Cryptocurrency on the path to Legalisation?

By Vineet Ojha (finserv@vinodkothari.com)

From conservative investors to cryptocurrency enthusiasts, cryptocurrency has been the hot button issue. In the tech world, a common phrase is “that’s so crazy it just might work”, and hence, an open-source, unregulated, P2P currency has been thriving for the better part of the last decade. The Indian regulators have not taken lightly to the phenomenal increase in the transaction of cryptocurrencies including Bitcoin, in India and globally as they don’t have any intrinsic value and are not backed by any kind of assets. The price of cryptocurrencies therefore is entirely a matter of mere speculation resulting in spurt and volatility in their prices. The recent introduction of crypto tokens by the Government of India may be the first step to the legalization of cryptocurrencies.

This year saw the gradual restriction on cryptocurrency investment by the regulators. The government went all out to eliminate its use in financing illegitimate activities. RBI, on 5th April 2018, directed lenders to wind down all banking relationships with exchanges and virtual currency investors within three months. Yet, it says the feasibility of these coins is being studied and hints at launching its own digital currency. This move saw protests from various exchanges through detailed representations to the RBI on why this ban should be lifted.

It looks like the plea of the investors and exchanges might have been heard as the government is considering launching crypto tokens in India for financial transactions and is evaluating if they can replace smart cards. Unlike cryptocurrency, crypto tokens do not impact the country’s monetary policy as one will have to pay physical money to buy a token. Although, the existing ban on cryptocurrencies is said to continue, it seems like the government is working on regulations and specific actions, including a roadmap for permitting cryptocurrencies in India sometime in the future.

Scenario in India

November 2017, Indian investors made a beeline for cryptocurrencies. The price boom being irresistible, registered an increase in the costumers enrollment for the currency. The value of the cryptocurrency breached the USD 11,000 per bitcoin effectively doubling within a single month. This was despite the murmurs that RBI could potentially declare bitcoin and its kin illegal in India.

December 2017, the regulators buckled up and issued the second warning against these currencies, with the first one being issued way back in December 2013. The finance ministry compares virtual currencies to ponzi schemes.

January 2018, the government continued issuing caveats to clarify that cryptocurrencies are not legal tender. The income tax department reportedly began sending tax notices to investors. Banks suspended the withdrawal and deposit facilities of some exchanges. Some lenders disassociated with them completely.

April 2018, investors were directed to slow transactions in cryptocurrencies on RBI’s command as it considered a proposal for issuing its own digital currency. It said that the feasibility of these coins was under consideration. Exchanges drag the central bank to court in protest.

July 2018, the ban became effective. Some petitioners sought  a stay order from the Supreme Court on the ban at least till the next date of the hearing. However, their request was denied.

August 2018, the government introduced crypto tokens, assuring the exchanges that they are considering a future for cryptocurrency in the economy.

Why Crypto Tokens?

The concept of crypto tokens is different to that of cryptocurrency. Although, terms like cryptocurrency, altcoins, and crypto tokens are often erroneously used interchangeably in the cryptocurrency cosmos, they are all different terms. Cryptocurrency is the superset, and altcoins and crypto tokens are its two subset categories. A cryptocurrency is a standard currency which is used for the sole purpose of making or receiving payments on the blockchain.

The foremost reason for the introduction of crypto tokens is to replace smart cards.  In words of a  senior government official

The committee is examining if crypto tokens can be used to replace smart cards such as metro cards in the public sector to start with. Similarly, in the private sector, it can be used in loyalty programs such as air miles where its use is limited to buying the next ticket and can’t be converted into money,”[1].

The convenience of the token is that it could be stored as a code in any basic mobile feature phone. Secondly, as stated above, tokens don’t expose the monetary policy of the economy as the transaction is basically done through physical money. Hence, the underlying currency is the Rupee. It seems that tokens are more like an experiment by the government or a method to slowly establish a regulated environment for crptocurrencies to thrive.

Conclusion

The government seems to be testing waters with the introduction of tokens. Their intentions are still unclear, either it be to bring back cryptocurrency or to introduce their own digital currency. We will have to wait and see the performance of tokens for a clearer picture.

