Credit Cards and EMI Cards From an NBFC Viewpoint

By Vishes Kothari (vishes@vinodkothari.com)

With the proliferation of retail lending NBFCs offering a variety of traditional and disruptive products, there has been the frequent question about NBFCs being able to issue credit cards.

This question leads onto various further questions- for example, is a credit ‘card’ facility in virtual form also a credit card? Hence it appears that one must first examine what exactly is the defining feature of a credit card. This note intends to explore this pertinent question.

Credit Card: Defining features

There is no direct definition of the credit card to be found in Indian laws and regulations issued by the RBI. This is because before the advent of new technologies resulting in new products, it was generally quite clear as to what was meant by a credit card facility. A card meant what looked like a card – the piece of plastic that one would keep in one’s pocket or wallet. However, technological advancements have completely changed that perception.

In UK law, one finds a definition of a credit card in The Credit Cards (Merchant Acquisition) Order 1990. This regulation provides:

“credit card” means a payment card the holder of which is permitted under his contract with the issuer of the card to discharge less than the whole of any outstanding balance on his payment card account on or before the expiry of a specified period (subject to any contractual requirements with respect to minimum or fixed amounts of payment), other than:

 (a) a payment card issued with respect to the purchase of the goods, services, accommodation or facilities of only one supplier or of suppliers who are members of a single group of interconnected bodies corporate(1) or who trade under a common name,

(b) a payment card with respect to which the payment card account is a current account, or

(c) a trading check; 

“payment card” means a card, the production of which (whether or not any other action is required) enables the person to whom it is issued (“the holder”) to discharge his obligation to a supplier in respect of payment for the acquisition of goods, services, accommodation or facilities, the supplier being reimbursed by a third party (whether or not the third party is the issuer of the card and whether or not a fee or charge is imposed for such reimbursement);

A credit card has thus been defined by an exclusion principle- it is all those payment cards which a user can use to ‘discharge obligations’ (i.e. make payments) with the exception of debit cards, cheques and cards which can be used at the outlet of only a single brand/store.

Thus, the credit card appears to have been defined by its ability to claim credit from the issue to make payments to a third party, via the use of the card.

This definition appears quite convenient to apply to the Indian financial services sector.

 

Who can issue credit cards?

Prior approval of the RBI is not necessary for banks desirous of undertaking credit card business either independently or in tie-up arrangement with other card issuing banks.

In the case of NBFCs, the RBI vide Master Direction DNBR. PD. 008/03.10.119/2016-17 dated September 01, 2016, has stipulated that only the following types of NBFCs are permitted to issue credit cards with the prior approval of the RBI:

  1. Issue of Credit Card

Applicable NBFCs registered with the Bank shall not undertake credit card business without prior approval of the Bank. Any company including a non-deposit taking company intending to engage in this activity requires a Certificate of Registration, apart from specific permission to enter into this business, the pre-requisite for which is a minimum net owned fund of ₹ 100 crore and subject to such terms and conditions as the Bank may specify in this behalf from time to time. Applicable NBFCs shall not issue debit cards, smart cards, stored value cards, charge cards, etc. Applicable NBFCs shall comply with the instructions issued by Bank to commercial banks vide DBOD.FSD.BC.49/ 24.01.011/ 2005-06 dated November 21, 2005 and as amended from time to time.

 It seems clear that the RBI intends to make the eligibility criteria very steep by putting in place the requirement for an NOF of 100 crores. Moreover, the issuance of credit cards can only happen via approval route.

The case of virtual credit-cards

New technologies have led to the development of various new products and variants of traditional credit card facilities. One such development is the possibility of having ‘virtual credit cards’ which function via a downloadable app or other software and eliminate the need for a plastic card altogether. The question arises that are such virtual cards to be considered as ‘credit cards’ and hence, is it that only the NBFCs eligible to issue credit cards may issue the virtual variants?

A literal reading of the definition/regulations above would, of course, imply that the credit card refers to a plastic card. Hence once could conclude that any NBFC can issue virtual ‘credit cards’ as it does not involve the use of a card at all.

