with the lessee within the
predetermined lease period, but also to
achieve a predetermined yield on the
funds employed to finance the
investments.
 It is a sub-part of finance lease. Under this, the
owner of an asset sells the asset to a party (the
buyer), who in turn leases back the same asset
to the owner in consideration of lease rentals.
 However, under this arrangement, the assets
are not physically exchanged but it all happens
in records only.
 This is nothing but a paper transaction.
 Sale and lease back transaction is suitable for
those assets, which are not subjected
depreciation but appreciation, say land.
 The advantage of this method is that the lessee
can satisfy himself completely regarding the
quality of the asset and after possession of the
asset convert the sale into a lease arrangement
 Under this transaction, the seller
assumes the role of a lessee and the
buyer assumes the role of a lessor.
 The seller gets the agreed selling price
and the buyer gets the lease rentals.
 It is possible to structure the sale at
agreed value (below or above the fair
market price) and to adjust difference in
the lease rentals.
 Thus the effect of profit /loss on sale of
assets can be deferred
 An operating lease stands in contrast to the
financial lease in almost all aspects.
 This lease agreement gives to the lessee
only a limited right to use the asset.
 The lessor is responsible for the upkeep and
maintenance of the asset.
 The lessee is not given any uplift to
purchase the asset at the end of the lease
period.
 Normally the lease is for a short period and
even otherwise is revocable at a short notice.
Mines, Computers hardware, trucks and
automobiles are found suitable for operating
lease because the rate of obsolescence is
very high in this kind of assets.
 Full financing

 Additional source of finance

 Improved cash flow

 Cheaper source of finance

 Off balance sheet financing

 Improved borrowing capacity

 Free from rating

 Tax benefits

 Flexibility

 Favourable terms

 Eliminate the risk of obsolescene

 Ownership unaffected
 Deprival of ownership

 Restriction on use

 Financial commitment

 Loss of residual value

 Consequences of default

 Understatement of lessee’s asset

 Loss of incentives
 Tax shields

 Full security

 High profitability

 Trading on equity

 Growth potential
 Funding option

 Cost of alternative funding

 Tax paying/non tax paying companies

 Effect of add-ones

 Cashflow and discount rate

The hire purchase Act
of India 1972, defines a
hire purchase
agreement as an
agreement under which
goods are let on hire
and under which the
hirer has an option to
purchase them in
accordance with the
terms of agreement.
It involves two parties:
Hirer: The party which receives the asset.
Hiree: The party which rents out the
asset.

however, hire purchase contracts can

have three parties namely, seller,
financiers and hirer. Such contract is
known as tripartite deal.
 Goods are let out on finance by a finance
company to the hire purchaser customer
 Buyer is required to pay an equal amount of
periodic installments during a given period
 Ownership transfers at the payment of the last
installment
 The hirer is required to make a down
payment of 20-25% of the cost and pay the
balance amount along with interest in advance
or arrears over a time period of 36-48months‡
 Alternatively, instead of the down payment,
the hirer has to deposit an equal amount as a
fixed deposit with the finance company which
provides entire finance on hire purchase
terms, repayable with interest in EMI over 36-
48 months.
 Deposits and the accumulated interest
is returned to the hirer upon the
payment of last installment.‡
 The interest on each hire purchase
installment is computed on the basis of
flat rate of interest is applied to the
declining balance of original loan
amount to determine the interest
component of installment for a given
flat rate of interest, the equivalent
effective rate of interest is higher.
Tripartite hire contract:
- The dealer contract a finance company to
finance hire purchase deal.

- The customer selects the goods and

expresses his desire to avail of hire
purchase agreement.

- Customer signs the proposal form &

submits it to dealer together with the cash
down payment.

- The dealer then sends the documents to

finance company.
- The finance company, if decided to accept
proposal, signs the agreement and send copy
to the hirer alongwith the instructions and
also notify to dealer

- The dealer delivers goods to the hirer &

property in goods transferred to the finance
company

- The hirer makes the paymnet of installments

periodically.