Please read our related articles on cryptocurrency here:

Legal Nature of Bitcoins: the encrypted digital currency by Vallari Dubey: http://vinodkothari.com/blog/legal-nature-of-bitcoins-the-encrypted-digital-currency-by-vallari-dubey/

Cracking The ‘Bitcoin’ Nut This Budget Session: http://vinodkothari.com/blog/cracking-bitcoin-nut-this-budget-session/


[1] https://www.moneycontrol.com/news/business/markets/sensex-likely-to-be-in-40000-42000-range-by-next-independence-day-2019-poll-2835741.html

Co-lending arrangement between Banks and NBFCs for PSL

By Simran Jalan (finserv@vinodkothari.com)

Introduction

The Reserve Bank of India (RBI), in its press release on ‘Statement on Developmental and Regulatory Policies’ dated August 1, 2018[1], sets out various policy measures. One of the initiatives introduced relates to co-origination of loans by the banks and NBFCs for lending to the priority sector.

Before delving into the initiative, we shall briefly discuss the concept of priority sector and priority sector lending (PSL).

Categories of priority sector

Priority Sector category includes agriculture; micro, small and medium enterprises; export credit; education; housing; social infrastructure; renewable energy and others.

PSL target

According to the Master Circular – Priority Sector Lending- Targets and Classification[2] issued by RBI, the total priority sector lending (PSL) for domestic scheduled commercial banks (excluding Regional Rural Banks and Small Finance Banks) should be 40% of Adjusted Net Bank Credit or Credit Equivalent Amount of Off- Balance Sheet Exposure, whichever is higher. Further, there are also sub-targets specifically for agriculture, micro enterprises and weaker sections.

Existing Scenario

Commercial banks are required to meet the PSL requirement specified in the aforesaid circular. However, banks neither have the outreach nor the inclination to reach out to the communities living in geographically remote areas. The banks are even unable to perform credit evaluation or credit underwriting of the borrowers falling under the priority sector category due to lack of outreach. Consequently, apart from direct funding, banks have been exploring several options for meeting the minimum requirement:

  1. On-lending: In this structure the loan is sanctioned by banks to eligible intermediaries for onward lending only for creation of priority sector assets.
  2. Direct Assignment: Banks enter into transaction with NBFCs for assignments/ purchase of pool of assets representing loans under various categories of priority sector, as prescribed under the aforesaid circular.
  3. Business Correspondent: Commercial banks intending to increase their outreach have been engaging the services of BCs. Such NBFCs or other eligible entities provide various services such as identification of borrowers, collection, recovery, follow-up and such other ancillary services. The loans under various categories of priority sector are originated in the books of the bank through the assistance of BC.
  4. Co-lending: Both banks and NBFCs enter into a co-lending arrangement, whereby the exposure on the borrower is in a pre-decided ratio.

Though, there are existing regulations on direct assignment as well as appointment of BC, currently the co-lending arrangement is not regulated under any existing guidelines of RBI.

Co-lending regulations awaited

As per the press release, RBI shall be coming up with such guidelines wherein schedule commercial banks (excluding regional rural banks and small finance banks) may co-originate loans with systematically important non-deposit taking NBFC for fulfilling their mandatory priority sector lending requirement.

Under the co-lending arrangement, there would be joint contribution of credit by both lenders at the facility level. The said arrangement shall also involve sharing of risks and rewards between the banks and NBFCs, as per their mutual agreement. The risks and rewards could be shared equally or in a proportion which shall be predefined.

This step is taken by RBI to provide a competitive edge for credit to the priority sector and to mitigate the challenges faced by the banks on priority sector loans. The NBFCs operates on low cost infrastructures and have reach to the remote locations. Coming together with NBFCs shall definitely assist the banks to meet their PSL requirements with ease.

Conclusion

The guidelines have not yet been issued and it is expected that RBI shall come out with its regulations for governing such co-lending arrangement by the end of September 2018. In consequence, there can be a decline in the direct assignment arrangement undertaken by banks. The reason being that in co-lending there is joint origination and the risk and rewards are shared in a mutually agreed proportion, however, in case of direct assignment, the NBFC transfers the loan portfolio and has no residuary interest left. Such difference can lead to a decline in the direct assignment transactions undertaken by banks with NBFCs.


[1] https://www.rbi.org.in/Scripts/BS_PressReleaseDisplay.aspx?prid=44637

[2] https://rbi.org.in/scripts/BS_ViewMasCirculardetails.aspx?id=9857

SEBI’s yet another attempt to give domestic bond market a push

By Rajeev Jhawar (rajeev@vinodkothari.com)

In a vibrant market, resides a healthy economy. On the budget day, India sought to expand its bond market beyond the traditional ambit of sovereign debt. In pursuant to this, Securities and Exchange Board of India has initiated to diversify borrowings of Indian corporates by mandating to raise at least a quarter of their incremental funds from the bond market. The regulator came out with a consultation paper in order to address the liquidity problem persisting in the bond market, with an intention to create a robust secondary market for the debt securities in India.

