Cautious Approach to be taken by NBFCs while outsourcing activities ancillary to financial services

By Mayank Agarwal & Anita Baid, ( finserv@vinodkothari.com)

The Reserve Bank of India (RBI), on the 9th of November, 2017 released a notification bringing out the Directions on Managing Risks and Code of Conduct in Outsourcing of Financial Services by Non-Banking Financial Companies (NBFCs).[1] (“Directions”) These Directions are a much awaited outcome of the draft guidelines[2] which had been issued long back, in the year 2015. The Directions come in the wake of ever-increasing need to outsource ancillary activities such as applications processing (loan origination, credit card), document processing, marketing and research, supervision of loans, data processing and back office related activities in order to provide the customers best possible services associated with the core business of the company. The Directions have been issued to ensure that there exists no possibility of discrepancy or fallibility that could affect the customer as well as the NBFC in an adverse manner.

Read more

Mandatory linking of Aadhaar and PAN under PMLA

By Anita Baid, (finserv@vinodkothari.com)

PML Second Amendment Rules

The Ministry of Finance on 1st June, 2017 vide notification No. G.S.R. 538(E) issued the [1]Prevention of Money-Laundering (Maintenance of Records) Second Amendment Rules, 2017 (hereinafter referred to as “Second Amendment Rules”) mandating all account holders of the reporting entities i.e., banks and financial institutions to link Aadhaar number issued by the Unique Identification Authority of India and Permanent Account Number (PAN) or Form No. 60 as defined in Income-tax Rules, 1962. The timelines for the same were as below- Read more

RBI’s P2P Regulations: A step forward or backward?

The Reserve Bank of India issued a Master Directions – Non Banking Financial Company – Peer to Peer Lending Platform (Reserve Bank) Directions, 2017 (hereinafter referred to as “Directions”) on 4th October, 2017[1], which is an extensive statement outlining in detail the various rules and regulations that all existing and prospective entities carrying on or intending to carry on the business of Peer-to-Peer (P2P) lending (hereby known as NBFC-P2P) will have to comply with. These Directions shall come in force with immediate effect and shall apply to all NBFC-P2Ps, i.e. with effect from the date of issuance of the Master Directions, mentioned above.

1. Registration

1.1. Eligibility criteria

The basic eligibility criteria for carrying on the business of setting up a P2P lending platform are as follows:

  • Only a Non-Banking Financial company shall undertake the business of P2P lending platform.
  • All NBFC-P2Ps that are either commencing or carrying on the business of Peer-to-peer lending platform must obtain a Certificate of Registration (CoR) from the bank.
  • Every existing and prospective NBFC-P2P must make an application for registration to the Department of Non-Banking Regulation, Mumbai of RBI.
  • Any company seeking registration as an NBFC-P2P must have Net Owned Funds of at least Rs. 2 Crores or higher as RBI may specify.
  • The RBI has imposed the condition that the company seeking registration must be incorporated in India and must have a robust IT system in place. The management must act in public interest and the directors and promoters must be fit and proper.

While the eligibility criteria remains same for those already into business and prospective ones, however, there is a slight difference in the way the application process of these two categories will be dealt with by the RBI.

1.2. Prospective P2Ps

An entity intending to set up a P2P lending platform will have to make an application to the RBI and at the time of making the application, it should achieve net-owned funds of Rs. 2 crores which must be parked into Fixed Deposit.

Upon submission of the application, if the RBI is of the view that the aforesaid conditions have been fulfilled, it will grant an in-principle approval for setting up of a P2P lending platform, subject to such conditions which it may consider fit to impose. This approval will be valid for a maximum of 12 months from the date of granting of the approval. Within this period of 12 months, the company must put in place the technology platform, enter into all other legal documentations required. We are of the view that during this period, the entity will be allowed to break the fixed deposit and utilize that money to incur capital expenditure as the ones mentioned above. The entity will have to report position of compliance with the terms of grant of in-principle approval to the RBI.

Once the systems are in place and the RBI is satisfied that the entity is ready to commence operations, it shall grant the Certificate of Registration as an NBFC–P2P.

This high NOF requirements and the long gestation can deter prospective players from entering into the market.

1.3. Existing P2Ps

The situation will be different for entities who are already into the business. Any entity carrying out the business of Peer-to-peer lending platform as on the effective date of these Directions, can continue to do so provided that they apply for registration as an NBFC-P2P to the RBI  within 3 months from the date of effect of these Directions. This will however, not hamper their business, as the RBI allows them to carry on the business, during the pendency of the application and until the application for issuance of CoR is rejected. If the application is rejected, the applicant will have to wind up its business.

