2022 in retrospect: Regulatory activity in the financial sector
– Vinod Kothari | finserv@vinodkothari.com
It has been a brisk year in terms of activity – a busy regulator kept all regulated entities busier. This year marked the initiation of a new SBR framework for NBFCs – hence there was a lot of buzz in terms of understanding the new regulatory framework. The names of 16 Upper layer entities were declared by the RBI – consisting of 5 HFCs, 10 NBFC-ICCs, one CIC[1]. As is the design, UL entities are treated at par with banks in terms of regulatory intensity –hence, there is a LEF (large exposure framework), differential provisioning norms in case of standard assets, CET-1 capital requirement, mandatory listing etc.
Digital lending
However, in terms of its impact on business, the most important regulatory development was the Digital Lending Guidelines, dated September 2, 2022. Digital fintech lenders were tangoing with banks and NBFCs. As one would imagine, originating loans doesn’t need much persuasion, as all you would need is someone who buys stuff that he doesn’t need, under terms that he doesn’t read, and with money he doesn’t have. So fintech platforms will divert these borrowers to banks and NBFCs, under so-called sourcing partnerships, providing a first loss default guarantee, and sweeping the entire excess spread, which was anyways good enough to bear the losses.
The DL guidelines upended the FLDG business – as a result, many of the sourcing partnerships were completely terminated, whereas some others turned themselves into co-lenders[2]. DL guidelines also provided for regulation of LSPs (lending service providers), for whom their respective principals will be liable. There is a mandatory disclosure requirement of an all-inclusive APR (annual percentage rate), KFS (key fact statement). There is a cooling off period between 1-3 days permitting a borrower to exit the borrowing facility only by paying the proportional APR. And a privacy policy to be put in place that would regulate the access, sharing and storing of customer data and information[3].
Microfinance regulations
Yet another measure aimed at borrower protection was the new Microfinance Regulations – which shifted the entire thrust from entity regulation to activity regulation[4]. Thus, microfinance loans, no matter originated by whom, will have to abide by these Directives. Thus, if a borrower under an unsecured loan has an annual household income not exceeding Rs 3 lacs, he will qualify to be a microfinance borrower. While the lending rates itself is not controlled (except for the purpose of priority sector treatment in the hands of a buying bank), the rates have to come from a board approved policy. The debt servicing cannot be more than 50% of the household income. All the more, there is a substantial control on recoveries, including a discipline on physical visit to the residence of the borrower.
New SBR framework for NBFCs[5]
The scale-based regulatory framework is slowly sinking in – tranches of regulations were announced throughout the year. The Framework, applicable to all NBFCs from 1st October 2022 has made major changes.
A Chief Compliance Officer requirement has been added – which UL entities need to appoint by 1st April, 2023 and ML entities by 1st Oct, 2023. The CCO shall be appointed for a minimum of 3 years, and shall be reporting to either the MD/CEO or Board or Audit Committee. In addition, the company has to put in place a compliance framework – the major additional features of the compliance framework, other than the appointment of CCO, are to in place an independent corporate “compliance function” (not necessarily a compliance department), ensuring a strong compliance risk management programme, etc. Further, compliance risk is put directly under the responsibility of the board.
Entities have to put in place restrictions on lending to directors, KMPs, senior management personnel and their relatives as well as entities in which director/relative is interested. Lending to directors and related parties, above Rs. 5 crores would require the approval of the Board and below the said limit would be reported to the Board. Further, any loan to SMPs would be reported to the board and shall not be sanctioned by the SMP or committee where he/she is a member.
Compensation to KMPs has to abide by the new norms, effective 1st April, 2023. However, the interim period was to be seen as a period allowed for preparations and applicable NBFCs ideally have started aligning their practices in accordance with the provisions of these guidelines. To ensure that long term interests are not compromised by short-term performance indicators, there need to be malus and clawback provisions in case of variable compensation. NBFCs which do not have an NRC would now be required to have an NRC with constitution, powers, functions and duties as laid down in section 178 of the Companies Act, 2013.
Additionally, ML and UL entities, having more than 10 fixed point service delivery units, shall mandatorily implement CFSS. The intention is to make digital customer interface available and accessible 24*7 and provide a seamless interface which includes all digital offerings and related transactions.
Asset reconstruction companies
The ARCs, 29 of them as of now, were a product of the SARFAESI Act, but got a real booster from the IBC. Their regulatory framework was revamped with the new Master Circular of October 2022[6]. The new requirements include – need for independent director who shall chair the board meetings, disclosures in offer documents, increase in NOF requirement from the present Rs 100 crores to Rs 200 crores by March 2024 and Rs 300 by March 2026, though over a glide path period, In addition, the requirement of minimum investment by ARCs in SRs was redefined, by relating it to 15% of the transferor’s share, or 2.5% the total value of SRs, whichever is higher – this is a substantial reduction in the minimum fund infusion by ARCs themselves, which means more security receipts may be offloaded to investors.