SEBI’s proposal and corresponding inferences

The regulator proposed that listed Companies with outstanding long-term borrowings of Rs. 100 crores and a credit rating of “AA and above” will have to compulsorily raise 25% of their debt from the bond market from the next financial year, as a part of corroborating the same. Lower rated corporates have been exempted from the framework for the time being due to the limited demand for such securities.

It is believed that if the 25% norm is followed religiously, it would tantamount to increased bond floatation as more companies would be able to access the debt market. Ideally, the move should provide insurance companies, provident funds and pension funds an opportunity to invest in high yielding instruments and open up a new funding avenue for lower-rated companies. Besides, the government might limit corporates’ dependence on banks and the risk associated with it. However, there is a need for an expansion in the investor base for implementation of these rules.

Rationale

There is no secondary market for corporate bonds in India to speak of. The sorry state of affair could be because of illiquid debt market, bad press in case of default, risk averse attitude as well as dearth of investor’s awareness.

On the bright aspect, bonds are ideal way to raise financing for a certain kind of long-gestation infrastructure project. Typically, infrastructure projects are capital-intensive and long-gestation. It takes years to roll out toll-roads, build flyovers and set up massive power generating plants. The project developer has no cash flow to service debt until the project is running and banks may not be considered a viable source as bank funding is short tenure, which would result in asset-liability mismatch.

A sound corporate bond market, would take a lot of pressure off banks, which are reeling under bad debts. Retail investors will also get a chance to invest in such projects via debt funds. In short, large exposure to risk would be substantiated with huge rewards.

The issuer-issuance conundrum

 

The  chart above demonstrates the issuance by  various  entities. It is palpable that almost 60-70% of the total issues are done by financial sector entities and the private sector non-financial entities constitutes only around 20 % of the total issuances. One of the major reasons for this huge concentration among the financial institutions is the relaxation with respect to DRR enjoyed by them. In order to liberalize the regulatory framework for all types of issuers, the Working Group has proposed to scrap it off for all types of issuers.

Debenture Redemption Reserve (DRR)

As noted above that financial sector companies, including NBFCs, are currently exempted from the requirement of maintenance of DRR for debenture issuance on private placement basis, whereas all issuance by non-financial entities and entities doing public issue are required to set aside a part of their profits (equivalent to 25 % of the value of outstanding debentures) as DRR. Besides, such companies have to invest at least an amount equivalent to 15% of the debentures maturing during the year in bank deposits, government securities, etc. Such an earmarking of funds imposes an opportunity cost on the issuer.

In respect to DRR, the paper provides that DRR maintenance imposes a significant cost on public issue of bonds and on bonds issued on private placement basis by non-financial corporates, and given that issue of protection of bond investors, in cases of default, has been significantly addressed by the enactment and operationalization of Insolvency and Bankruptcy Code, it is felt that if the requirement of DRR is dispensed with, it will naturally facilitate more corporates to access the bond market for their financing needs.

Investment Grade

The need to invest in bonds with lower ratings and deviating from ‘AA’ to ‘A’ grade ratings, would impact pension and provident funds more because they have largely invested in AAA-rated securities. As of today, even the provision to invest in up to AA-rated instruments is hardly explored by most of the larger investors. Corporate bonds rated ‘BBB’ or equivalent are investment grade. In India, most regulators permit bonds with the ‘AA’ rating only as eligible for investment. However, this case may not hold true post SEBI’s proposal.

As per SEBI, in 2016-17, 51 percent of total borrowings came from bonds compared to 37 percent in 2012-13, a good indication for deepening of bond market. However, borrowings are still heavily skewed towards high rated borrowers, with 90 percent of the issuance concentrated in the AA and AAA rated categories. In light of the extant depth structure of the bond markets, it is supposed that the proposed rules should not be onerous for corporates.

Impact on Financier’s Interest

The entry barrier for lower rated corporate bonds would be demolished because the proposal might escalate the pool of investment grade issuers. So far, the small borrowers resorted mostly to institutional finance and inter-corporate deposits. The bond avenue would serve as an alternative for them to raise finance at a reasonable price keeping in mind investor’s perpetual keenness to diversify their investments. It may be useful to classify BBB-rated corporate bonds as investment grade and thus allow pension funds and insurance companies to enter that space.

Compliance

SEBI proposed a “comply or explain” framework for the new rules. This means that companies would need to disclose non-compliance as part of “continuous disclosure requirements,” the regulator said.

Further, from the third year of implementation i.e. FY 2021-22, the requirement of bond borrowings shall be tested for a contiguous block of two years i.e. FY 2021-22 and FY 2022-23,which will be treated as one block and the requirement of 25% borrowing through bond market shall need to be complied for the sum of incremental borrowings made across the period of the block and at the end of block if there is any deficiency in the requisite bond borrowing, a monetary penalty in the range of 0.2% to 0.3% of the shortfall shall be levied.