2. Scope of Activities

The Master Directions, next, discuss about the Dos and Don’ts of the P2P lending platforms. Let us first discuss about the Dos.

2.1. Dos

An NBFC-P2P can only act as an intermediary that provides an online platform to the participants, i.e., borrowers and lenders, involved in P2P lending. It should ensure adherence to legal requirements applicable to the participants as prescribed under relevant laws, which means this includes the KYC Directions prescribed by RBI.  It is also required to store and process all data relating to its activities and participants on hardware located within India. It is permitted to invest in instruments specified by RBI provided they are not traded in.

Another important function that has been added to the scope of the NBFC-P2P credit assessment and risk profiling of the borrowers, the findings of which must be disclosed to the prospective lenders. Earlier, only few of the platforms carried out underwriting on behalf of the lenders, but, henceforth, this is something that a platform will have to carry out mandatorily.

In addition to the above, NBFC-P2Ps will have to get themselves registered with all the Credit Information Companies (CICs) in the country and file the credit information (relating to borrowers), and update them regularly on a monthly basis or at such shorter intervals as may be mutually agreed upon between the NBFC-P2P and the CICs.

NBFC-P2Ps shall also ensure that appropriate agreements are executed between the participants and the platform, which should categorically specify the terms and conditions agreed between the borrower, lender and the platform. The interest rates to be charged on the loans must be displayed in Annualized Percentage Rate (APR) format on the website of the platform.

2.2. Don’ts

Despite being an NBFC, NBFC-P2Ps are prohibited from lending on its own. It shall ONLY act as an intermediary and nothing more. It should not provide or arrange any credit enhancement or credit guarantee and also all loans intermediated must be purely unsecured in nature. It is required to maintain an escrow account to transfer funds and should not hold on its own balance sheet any funds received from lenders for lending, or from borrowers for repayment. It is prohibited from cross-selling any product on its platform except for loan specific insurance products. International flow of funds is also not permitted for NBFC-P2Ps.

During surveys we have observed that some P2Ps have been engaged in lending through their own platforms. This will have to be stopped now. P2Ps are not allowed to carry on any other activity other than P2P loan intermediation. This is much stricter regulation than for any other type of NBFC.  Mortgage guarantee companies are allowed to take up any other activity up to 10% of its total assets. All other NBFCs must in general satisfy the principality requirements- at least 50% of its total assets must be financial assets and at least 50% of its total income must be from these assets. This is far more lenient than that being allowed for P2Ps.

 

 

3. Prudential Norms

Like all other Directions issued by the RBI for NBFCs, these Directions also lay down the prudential regulations for this class of entities. They are as follows:

  1. Leverage: The outside liabilities of a platform must not exceed 2 times of its owned funds;
  2. Concentration limits: The Directions provide for several concentration limits, which are:
    1. Maximum that a single lender can lend across all P2P platforms – Rs. 10 lakhs;
    2. Maximum that a single borrower can borrow across all P2P platforms – Rs. 10 lakhs;
  • Maximum that a single lender can lend to a single borrower across all P2P platforms – Rs. 50,000;

One apparent concerns that we can point out in this regard is as follows:

Say for instance, a borrower requires a funding of Rs. 5 lakhs, in such case, the platform will have require at least 20 lenders empanelled with itself to meet the requirements of the borrower. Thus, the platforms will have to have large lender base to survive and be able to satisfy loan requirements of borrowers. Therefore, the success of the platforms will be directly related to the scalability of their business.

The P2Ps are also required to obtain a certificate from the borrower and lender, as applicable, that the aforementioned limits are being adhered to.

  1. Tenure: The tenure of the loans extended through the platforms cannot exceed 36 months.

4. Operational Guidelines

An NBFC-P2P is required to have a Board approved policy in place specifying the eligibility criteria, pricing of services and rules for matching participants on its platform.

The Directions explicitly state that the obligation of an NBFC-P2P does not diminish towards those activities that it has outsourced. It will be held responsible for the actions of its service providers including recovery agents and the confidentiality of information pertaining to the participant that is available with the service provider.

5. Transparency

The Directions has provided for one way transparency. On one hand, it states that the NBFC-P2Ps must disclose to the lender details about the borrower including:

  • personal identity;
  • required amount;
  • interest rate sought; and credit score as per the P2P’s credit rating mechanism;
  • terms and conditions of the loan, including
    • likely return; and
    • fees and taxes associated with the loan.