- On completion of the contract period, the

hirer pays the last installment and property of
 Hire purchase is based on an agreement in
writing.
 The buyer takes possession of the goods at the
time of entering into contract.
 Each installment is treated as hire charges.
 Ownership transfer from the buyer to the seller
on the payment of the last instalment.
 The purchaser has the right to terminate the
agreement any time before the property passes.
 Hire purchase agreement has to be in
writing and signed by both parties. The
agreement must contain-
 Description of the goods.
 Hire purchase price of the goods.
 The date of commencement of the
agreement.
 The number of installments ,amount,
and due date.
 To buy the goods at any time by giving
notice to the owner and paying the balance
of the HP price less a rebate (each
jurisdiction has a different formula for
calculating the amount of this rebate)
 To return the goods to the owner — this is
subject to the payment of a penalty to
reflect the owner's loss of profit but subject
to a maximum specified in each
jurisdiction's law to strike a balance
between the need for the buyer to minimize
liability and the fact that the owner now has
possession of an obsolescent asset of
reduced value
 With the consent of the owner, to assign
both the benefit and the burden of the
contract to a third person. The owner
cannot unreasonably refuse consent
where the nominated third party has good
credit rating

 Where the owner wrongfully repossesses

the goods, either to recover the goods
plus damages for loss of quiet possession
or to damages representing the value of
the goods lost.
 To pay the hire installments
 To take reasonable care of the goods (if
the hirer damages the goods by using
them in a non-standard way, he or she
must continue to pay the installments
and, if appropriate, compensate the
owner for any loss in asset value)
 to inform the owner where the goods will be
kept.
 A hirer can sell the products if, and only if, he
has purchased the goods finally or else not to
any other third party.
 it is pretty much similar to installment but the
main difference is of ownership.
 The owner usually has the right to
terminate the agreement where the
hirer defaults in paying the installments
or breaches any of the other terms in
the agreement. This entitles the owner:
 to forfeit the deposit
 to retain the installments already paid
and recover the balance due
 to repossess the goods (which may have to be
by application to a Court depending on the
nature of the goods and the percentage of the
total price paid)
 to claim damages for any loss suffered.
 Expensive items such as machinery and
plant can be acquired without huge
financial investment.
 Interest charged and depreciation are
tax deductible
 Terms can be flexible and fixed
repayments make for easy future
budgeting.
 After full payment of the hire purchase
agreement, ownership of the goods is
transferred to the hirer.
1. Higher prices:
The buyer has to pay much higher prices than that payable on
cash purchase. The seller adds a margin to cover interest and
risk.
2. Transfer of Ownership:
The buyer does not get ownership of goods until last installment
paid. He cannot sell the goods before final payment.
3. Risk of bad debts:
When the buyer fails to pay installments, the seller may suffer
loss. He may have to spend money and time to recover goods
from the buyer.
4. Large investment:
The hire purchase seller has to invest considerable funds
because payments are received from buyers over a long period
of time.
 Ownership of the Asset: In lease,
ownership lies with the lessor. The
lessee has the right to use the
equipment and does not have an option
to purchase. Whereas in hire purchase,
the hirer has the option to purchase.
The hirer becomes the owner of the
asset/equipment immediately after the
last installment is paid.
 Duration: Generally lease agreements
are done for longer duration and for
bigger assets like land, property etc.
Hire Purchase agreements are done
mostly for shorter duration and cheaper
assets like hiring a car, machinery etc.

 Tax Impact: In lease agreement, the

total lease rentals are shown as
expenditure by the lessee. In hire
purchase, the hirer claims the
depreciation of asset as an expense.
 Extent of Finance: Lease financing
can be called the complete financing
option in which no down payments are
required but in case of hire purchase,
the normally 20 to 25 % margin money
is required to be paid upfront by the
hirer. Therefore, we call it a partial
finance like loans etc.
 Rental Payments: The lease rentals
cover the cost of using an asset.
Normally, it is derived with the cost of
an asset over the asset life. In case of
hire purchase, installment is inclusive of
the principal amount and the interest for
the time period the asset is utilized.
 Repairs and Maintenance: Repairs
and maintenance of the asset in
financial lease is the responsibility of
the lessee but in operating lease, it is
the responsibility of the lessor. In hire
purchase, the responsibility lies with the
hirer.
 Depreciation: In lease financing, the
depreciation is claimed as an expense in
the books of lessor. On the other hand,
the depreciation claim is allowed to the
hirer in case of hire purchase
transaction.
Securitisation
 Securitisation in its present form
originated in the mortgage markets in
USA.
 First Securitisation of receivables outside
the mortgage markets -Sperry
Corporation securitised its computer
lease receivables in 1975.
 India-the first Securitisation was done in
1991when Citibank securitised a pool
from its auto loan portfolio and placed
the paper with GIC Mutual.
 Securitization is the financial practice of
pooling various types of contractual debt
such as residential mortgages, commercial
mortgages, auto loans or credit card debt
obligations and selling said consolidated debt
as bonds , pass-through securities, or
Collateralized mortgage obligation (CMOs),
to various investors. The principal and
interest on the debt, underlying the security,
is paid back to the various investors regularly.
Securities backed by mortgage receivables
are called mortgage-backed securities (MBS),
while those backed by other types of
receivables are asset-backed securities (ABS).
• Corporate Finance • Features of
▫ General claim Securitisation
against the assets of ▫ Claim against specific
the company identified assets of the
▫ Mobilised against the issuer
general strength of ▫ Resource mobilisation
the balance sheet by stripping the assets
▫ Subject to entity off the balance sheet
wide risks and then servicing
▫ Scalability subject to them
entity wide prudential ▫ Insulated from entity
limits and regulatory wide risks
constraints ▫ This is structured
financing
▫ Highly scalable and not
subject to regulatory /
prudential constraints
 Securitization is “the issuance of
marketable securities backed by the
expected cash flows from specific assets
(receivables)”
 The initial owner of the loans.
Originator Sells them to the SPV