Whether SEBI’s attempt would prove to be a boon or a bane, is likely to be seen as days unfold.

 

Interim Compensation to the Payee of the Dishonoured Cheque

By Shreya (legal@vinodkothari.com)

Background:

Negotiable Instruments are the principal instruments for fulfilling commercial obligations and they play a very significant role in the modern trade and business community. Law relating to negotiable instruments is provided in the Negotiable Instruments Act, 1881(“the Act”) as amended from time to time.

Dishonour of cheque due to insufficiency of funds was made a penal offence by the insertion of Chapter XVII in the Act by the Banking Financial Institutions and Negotiable Instruments Laws (Amendment) Act, 1988. The object of criminalising dishonour of cheque was to regulate the expanding trade, commerce, business and industrial activities, to safeguard the interests of the creditors as well as to ensure greater vigilance in the matters of finance.

The Negotiable Instruments (Amendment) Act, 2017: Objects and Reasons

The Lok Sabha has passed the Negotiable Instruments (Amendment) Act, 2017 (“the Amendment Act”) on July 23, 2018. It shall come into effect on the date appointed by the Central Government by way of a notification in the Official Gazette. The amendment has inserted two provisions, sections 143A and 148 in relation to cheque dishonour cases which empower the trial court and the appellate court, as the case maybe, to order payment of interim compensation during the trial and deposit of certain minimum sum in an appeal by the drawer of cheque against conviction.

In the Statement of Objects and Reasons appended to the Amendment Bill, it was stated that “injustice is caused to the payee of a dishonoured cheque who has to spend considerable time and resources in court proceedings to realise the value of the cheque” on account of “delay tactics of unscrupulous drawers of dishonoured cheques due to easy filing of appeals and obtaining stay on proceedings.” The Amendment Act, thus, seeks to provide relief to payees of dishonoured cheques who get caught up in lengthy litigations and to discourage frivolous and unnecessary litigation.

Salient Features of the Amendment Act:

Under the newly inserted section 143A in the Act, the trial Court has power to order payment of interim compensation by the drawer of the cheque to the complainant. Such payment can be ordered in both summary trial and a summons case (as provided under section 143 of the Act) where the accused drawer pleads not guilty to the charge made in the complaint. In other cases, it can be ordered upon framing of charges. The section has made the payment of interim compensation subject to following conditions:

  1. The interim compensation shall not exceed twenty percent of the amount of the cheque.
  2. The interim compensation is to be paid within sixty days from the date of the order of payment. A further extension of maximum thirty days can be granted if the drawer of the cheque shows sufficient cause.
  3. The interim compensation is to be recovered in accordance with section 421 of the Code of Criminal Procedure, 1973 (“the CrPC”). Section 421 prescribes two modes of recovery of fine- (a) attachment and sale of any movable property of the drawer, (b) recovery as arrears of land revenue from the movable or immovable property of the drawer by way of a warrant issued to the Collector of the concerned district.
  4. If the drawer of the cheque is acquitted, the complainant shall be directed to repay to the drawer the amount of interim compensation along with interest at the bank rate as published by the Reserve Bank of India, prevalent at the beginning of the relevant financial year. The repayment has to be made within sixty days of the date of order of acquittal subject to a further extension of not more than thirty days if the complainant shows sufficient cause for delay.

While Section 143A confers power on the trial Court to order payment of interim compensation, Section 148 empowers the Appellate court to order the drawer to deposit such sum which shall be a minimum of twenty per cent of the fine or compensation awarded by the trial Court. Such deposit is in addition to the interim compensation already paid pursuant to section 143 A. The deposit is to be made subject to the following procedure and conditions laid down in the section:

  1. The amount is to be deposited within sixty days from the date of the order of payment. A further extension of maximum thirty days can be granted if the appellant shows sufficient cause.
  2. The amount deposited may be directed to be released to the complainant at any time during the pendency of the appeal.
  3. If the appellant is acquitted, the complainant shall be directed to repay to the drawer the amount of the deposit along with interest at the bank rate as published by the Reserve Bank of India, prevalent at the beginning of the relevant financial year. The repayment has to be made within sixty days of the date of order of acquittal subject to a further extension of not more than thirty days if the complainant shows sufficient cause for delay.