On the other hand it requires the NBFC-P2Ps to make the following disclosures to the borrowers:

  • amount of loan proposed by the lender
  • the interest rate offered by the lender etc.

However, it restricts the platform to give out the personal identity and contact details of the lender to the borrower.

Therefore, the Directions provide for full transparency with respect to borrower’s information but partial transparency with respect to lender’s information.

Apart from information of the participants, the Directions require the platforms to provide the following information on its website:

  1. overview of credit assessment/score methodology and factors considered;
  2. disclosures on usage/protection of data;
  3. grievance redressal mechanism;
  4. portfolio performance including share of non-performing assets on a monthly basis and segregation by age; and
  5. its broad business model.

6. Signing of the loan terms

One of the requirements of the Direction is that no loan shall be disbursed unless the individual lender has approved the individual recipient of loan and all the concerned parties have signed the loan contract.

Here it is important to take a note that while signing the terms of loan, sufficient measures must be taken by the platform to ensure that the personal and contact details of the lender continues are not revealed to the borrower, owing to the restrictions imposed by the Directions on the platform with respect to transparency.

7. Fund Transfer Mechanism

RBI has put a lot of focus on implementing an efficient fund transfer mechanism in order to eliminate any fears of money laundering or usage by the company for its benefit. The Directions stipulate that Fund transfer between the participants on the Peer-to-peer lending platform must take place through escrow accounts which will be operated by a trustee, who must mandatorily be promoted by the bank maintaining the escrow accounts. At least 2 escrows accounts must be maintained – one comprising funds received from lenders and pending disbursal, and the other for collection from borrowers as repayment of loans. All forms of transfer of funds must take place through bank accounts ONLY and cash transactions are prohibited. The graphical representation of the proposed mechanism was included in the Directions, the same has been reproduced below for your reference.

 

The graphic provided on the Directions for the funds transfer mechanism is somewhat ambiguous as it shows only one escrow account, and also shows direct flow of instructions between the lender/borrower and the Trust, which is odd, as it is the platform who should control the flow of information to the Trust.

8. Fair Practices Code

NBFC-P2Ps are required to follow the usual NBFC related Fair Practices Code (FPC) with the approval of its board. They are further required to disclose the same on their website for the information of various stakeholders.

The NBFC-P2Ps are prohibited from providing any assurances on the recovery of loans.
The platform is required to post the following disclaimer on its website –

“Reserve Bank of India does not accept any responsibility for the correctness of any of the statements or representations made or opinions expressed by the NBFC-P2P, and does not provide any assurance for repayment of the loans lent on it”

The Board of Directors shall also provide for periodic review of the compliance of the Fair Practices Code and the functioning of the grievances redressal mechanism at various levels of management. A consolidated report of such reviews shall be submitted to the Board at regular intervals, as may be prescribed by it.

9.Information Technology Framework

Given the fact that the core operation of P2P lending platforms depends on a robust IT framework, the Directions state that the technology must be scalable in nature to handle growth in business. The Directions also stipulate that there should be adequate safeguards built in its IT systems to ensure that it is protected against unauthorized access, alteration, destruction, disclosure or dissemination of records and data. The RBI also reserves the right to, from time to time, prescribe technical specifications, as deemed fit. The rest of the IT laws are same as those issued to NBFC-SIs in general.

10.Fit and Proper Criteria

An NBFC-P2P must ensure that a policy is put in place with the approval of Board of Directors, setting out the ‘Fit and Proper’ criteria to be met by its directors and also obtain a Deed of Covenants signed by the Directors. RBI may, if it deems fit and in public interest, may independently assess the directors and have the power to remove the concerned directors.

The guidelines have, surprisingly, been kept at par with NBFC-SI. The Deed of Covenants, regular reporting requirements etc. are all observed by NBFCs which are systemically important i.e. NBFCs having asset size of over 500 crores. For P2P platforms to have to observe these is perhaps over-regulation.