In terms of their business, ARCs have now been permitted, by an amendment of the TLE Directions, to buy any stressed loans, as against the earlier requirement of buying only those loans which are trailing by at least 60 days.
Further, in case NPLs are sold against security receipts held by the seller, the seller has to continue to provide for the provisions, but the resulting losses in the books of NBFCs may be spread over a period.
Securitisation and transfer of loan exposures
The requirement of minimum holding period – for both transfer of loan exposures and securitisation – was redefined, to run from the date of registration of security interest with CERSAI, except in case of unsecured loans or those which cannot be cersai registered. In case of securitisation of home loans and real estate loans, the MHP cannot start until full disbursement of the loan.[7]
The RBI suddenly showed a frown for short term loans – hence, if the residual maturity of the loan is less than 365 days, such loan cannot be securitised, though there is no bar on assignment of the same under TLE Directions.
Factoring Regulations
For no apparent reasons, the regime for factoring continues to be unclear and restrictive. While the intent of the amendment made to the law in 2021 was to move out of the condition of being a predominantly factoring entity, the RBI responded to the amendments, introducing a so-called “certificate of registration” requirement which will need an AUM of Rs 1000 crores, and of course, satisfaction of under conditions, including NOF of Rs. 5 crores. The “other” conditions also include a clean regulatory track – almost putting entities under a virtual licensing regime. One wonders how many NBFCs would have gone for such a certificate of registration.
Overseas Investment regime
The new set of OI Rules, Regulations and Directions were issued in August 2022. The new rules make a distinction between overseas portfolio investment and overseas direct investment. The former includes a minority investment by residents into listed entities, whereas acquisition of any shares in an unlisted company, and control over a listed company will be regarded as ODI. A foreign subsidiary is defined to include an entity with control of 10% or more on voting rights. Roundtripping, which was earlier shrouded in mystery and subject to RBI approval based on merit, is now clearly permitted, as long as the investment is in bonafide business activities and the structure in India is within two layers of subsidiaries. Those having NPA accounts, or accounts which are wilful defaulters, will not be permitted to make overseas investment without NOC of the regulator.[8] Additionally, ODI in financial services activity has been liberalised, manner of investing in debt instruments has been clarified and acquisition or transfer by way of deferred payment now permitted.
Credit cards
For the first time, the term ‘credit card’ has been explicitly defined, to mean “a physical or virtual payment instrument containing a means of identification, issued with a pre-approved revolving credit limit, that can be used to purchase goods and services or draw cash advances, subject to prescribed terms and conditions.” The new directions for issuance of credit card and debit cards, lays down the general guidance and conduct for issuing entities, specifically recognising NBFCs as issuers. Certain key aspects like eligibility conditions for issuance of credit cards, guidelines with respect to billing, interest rate charges etc. penalty for unsolicited cards have been retained from existing provisions. An NBFC shall not undertake credit card business without prior approval of RBI and shall also require a minimum net owned fund of ₹100 crore (eligibility same as existing conditions).[9]
Also, there was a separate RBI communication, dated June 20, 2022 restricting the loading of prepaid cards with credit lines.
Central Bank Digital Currencies
The RBI’s disapproval of private crypto currencies was always vocal – it has got force now with the debacle of FTX. No one can oppose the RBI when it comes to private cryptos, but in the meantime, as per plans, the RBI has debuted central bank digital currencies on a pilot basis, both for wholesale (that is, banks to banks) transactions, as also for retail transactions[10]. CBDCs are almost sure to be introduced in India, and from what it seems, it will still have the benefit of full anonymity. [11]
[1] https://vinodkothari.com/2022/10/rbi-introduces-corporate-governance-norms-for-asset-reconstruction-companies/
[2] https://vinodkothari.com/2022/08/rbi-regulations-on-digital-lending/
[3] https://vinodkothari.com/2022/08/faqs-on-digital-lending-regulations/
[4] https://vinodkothari.com/2022/03/microfinance-specific-regulations-made-uniformly-applicable-to-all-microfinance-lenders/
[5] https://vinodkothari.com/sbr/
[6] https://vinodkothari.com/2022/10/rbi-introduces-corporate-governance-norms-for-asset-reconstruction-companies/
[7] https://vinodkothari.com/2022/12/holding-period-requirements-for-assignments-and-securitisation/
[8] https://vinodkothari.com/2022/12/faqs-on-overseas-investment/
[9] https://vinodkothari.com/2022/05/the-card-business-for-nbfcs/
[10] https://vinodkothari.com/2022/11/introduction-of-the-digital-rupee/
[11] https://vinodkothari.com/2022/02/cbdcs-in-india-a-leap-of-faith/
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