In our opinion, this is not in keeping with the spirit of the law. Restrictions have been placed to restrict the NBFCs which can issue credit cards as this facility is a sensitive facility which is offered to and used by members of the lay public. If by merely changing the actual form of the credit card, i.e. by making it a downloadable app or any other virtual form, if one could circumvent all the checks and balances that have been put into place on who can issue credit cards, then that would not be in keeping with the spirit of the law/regulations.

In our view the regulation applies not only to potential credit card issuers but instead to credit facility issuers- i.e. issuers wanting to issue credit card-like instruments, whatsoever may be their actual form. Hence we would hold that only those NBFCs which are eligible to issue credit cards are eligible to issue virtual credit cards.

 

EMI CARDS

There have appeared on the market another type of card – the ‘EMI Cards’.

While a credit card facility involves the user having an instrument which gives him access to an on-tap revolving line of credit, the EMI Card is a card with a pre-approved loan. When the user of the card presents the Card at third party merchant outlet, the Card converts the purchase payment into EMI payments payable to the card issuer. Hence the card acts like a pre-approved loan. Usually no interest rates are charged from the user of the card, instead there the card issuer has an arrangement with the merchant (perhaps a commission arrangement). Such cards might also come with an annual subscription fee charged from the user.

In an EMI card the issuer of the instrument is able to regulate the expenses for which the holder can make payments using the EMI card, unlike in case of a credit card, where the issuer has no control over the places where the card is being used. The issuer of an EMI card can reject a loan request as per the agreement under which the card is issued, even when there is unused balance on the card, whereas in case of credit card the issuer cannot reject a payment request if there is unused balance on the instrument.

An EMI card is an instrument which is mostly used to finance purchase consumer goods by the holder of the card, whereas credit card are being used to pay for any kind of expenses of the holder.

The issuer of an EMI card is able to have greater control over its usage by the holder as compared to a credit card issuer.

Hence in a credit card, while the user taps into a new loan each time he avails of credit via using the card facility, an EMI card is an instrument which activates a loan up to a certain pre-approved limit.

Because the EMI Card is not a credit facility, it would follow that the usual restrictions applicable to the issuance of credit cards would not be applicable here. However, the distinction between a traditional credit card and a so-called EMI card is too thin to be visibly clear. Therefore, there is a strong possibility of the regulations on credit cards getting surpassed by entities promising loan facilities via cards. While the need for regulatory clarity is clear, in the meantime, issuers have to be able to evidence their ability to control the facility, such that the card does not become a surrogate for a credit card.

Property Share Business Models in India

By Vishes Kothari (vishes@vinodkothri.com)

Real estate suffers from the paradox of being a much sought after mode of investment which is at the same time illiquid, has high investment threshold and is difficult to adminster and manage. However technology can provide newer and more efficient ways of investing smaller amounts into co-ownership of property.

Property sharing is a concept which has caught in various developed economies and is now beginning to gain traction in Indian markets. The startup sets up a portal where individuals can get together to buy a property, enjoy the rentals it generates and finally be able to sell their share when they want, thus enjoying capital gains. The management of the property has to be done by the startup itself.

Various models can be constructed to devise a method whereby a group of individuals collectively owns a property, divides the rental revenues among its members and nominates a single entity to manage and adminster the property on it’s behalf.

Of course, there already are vehicles which have been envisaged for shared property investment- namely Real Estate Investment Trusts (REITs). However REITs are suited towards large scale investments in commercial real estate.. REITs must be publicly listed.The minimum issue size for a REIT is 500 crores. Thus REITs are not suitable for shared investment in say, a small office or a 2 BHK. Hence a business model using an alternative instrument must be devised.

What must be the features of such a business model?