11.Requirement to obtain prior approval of the Bank for allotment of shares, acquisition or transfer of control of NBFC-P2P

Given the fact that most P2P lending platforms are start-ups in nature, the requirements are very restrictive in nature. The Directions stipulate that prior approval from the banks will be required in case of:

  1. any allotment of shares which will take the aggregate holding of an individual or group to equivalent of 26 per cent and more of the paid up capital of the NBFC-P2P;
  2. any takeover or acquisition of control of an NBFC-P2P, which may or may not result in change of management;
  3. any change in the shareholding of an NBFC-P2P, including progressive increases over time, which would result in acquisition by/ transfer of shareholding to, any entity, of 26 per cent or more of the paid up equity capital of the NBFC-P2P;
  4. any change in the management of the NBFC-P2P which would result in change in more than 30 per cent of the Directors, excluding independent Directors;
  5. any change in shareholding that will give the acquirer a right to nominate a Director

A public notice of at least 30 days shall be given before effecting the sale or transfer of the ownership.

The format for application for prior approval is the same as for other NBFCs.

This is quite unprecedented level of regulation and will seriously increase the bureaucracy PE/VC investors and startups have to go through before a funding round can be closed.  Even a 1% allotment which takes one’s shareholding past 26%, then prior permission will be required. Again, should an investor want the right to nominate a Director, then prior approval will be required. This level of regulation is higher than for regular NBFCs and would slow down the process of investments in P2P platforms in India.

12. Reporting Requirements

NBFC-P2Ps must submit a statement showing number and amount of loans during, at the closing of and outstanding at the beginning and end of quarter, including the number of lenders and borrowers outstanding as at the end of quarter to RBI regional office within 15 days after the quarter to which they relate.

They must also disclose the amount of funds held in the Escrow Account, with credit and debit summations for the quarter. Further, number of complaints outstanding at the beginning and end of quarter and disposed of during the quarter, bifurcated between the lenders and borrowers must also be disclosed in order to constantly improve the state of the industry.

13. Conclusion

The regulations on P2P platform was much awaited, but the way the Directions have been crafted, this could cause serious damage to these platforms. To start with, the requirement of maintaining NOF of Rs. 2 crores is not justified since the business is not a capital intensive one. Next, we also feel that RBI has taken a very cautious approach with respect to the credit concentration, however, we feel that this may be enhanced in the future looking at the performance of the sector. Next, the time required for registration of new P2P platforms also seems to be on the higher side. Further, the list of instances for which prior approval will have to be sought from RBI by the platform, may act as a deterrent for the investors who may interested in investing in P2P platforms.

Having said that, the attempt of giving a regulatory shape to the P2P businesses in India, itself must be applauded.


[1] https://www.rbi.org.in/Scripts/BS_ViewMasDirections.aspx?id=11137

APPLICATION UNDER SARFAESI- A Liberal Approach by the Supreme Court

By Richa Saraf, (legal@vinodkothari.com)

 

In the case of M.D. Frozen Foods Exports Pvt. Ltd. v. Hero Fincorp Ltd.[1], the Hon’ble Supreme Court held that there was no illegality in an Non-Banking Financial Company (NBFC) invoking SARFAESI Act for recovery of loan arrears with respect to an account classified as Non-Performing Asset (NPA) before the NBFC got notified under the Act. It also clarified that NBFC is entitled to initiate both arbitration proceedings and SARFAESI proceedings with respect to a loan account, and that the ‘doctrine of election’ was not attracted in such a scenario. There was a cleavage of judicial opinions inter se the High Courts, while the Full Bench of the Orissa High Court, as also the Delhi High Court and the Allahabad High Court have taken a view favourable in terms of the simultaneous legal processes under the SARFAESI Act and arbitration recovery proceedings, the Andhra Pradesh High Court has taken a divergent view and after careful scrutiny of the rival contentions and the judicial precedents cited, the Apex Court has finally settled the law on the point. Below, we discuss the same.  Read more

The Financial Resolution and Deposit Insurance Bill, 2017: Key Highlights

By Nidhi Bothra, (nidhi@vinodkothari.com)

 

In March, 2016 a committee was constituted under the Chairmanship of Mr. Ajay Tyagi to draft and submit a bill on resolution of financial firms. In September, 2016, the Committee submitted its report and bill which was titled as “The Financial Resolution and Deposit Insurance Bill, 2016”[1] (Bill 2016). The objective of the Bill, 2016 was to provide for a framework for safeguarding the stability and viability of financial services providers and to protect the interest of the depositors, as the name of the bill also suggests[2].

The Financial Resolution and Deposit Insurance Bill, 2017[3] (Bill, 2017) is formulated to provide resolution to certain categories of financial service providers in distress; the deposit insurance to consumers of certain categories of financial services; designation of systemically important financial institutions; and establishment of a Resolution Corporation for protection of consumers of specified service providers and of public funds for ensuring the stability and resilience of the financial system and for matters connected therewith or incidental thereto.