SPV Set up specifically for transaction.

Purchases assets from Originator.
Special purpose
Company/Trust/ Mutual Fund
Vehicle

The loan customers.

Obligors Pay cashflows that are securitised

Subscribe to securities
Investors issued by SPV
 Collects money from Obligors,
Collection monitors and maintains assets.
Agent Usually the originator

Provides a rating for the deal

Credit Rating based on structure, rating of parties
Agency & portfolio, legal and tax opinion et

Credit Provides credit enhancement

by way of swaps, hedges,
Enhancement
guarantees, insurance etc.
Provider
As structurer for designing &
Merchant executing the transaction and
Banker as arranger for the securities
 Obligors Credit Enhancement
Providers

2 Collections 3Credit enhancement

Original 9 Issue of securities
1 Cash flows
Loan
10 11 Servicing
Collection Sale of SPV of securities Investors
Agent asset 6
4 Rating 8 Subscription to securities
7
Originator Purchase Rating
consideratio Agency Arranger
n
5 Contracts
Ongoing cash flows
Initial cash flows
Structurer
• Determine which asset he wants to securitise
• The SPV is formed
• The SPV is funded by investors and issue
securities to the investor
• The SPV acquires the receivables
• The servicer for tranzaction is appointed
• The debtors are not notify depending upon legal
requirements
• Service collects receivables
• The SPV either passes the collection to the
investors or reinvest the same to pay off at
statified intervals
• In case of default servicer takes action as SPV’s
agent
 The financial assets are cherry picked
and then bundled into a pool
 The pool becomes a statistical
phenomenon exhibiting a homogeneous
character
 The risk associated with any single asset
gets dispersed into the pool
• Credit rating :
Collateral risk(Asset risk)
Structural risk
Commingling risk
Legal risk
Third party risk
Credit risk
• Special purpose vehicle
Holding title to transferred asset
Issuing beneficial interest
Collecting cash proceeds
Distributing proceeds
• Pass through certificate
• Pay through certificate
 Novation

 Assignment
- Statutory assignment
- Equitable assignment

 Sub participation
• Gains to originator :
• Satisfy Risk weighted capital adequacy
norms
• Focus on growth of franchise with out
the need to focus on growth of capital
base.
• Permit off balance sheet financing
• Rewards better quality
• Give Weaker firms way out
• Reduces cost of capital
• Better risk management
• Economic benefits :
• Bringing financial market & capital market
together
• Increases no. of debt instruments
• Intermediate cost reduced
• Breaks the process of lending and funding
into several discrete steps leading to
specialization
• The rate of asset turnover is increased
• Facilitates flow of fund from capital surplus
to defeciency
• Risk can be re distributed
• The debt market get greater depth
 Benefits to investors :
 Closely alligned to investor’s needs
 Securitised asset classes have shown much
higher rating resilience
 Default history tranches much safer
 Default recovery rate is much higher
 Risk free investment
 Help in managing income
 Independently takes the decision
 True sale
 Tax neutral bankruptcy remote SPE
 Stamp duties
 Taxation & accounting
 Eligibility
 Debt market
 Lack of investor appetite
 Cultural factors
 Capital market infrastructure
 Regulatory environment
 Quality of asset
 System deficiency
 Standardization
 Documentation
 surveillance