The nomination of another entity to manage and adminster the property is a sensitive issue legally. The model must be so devised that only the management and adminstration of the property is handed over to the entity. The moment the management of moneys is handed over to the entity and/or a certain rate of return on this money is promised, it would classify as investment activity. Any such entity which is taking on investment activity on behalf of others would fall under the regulatory purview of SEBI and would require prior registration as Alternative Investment Fund (AIF) or a Collective Investment Scheme (CIS).  These are defined by SEBI as follows:

“Alternative Investment Fund or AIF means any fund established or incorporated in India which is a privately pooled investment vehicle which collects funds from sophisticated investors, whether Indian or foreign, for investing it in accordance with a defined investment policy for the benefit of its investors.”

“Any scheme or arrangement made or offered by any company under which the contributions, or payments made by the investors, are pooled and utilised with a view to receive profits, income, produce or property, and is managed on behalf of the investors is a CIS.“

Thus the three critical features of an AIF are: (a) pooling of money; (b) entrustment of money to someone such that the investors are not the ones who are managing their own money; and (c) Contribution by investors with a view to receive profits[1].  A CIS is, in addition, publicly offered.

A possible business model could be as follows:

  • A particular property is listed, say for, Rs. 1 crore on a portal.
  • 10 buyers are required, each paying Rs. 10 lakh.
  • Once 10 such buyers indicate their willingness to invest on the portal, they together form an LLP/ Company with each buyer holding equal stake/partnership interest in the entity. Let us call this entity E. The incorporation process has to be facilitated by the portal itself.
  • E now acquires the property.
  • E must hand over the management and administration of the property to the portal, via, say a Power of Attorney arrangement.
  • The portal now manages the property on behalf of E, rentals flow upstream to E and are divided equally among its stakeholders.
  • If at any point of time any of the stakeholders wishes to sell his stake and is able to find a potential buyer for his stake at a mutually agreeable price; then the equity/partnership interest gets transferred to the new buyer.

The questions arises- does the portal fall under the definition of an AIF/CIS ? We now analyse each of the 3 conditions to qualify as an AIF separately:

  1. Pooling of Money:  AIF involves pooling of money by the investors for a particular property collectively owned by the investors themselves. In the present situation, entity E owns the property, while the Portal manages/administers the property. Hence the Portal does not hold the funds itself during any part of the process.
  2. Distancing of ownership and management of the funds: The Portal is being appointed with the sole intention of managing the apartments in the interests of the shareholders of the entity E, and is not involved with the making of any investment decisions or administration of investor funds. The investment decision has already been made by the owners when they decide to invest in the property.
  3. No guaranteed profit or rate of return: There is no guaranteed profit or rate of return. Revenues come from rentals as well as from sale of apartments. Both these revenue streams are market dependent and the portal will not make any promise or advertisement concerning rates of return.

Thus the portal is not going to fall under the definition of an AIF. While the portal is a publicly accessible website, since at no point does the portal take control of the funds, it would not qualify as a CIS.

The notion that property ownership can flow from holding equity/partnership interest in a company/LLP finds validation in the Hill Properties Ltd vs Union Bank of India (1975) ruling pronounced by the Supreme Court, if the Articles of Association of the Company provide for this. Moreover, this right can be sold, hypothecated or mortgaged. Thus, it follows that owners of equity/partnership interest in the Company/LLP will become fractional owners of the property. Moreover they can resell their share, hypothecate it or mortgage it.

Stamp duty Issues

  1. Stamp duty is applicable when the property is bought by E.
  2. If the property owners’ interest is regarded as fractional ownership interest in the property, then the fractional interest itself amounts to immovable property. Note that the definition of immovable property as given in Stamp Act includes any interest in immovable property as well. On the contrary, if E is a body corporate, and the fractional owner is transferring the shares/ownership interest in the body corporate, there is no question of any stamp duty as applicable to immovable property. At best the stamp duty applicable on sale of shares/ownership interest may be applicable, which also may be avoided if the shares are in demat format.
  3. Should the entity E decide to sell the property in its entirety, then stamp duty will be applicable.