The proposed legislation together with the Insolvency and Bankruptcy Code, 2016 is expected to provide a comprehensive resolution mechanism for the economy.

The existing draft of the Bill, 2017 has been referred to a Joint Parliamentary Committee of both the Houses, under the Chairpersonship of Shri Bhupender Yadav, for examination and presenting a Report to the Parliament.

The Bill is divided into several chapters, which deal with establishment of a Resolution Corporation, its powers, management and functioning which is broadly to function along with the appropriate regulator[4] of financial services provider, classification of persons as systematically important financial institutions, deposit insurance, restoration and resolution plan, method of resolution, liquidation etc.

Highlights of the Bill, 2017

The brief highlights of the Bill[5], 2017 are as follows:

  1. Establishing the Resolution Corporation – A resolution corporation would be formulated broadly with the objective of
    1. monitoring certain financial services provider[6];
    2. providing deposit insurance to banking institutions;
    3. classifying certain persons as specified service provider [7] into one of the categories of risks to viability;
    4. acting as an administrator or liquidator for such service provider or resolve a specified service provider which has been classified into critical risk category;
    5. set up funds including Corporation Insurance Fund, set up for deposit insurance provided by the Corporation to the insured service providers[8] and other funds such as Corporation Resolution Fund for meeting the expenses of carrying out resolution of specified service providers and Corporation General Fund for all other functions of the Corporation.
  2. Deposit Insurance – Chapter IV of the Bill, 2017 discusses about deposit insurance and largely deals with
    1. Determination of amount payable by the Corporation, to a depositor on account of deposit insured;
    2. Amount payable to an insured service provider[9] on account of resolution but not bail-out or eligible co-operative bank on account of merger or amalgamation;
    3. If the Resolution Corporation is dealing with the resolution of an insured service provider, then the Corporation may decide to invite offers from other insured service providers to take over the liabilities, deposits or realisable assets of the insured service provider.
  3. Categorisation as SIFIs[10] – Certain persons can be classified as SIFIs by the Central Government in consultation with the appropriate regulator, as per Section 25 of the Bill, 2017, if it meets the criteria prescribed by the Central Government in this regard. Once categorised as an SIFI, then are deemed to be specified service provider and the provisions of being a specified service provider under the Bill, 2017 become applicable to them. It is important to mention that any financial service provider or domestic systematically important banks can be classified as SIFIs. Once classified as SIFIs, the Central Government may designate, its holding, subsidiary, associate company or any other body corporate related to it as financial service provider and falling into the ambit of being SIFI.
  4. Registration of specified service provider – Chapter V of the Bill, 2017 talks about registration of specified service providers and states that if a person classified as a specified service provider or deemed to be a service provider, it shall be deemed to be registered under the Act, from the date of classification. If the appropriate regulator has issued a license in favour of a specified service provider, such license shall be deemed to be registration for the purpose of this Act as well.
  5. Risk to viability categories – The Bill, 2017 specifies 5 categories[11] of risk to viability under Section 36 (5) and are as follows —
    1. low, where the probability of failure of a specified service provider is substantially below the acceptable probability of failure;
    2. moderate, where the probability of failure of a specified service provider is marginally below or equal to acceptable probability of failure;
    3. material, where the probability of failure of a specified service provider is marginally above acceptable probability of failure;
    4. imminent, where the probability of failure of a specified service provider is substantially above the acceptable probability of failure;
    5. critical, where the probability of failure of a specified service provider is substantially above the acceptable probability of failure, and the specified service provider is on the verge of failing to meet its obligations to its consumers

The classification of a specified service provider into any of the categories of risk to viability except the category of critical risk to viability under section 45, shall be kept confidential by the appropriate regulator, the Corporation and by all relevant parties.

6.   Categorisation of specified service providers under risk to viability categories

  1. The Resolution Corporation in consultation with the appropriate regulator categorise specified service providers under risk to viability categories.
  2. The Resolution Corporation shall have no power to classify a specified service provider into the category of low or moderate risk to viability.
  3. While classifying under risk categories, they can assess, evaluate and classify the holding or non-regulated operational entity within the group of the specified service provider as deemed to be a specified service provider.

7.   Restoration and Resolution Plan — Any specified service provider, classified in the category of material or imminent risk to viability shall submit a restoration plan to the appropriate regulator and a resolution plan to the Corporation within ninety days of such classification. Every restoration plan will prescribe for the details of restoring category to low moderate and resolution plan on who resolution will be achieved.