Analysis:

As already mentioned, dishonour of cheque is a penal offence under section 138 of the Act and it attaches criminal liability to the drawer of the dishonoured cheque. The traditional view is that the object of a criminal proceeding is ‘deterrence’ whereby punishment is imposed on the accused, through fine or imprisonment or both, whereas, the award of compensation or damages is considered to be a characteristic feature of a civil proceeding.

In this regard, reference must be drawn to Section 357 of the CrPC which empowers the Criminal Courts to order payment of compensation.

“357. Order to pay compensation.—(1) When a Court imposes a sentence of fine or a sentence (including a sentence of death) of which fine forms a part, the Court may, when passing judgment, order the whole or any part of the fine recovered to be applied –

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(b) in the payment to any person of compensation for any loss or injury caused by the offence, when compensation is, in the opinion of the Court, recoverable by such person in a Civil Court;

XX”

On this issue, the Supreme Court of India in the case of R. Vijayan v. Baby[1] observed that:

“Though a complaint under section 138 of the Act is in regard to criminal liability for the offence of dishonouring the cheque and not for the recovery of the cheque amount, (which strictly speaking, has to be enforced by a civil suit), in practice once the criminal complaint is lodged under section 138 of the Act, a civil suit is seldom filed to recover the amount of the cheque. This is because of the provision enabling the court to levy a fine linked to the cheque amount and the usual direction in such cases is for payment as compensation, the cheque amount, as loss incurred by the complainant on account of dishonour of cheque, under section 357 (1)(b) of the Code and the provision for compounding the offences under section 138 of the Act. Most of the cases (except those where liability is denied) get compounded at one stage or the other by payment of the cheque amount with or without interest. Even where the offence is not compounded, the courts tend to direct payment of compensation equal to the cheque amount (or even something more towards interest) by levying a fine commensurate with the cheque amount.”

The Court further pointed out that the provisions of Chapter XVII of the Act strongly lean towards grant of reimbursement of the loss by way of compensation. The trial courts should, unless there are special circumstances, in all cases of conviction, uniformly exercise the power to levy fine upto twice the cheque amount (keeping in view the cheque amount and the simple interest thereon at 9% per annum as the reasonable quantum of loss) and direct payment of such amount as compensation.

It appears from the language of section 357(1)(b) of the CrPC as well as the above ruling that the intent behind awarding compensation to the payee of dishonoured cheques in a criminal proceeding instituted under section 138 is to facilitate the payee to recover the

amount of cheque without having to initiate a separate recovery suit in a civil court so that matter arising out of the same cause of action is settled in the same court.

In line with the aforesaid, the Amendment Act now expressly provides for compensatory and restitutive provisions in addition to the traditional punitive provisions as regards the dishonour of cheques.

At this juncture, it is relevant to note that section 25(5) of the Payment and Settlement Systems Act, 2007 expressly provides for applicability of Chapter XVII of the Negotiable Instruments Act, 1881 to dishonour of electronic funds transfer. The section makes the dishonour of electronic funds transfer an offence punishable with imprisonment or with fine or both, similar to the dishonour of a cheque under the Negotiable Instruments Act. The Reserve Bank of India vide its circular no. DOC/2011-12/191 DPSS. O.PD.No 497/02.12.004/2011-12 dated September 21, 2011 had clarified that section 25 of the Payment and Settlement Systems Act, 2007 accords the same rights and remedies to the payee (beneficiary) against dishonour of electronic funds transfer instructions for insufficiency of funds in the account of the payer (remitter), as are available to the payee under section 138 of the Negotiable Instruments Act, 1881.

Thus, the payees of dishonoured electronic funds transfer shall also be entitled to the interim compensation on par with the payees of dishonoured cheques.

The Amendment Act, thus, is a welcome development for the payees of dishonoured cheques as well as dishonoured electronic funds transfer, in particular the banks and financial institutions as they will be greatly facilitated in recovery of amount by way of proceedings under section 138 of the Act. Further, this will allow them to continue to extend financing to the productive sectors of the economy leading to overall development of trade and commerce.

Concluding Remarks:

The Amendment Act is, undoubtedly, a positive step towards ensuring the credibility of cheques. However, the Amendment Act is not without its fare share of criticism. Some people are of the view that the Act is still not stringent enough to effectively deter the defaulting drawers of the cheques. As such, harsher penalties should be imposed on the repeat offenders in the form of increased fine or prohibition on issuing cheques for a specified period. Also, express provision should be inserted for expeditious trial of the cheque bouncing cases within the prescribed time period. Nonetheless, the Amendment Act will go a long way in ensuring relief to the payee of the dishonoured cheques.


[1] R. Vijayan v. Baby, (2012) 1 SCC 260 (Read judgement at: https://indiankanoon.org/doc/635335/).