 

Furniture rental startups: A financial perspective

Estimates peg the global furniture rental market at anything between $5-8 billion. Leasing/renting of home durables has seen steep growth. The idea of ownership has been superseded by the desire to gain better experiences by renting or sharing resources. Whatever the absolute numbers, the growth in mobility and intra-country migration suggests that there is a large and ever growing clientele of urban professionals with transferrable jobs and disposable income. Increasing numbers of furniture and appliance rental startups have sprung up to cater to this clientele. This article takes a quick look at the market and its potential in time to come. Read more

Cracking the ‘Bitcoin’ nut this Budget Session

Vallari Dubey & Saloni Mathur

finserv@vinodkothari.com
corplaw@vinodkothari.com

Introduction

In the words of Mr. Nassim Nicolas Talib, “Bitcoin is the beginning of something great, a currency without a government, something necessary and imperative.” Read more

Regulations on Prepaid Payment Instruments -Comparing the Master Circular and Master Directions

By Anita Baid, (finserv@vinodkothari.com)

With an enlarged view of the Government to make India go cashless and straddle towards the concept of digitalisation, many companies, specifically NBFCs are seeking approval from the Reserve Bank of India (RBI) to set up business in Prepaid Payment Instruments (PPI). Before getting into the present regulatory framework of such PPIs, one needs to understand the concept of such instruments. PPIs are a form of digital electronic instruments. PPI issuers open an account for its account holders known as PPI holders and with the help of such account, withdrawal/ deposit is made for some pre-ascertained payments or receipt. A certain amount is deposited into such PPI Account from the holder’s Bank A/c and using the balance deposited in the PPI Account, payments are made and/or even cash is received. The introduction of such mechanism enables a person to go cashless. Such PPI instruments can be of three types: Read more

Bitcoins in trouble?

 

Vallari Dubey

finserv@vinodkothari.com

 

Bitcoin as a virtual currency has seen its ups and downs, and quite recently, a surge in the graph of the currency, tells us an interesting story. Amidst the growth of crypto-currency market worldwide, much has been said about plenty of risk that bitcoin brings with itself. Read more

Getting a licence for Pre-paid Payment Instruments in India.

 By Ameet Roy,( finserv@vinodkothari.com)

Payment systems in India are governed by the Payment and Settlement Systems Act, 2007 (PSS Act) and the RBI is the regulatory of all payment system India. All applications for granting of licence under the PSS Act has to be made to the RBI.


Under the guidelines for Issuance and Operation of Pre-paid Payment Instruments (PPIs) in India, an entity desirous of entering into business of issuance and operation of pre-paid payment instruments shall at all time maintain a minimum paid up capital of Rs. 5 Crore and positive net worth of Rs. 1 Crore.

An entity which fulfils the above mentioned capital requirements should file an application for grant of licence under the PSS Act on Form A (Application form for authorisation to set up payments systems) to the RBI with a nominal application fee of Rs. 10,000/-. On the form the entity should give all its details along with –

  1. Citing concrete benefits to the financial system/ country from the operationalisation of the payment to be set up.
  2. Experience of the applicants in the relevant field (the RBI seems very determined to allow operation of PPIs to serious and experienced persons in the field of payment systems).
  3. Method of settlement of payment claims (gross / net / hybrid).
  4. Details of bankers of the applicant entity.
  5. Banker’s report on the functioning of the applicant account and its financial health.
  6. Details of settlement agents for the proposed payment system.
  7. Whether the settlement agent will act as central counterparty to provide guarantee.
  8. Amount of finance required to execute the payment system project
  9. Sources of finance –
    1. Amount of own capital proposed to be deployed
    2. Amount of borrowings expected from banks
    3. Amount of borrowing expected from sources other than banks (sources to be properly disclosed)
  10. Rate of return on investment expected from the payment system sought to be set up
  11. How does the applicant propose to recover its investment and earn an income, that is, whether through cash flows or by levying joining fees, security fees, annual/ operating charges etc.( full details to be given)

and various other information which will help the RBI assess the potential of the proposed business and its future prospects. The will only grant licence after being totally confident of the viability and security of the payment systems.

For help and assistance on the application of licence for setting up payment systems mail us at – finserv@vinodkothari.com