Where a systemically important financial institution is classified in the category of low or moderate risk to viability, it shall submit the information required under this subsection assuming that it is classified in the category of material or imminent risk to viability.

Where the Resolution Corporation determines that liquidation is the most appropriate method for the resolution of a specified service provider, notwithstanding anything in any other law for the time being in force relating to liquidation and winding up, the Corporation shall make an application to the Tribunal for an order of liquidation in respect of such specified service provider.

The detailed actions as prescribed under the Bill for various categories of risks is tabulated in Annexure I to this note.

Changes from the Bill, 2016

The Bill, 2016 aimed at including all NBFCs its foray. Bill, 2017 only intends to cover such NBFCs and other entities in the group, if such NBFC is classified on high risks to viability categories. This was an important and a necessary change from the Bill, 2016.

All the NBFCs, big and small will be continued to be monitored by the appropriate regulators, however, matters will get escalated only if they are on the risks to viability meter. Similar would be the case with other financial services providers as well.

Some key issues

Some key issues that the Bill, 2017 does not address or overlook are as follows:

  1. Definition of financial services provider – The Bill does not provide for a definition of financial services providers. The specified services provider will be deduced from the financial services providers, by and large. However the Bill, 2017 does not expressly provide for the universe of which the monitoring will be carried out. The Bill, 2017 indicates, NBFCs, insurance companies and banking institutions will fall in the ambit of discussion.
  2. NBFC-Ds – While the concept continues to be theoretical for all practical purposes, but the Bill, 2017 does not make a mention at all of this category of entities.
  3. Resolution and restoration plan — Chapter VII provides for resolution plan and restoration plan to be submitted to appropriate regulator and resolution corporation for material and imminent risk category specified service providers. The plans are to be submitted with 90 days. The brief contents of the plans to be provided to the authorities is prescribed in the Bill, 2017. However, are both plans to be provided within 90 days from the date of categorisation and for both categories?

For both categories of risks to viability, there can be strong intervention of the authorities in running of the business itself. One may find it difficult to find the distinction between the two categories of the risks to viability as the action taken by the authorities and from the specified service providers seems to be almost similar.

In case an entity is categorised as critical risk to viability, the turnaround of the resolution plan is to be carried out within one year, else the Resolution Corporation may require the liquidation of the entity. The entities, in determination here have an element of systemic risks and therefore liquidation of such entities can have daunting consequences on the economy. The provision for triggering liquidation should be well defined or determined in consultation with the Central Government.

4.   Rule-making – The devil, as they say, lies in the details. A lot of actions to be taken in each of the risks categorisation will come by way of rule-making. This will determine the effectiveness of the resolution plans and restoration plans prescribed in the Bill, 2017.

5.  Existing resolution mechanisms – The appropriate regulators have introduced several policy initiatives and resolution guidance and schemes for restructuring of stressed assets, special restructuring norms, strategic restructuring norms, corporate debt restructuring wherein the entities were required to submit resolution/ restructuring/ restoration plans within certain timeframes. The experience with these guidelines have indicated the failure of these guidelines and schemes to provide for a resolution plan within the dedicated time frame and also restoring the position of the entities.Therefore, appropriate learnings from those guidelines should also be reflected in the Bill,2017.

Annexure I

SL no. Category of risk to viability (Section 36) Categorised by ** Immediate action to be taken by the specified service provider Continued Action required by the specified service provider Action taken by appropriate regulator and/ or corporation
 
1 Low Appropriate Regulator No Action taken, regular monitoring of the activities of the entity may be conducted.

Where a SIFI is classified in the category of low or moderate risk to viability, it shall submit the information required under section 39 (2) assuming that it is classified in the category of material or imminent risk to viability.

2 Moderate Appropriate Regulator No Action taken, regular monitoring of the activities of the entity may be conducted.

Where a SIFI is classified in the category of low or moderate risk to viability, it shall submit the information required under section 39 (2) assuming that it is classified in the category of material or imminent risk to viability.

3 Material Resolution Corporation or Appropriate Regulator Submit a restoration plan[12] to the appropriate regulator and a resolution plan[13] to the resolution corporation within 90 days of such classification.

A copy of the restoration plan and resolution plan to be submitted to the resolution corporation and appropriate regulator respectively, within 15 days of the first submission, thereof.

Every systemically important financial institution shall submit a restoration plan to the appropriate regulator and a resolution plan to the Corporation within ninety days of its designation under section 25.

Every restoration plan or resolution plan shall be revised annually and the appropriate regulator and the Corporation shall be informed of such revised restoration plan, within seven days of the revision.

Every material change shall be immediately informed to the appropriate regulator and the Corporation.

Additional inspection may be carried out to monitor the risk to viability.

Appropriate regulator may prevent entity from taking certain business decisions including declaration of dividend, establishing new business or acquiring new clients, undertaking related party transactions, increasing liabilities etc.

Appropriate regulator may require the entity to increase capital, sell assets etc.

4 Imminent Resolution Corporation or Appropriate Regulator

 

Or

If the specified service provider has not submitted the restoration plan or resolution plan within prescribed time frame.

Submit a restoration plan to the appropriate regulator and a resolution plan to the resolution corporation within 90 days of such classification.

A copy of the restoration plan and resolution plan to be submitted to the resolution corporation and appropriate regulator respectively, within 15 days of the first submission, thereof.

Every systemically important financial institution shall submit a restoration plan to the appropriate regulator and a resolution plan to the Corporation within ninety days of its designation under section 25.

Every restoration plan or resolution plan shall be revised annually and the appropriate regulator and the Corporation shall be informed of such revised restoration plan, within seven days of the revision.

Every material change shall be immediately informed to the appropriate regulator and the Corporation.

The resolution corporation may appoint an officer to inspect the functioning of the entity and act as an observer.

The corporation may prevent the entity from accepting funds, declaring dividend, acquiring new businesses or new clients, undertake related party transactions etc.

The corporation may require the entity to infuse new capital or sell identified assets etc.

 

A specified service provider classified in the category of imminent risk to viability shall, if it is not a SIFI, submit a resolution plan to the Corporation within 90 days.

 

5 Critical Resolution Corporation or Appropriate Regulator – effective from the date of publication in official gazette N.A. N.A. Corporation shall be deemed to be the administrator[14] and may take the following actions:

a.       resolve the issue through a scheme or merger or amalgamation or bail-in instrument.

b.      Transfer whole or part of assets/ liabilities to another person

c.       Create a bridge service provider

d.      Cause liquidation of the entity

e.       No legal action or proceeding including arbitration shall commence or continue until conclusion of resolution.

f.       No repayment or acceptance of deposit shall be made or liabilities incurred.

g.      temporarily prohibit (not exceeding 2 business days) by an order in writing, the exercise of such termination rights of any party to such specified contract with the relevant specified service provider or its associate company or subsidiary

License granted to the entity by the appropriate regulator may be withdrawn or modified.

 


[1] http://dea.gov.in/sites/default/files/FRDI%20Bill-27092016_1.pdf

[2] See our article titled – Financial Resolution and Deposit Insurance Bill: Implications for NBFCs, by Vinod Kothari and Niddhi Parmar, here http://vinodkothari.com/blog/financial-resolution-and-deposit-insurance-bill-implications-for-nbfcs-by-niddhi-parmar/

[3] http://164.100.47.4/BillsTexts/LSBillTexts/Asintroduced/165_2017_LS_Eng.pdf

[4] Appropriate Regulator is defined in First Schedule to the Bill, 2017 to include a) RBI, b) IRDA, c) SEBI, d) Pension Fund Regulatory Development Authority or any other regulator as notified by the Central Government.

[5] http://164.100.47.4/BillsTexts/LSBillTexts/Asintroduced/165_2017_LS_Eng.pdf

[6] Financial services provider categorised as specified service providers and SIFIs fall within the purview of the Resolution Corporation. The detailed mechanism of monitoring is discussed further in the highlights.

[7] A specified service provider is a person as defined in Second Schedule to Bill, 2017 and includes

  1. A banking institution, , other than eligible co-operative bank including an insured service provider;
  2. Any insurance company
  3. Any Financial Market Infrastructure
  4. Any payment system, as defined under the Payment and Settlement Systems Act, 2007 (51 of 2007), not notified under section 227 of the Insolvency and Bankruptcy Code, 2016 (31 of 2016)
  5. Any non-banking financial company, not notified under section 227 of the Insolvency and Bankruptcy Code, 2016 (31 of 2016)
  6. Any systemically important financial institution
  7. Any other financial service provider (excluding individuals and partnership firms), not notified under section 227 of the Insolvency and Bankruptcy Code, 2016 (31 of 2016)
  8. A holding company of any specified service provider enumerated under items 1 to 7, registered in India which is not notified under section 227 of the Insolvency and Bankruptcy Code, 2016 (31 of 2016), subject to the determination by the Corporation under the proviso to sub-section (1) of section 33
  9. Non-regulated operational entities within a financial group or conglomerate of a specified service provider enumerated under items 1 to 7 subject to the determination by the Corporation under the proviso to sub-section (1) of section 33.
  10. Branch offices of body corporates incorporated outside India, carrying on the business of providing financial service in India.
  11. Any other entity or fund which may be notified by the Central Government

[8] As defined in Section 2 (19) of the Bill, 2017 — means any banking institution, that has obtained deposit insurance under sub-section (3) of section 33. Section 33 (3) states that every banking institution that has been granted a banking license by the appropriate regulator shall be deemed to be categorised as insured service provider for obtaining deposit insurance under the Act.

[9] Insured service provider is a banking institution that has obtained deposit insurance

[10] To qualify as an SIFI, the Central Government will consider the size, complexity of the financial service provider, the nature and volume of transactions undertaken, interconnectedness with other financial service providers and nature of services offered and possibility of substitution such business.

[11] The categorisation are based on assessment of the following parameters:

(a) adequacy of capital, assets and liability; (b) asset quality; (c) capability of management; (d) earnings sufficiency; (e) leverage ratio; (f) liquidity of the specified service provider; (g) sensitivity of the specified service provider to adverse market conditions; (h) compliance with applicable laws; (i) risk of failure of a holding company of a specified service provider or a connected body corporate in India or abroad; and (j) any other attributes as the Corporation deems necessary

[12] A restoration plan as per the provisions of Section 39, will contain details of assets and liabilities of the entity, including contingent liabilities, steps to be taken by the entity to move to moderate classification at least, time frame within which such restoration plan will be executed and other information relevant for the appropriate regulator to assess the plan.

[13] A resolution plan, as per the provisions of Section 40, will contain details of assets and liabilities of the entity, identification of critical functions of the specified service provider, access to financial market infrastructure services, either directly or indirectly, strategy plans on exiting the resolution process and any other relevant information.

[14] The resolution plan must be completed within one year from the date of classification into critical risk to viability. Where the plan is completed within one year and the Corporation deems necessary, it shall require liquidation of the entity.

SEBI requires disclosure by banks in case of NPA divergence

By Mayank Agarwal, (finserv@vinodkothari.com)

The banking sector is one of the pillars for economic development of any country, and any well balanced and healthy economy is largely dependent on a transparent and credible banking system. In recent years, the Indian economy has recognized the importance of a well-regulated and fundamentally strong banking framework and made it one of its priorities to clear out the vast amount of unhealthy practices and activities that tread on the fine line of regulation. A slew of new policies which led to clearer recognition norms, stricter disclosure requirements, more hands-on approach by the Reserve Bank of India (RBI) and an overall environment that is much more transparent than before are all testimony to the fact that the banking institutions are in for a major overhaul. The introduction of practices such as Asset Quality Review (AQR), restructuring norms and the introduction of Insolvency and Bankruptcy Code (IBC) by the RBI were steps aimed towards a fundamentally cleaner banking system. Read more

Guidance Note to NBFCs for nomination of counsel in Delhi High Court

By Richa Saraf, (legal@vinodkothari.com)

BACKGROUND:

  1. In exercise of its powers under sub clause (iv) of clause (m) of sub section (1) of section 2 read with section 31A of the Securitisation and Reconstruction of Financial Assets and Enforcement of Security Interest Act, 2002 ( “SARFAESI Act”), the Central Government issued a notification[1] dated August 5, 2016 notifying 196 Non- Banking Financial Companies (“Notified NBFCs”) as “Financial Institutions”, registered with the Reserve Bank of India (RBI) and having asset of Rs. 500 crore and above as per their last audited balance sheet, on which the SARFAESI Act is applicable. Read more

RBI revamps Directions for issuance of Commercial Paper

By Richa Saraf, legal@vinodkothari.com

The Reserve Bank of India (RBI) vide Notification No. MRD.DIRD.01/CGM (TRS) – 2017 dated August 10, 2017 has issued Reserve Bank Commercial Paper Directions, 2017 (“New Directions”). The new guidelines are in supersession of the existing directions on Commercial Paper in the Master Directions on Money Market (Section II) RBI/FMRD/2016-17/32 dated July 7, 2016 (“Old Directions”). The following table captures the difference between the old and new directions:- Read more