RBI aligns list of compoundable contraventions under FEMA with NDI Rules

‘Technical’ contravention subject to minimum compoundable amount, format for public disclosure of compounding orders revised.

– CS Burhanuddin Dohadwala | corplaw@vindkothari.com

Introduction

Compounding refers to the process of voluntarily admitting the contravention, pleading guilty and seeking redressal. It provides comfort to any person who contravenes any provisions of FEMA, 1999 [except section 3(a) of the Act] by minimizing transaction costs. Reserve Bank of India (‘RBI’) is empowered to compound any contraventions as defined under section 13 of FEMA, 1999 (‘the Act’) except the contravention under section 3(a) of the Act in the manner provided under Foreign Exchange (Compounding Proceedings) Rules, 2000. Provisions relating to compounding is updated in the RBI Master Direction-Compounding of Contraventions under FEMA, 1999[1].

Following are few advantages of compounding of offences:

  1. Short cut method to avoid litigation;
  2. No further proceeding will be initiated;
  3. Minimize litigation and reduces the burden of judiciary;

Present Circular

Pursuant to the supersession of FEM (Transfer or Issue of Security by a Person Resident Outside India) Regulations, 2017[2] (‘TISPRO”)and issuance of FEM (Non-Debt Instrument) Rules, 2019[3] [‘NDI Rules] and FEM (Mode of Payment and Reporting of Non-Debt Instruments) Regulations, 2019[4] [‘MPR Regulations’], RBI has updated the reference of the erstwhile regulations in line with the NDI Rules and MPR Regulations vide RBI Circular No.06 dated November 17, 2020[5] (‘Nov 2020 Circular’).

Additionally, the Nov 2020 Circular does away with the classification of a contravention as ‘technical’, as discussed later in the article.

Lastly, the Nov 2020 Circular modifies the format in which the compounding orders will be published on RBI’s website.

Compounding of contraventions relating to foreign investment

The power to compound contraventions under TISPRO delegated to the Regional Offices/ Sub Offices of the RBI has been aligned with corresponding provisions under NDI Rules and MPR Regulation as under:

Compounding of contraventions under NDI Rules
Rule No. Deals with Corresponding regulation under TISPRO Brief Description of Contravention
Rule 2(k) read with Rule 5 Permission for making investment by a person resident outside India; Regulation 5 Issue of ineligible instruments
Rule 21 Pricing guidelines; Paragraph 5 of Schedule I Violation of pricing guidelines for issue of shares.
Paragraph 3 (b) of Schedule I Sectoral Caps; Paragraph 2 or 3 of Schedule I Issue of shares without approval of RBI or Government respectively, wherever required.
Rule 4 Restriction on receiving investment; Regulation 4 Receiving investment in India from non-resident or taking on record transfer of shares by investee company.
Rule 9(4) Transfer by way of gift to PROI by PRII of equity instruments or units of an Indian company on a non- repatriation basis with the prior approval of the Reserve Bank. Regulation 10(5) Gift of capital instruments by a person resident in India to a person resident outside India without seeking prior approval of the Reserve Bank of India.
Rule 13(3) Transfer by way of gift to PROI by NRI or OCI of equity instruments or units of an Indian company on a non- repatriation basis with the prior approval of the Reserve Bank.

 

Compounding of contraventions under MPR Regulations
Regulation No. Deals With Corresponding regulation under TISPRO Brief Description of Contravention
Regulation 3.1(I)(A) Inward remittance from abroad through banking channels; Regulation 13.1(1) Delay in reporting inward remittance received for issue of shares.
Regulation 4(1) Form Foreign Currency-Gross Provisional Return (FC-GPR); Regulation 13.1(2) Delay in filing form FC (GPR) after issue of shares.
Regulation 4(2) Annual Return on Foreign Liabilities and Assets (FLA); Regulation 13.1(3) Delay in filing the Annual Return on Foreign Liabilities and Assets (FLA).
Regulation 4(3) Form Foreign Currency-Transfer of Shares (FC-TRS); Regulation 13.1(4) Delay in submission of form FC-TRS on transfer of shares from Resident to Non-Resident or from Non-resident to Resident.
Regulation 4(6) Form LLP (I); Regulations 13.1(7) and 13.1(8) Delay in reporting receipt of amount of consideration for capital contribution and acquisition of profit shares by Limited Liability Partnerships (LLPs)/ delay in reporting disinvestment / transfer of capital contribution or profit share between a resident and a non-resident (or vice-versa) in case of LLPs.
Regulation 4(7) Form LLP (II);
Regulation 4(11) Downstream Investment Regulation 13.1(11) Delay in reporting the downstream investment made by an Indian entity or an investment vehicle in another Indian entity (which is considered as indirect foreign investment for the investee Indian entity in terms of these regulations), to Secretariat for Industrial Assistance, DIPP.

Technical contraventions to be compounded with minimal compounding amount

As per RBI’s FAQs[1] whenever a contravention is identified by RBI or brought to its notice by the entity involved in contravention by way of a reference other than through the prescribed application for compounding, the Bank will continue to decide (i) whether a contravention is technical and/or minor in nature and, as such, can be dealt with by way of an administrative/ cautionary advice; (ii) whether it is material and, hence, is required to be compounded for which the necessary compounding procedure has to be followed or (iii) whether the issues involved are sensitive / serious in nature and, therefore, need to be referred to the Directorate of Enforcement (DOE). However, once a compounding application is filed by the concerned entity suo moto, admitting the contravention, the same will not be considered as ‘technical’ or ‘minor’ in nature and the compounding process shall be initiated in terms of section 15 (1) of Foreign Exchange Management Act, 1999 read with Rule 9 of Foreign Exchange (Compounding Proceedings) Rules, 2000.

Nov 2020 Circular provides for regularizing such ‘technical’ contraventions by imposing minimal compounding amount as per the compounding matrix[1] and discontinuing the practice of giving administrative/ cautionary advice.

Public disclosure of compounding order

Compounding order by RBI can be accessed at the RBI website-FEMA tab-compounding orders[1]. In partial modification of earlier instructions issued dated May 26, 2016[2] it has been decided that in respect of the Compounding Orders passed on or after March 01, 2020 a summary information, instead of the compounding orders, shall be published on the Bank’s website in the following format:

Sr. No. Name of the Applicant Details of contraventions (provisions of the Act/Regulation/Rules compounded)

(Newly inserted)

Date of compounding order

(Newly inserted)

Amount imposed for compounding of contraventions Download order

(Deleted)

It seems that the compounding order will not be available for download.

Conclusion:

The delegation of power is done for enhanced customer service and operational convenience. Revised format of disclosure of compounding orders will be more reader friendly. Delay in filing of forms under MPR Regulations on FIRMS portal is subject to payment of Late Submission Fees (LSF) as per Regulation 5. The payment of LSF is an additional option for regularising reporting delays without undergoing the compounding procedure.

Abbreviations used above:

  • PROI: Person Resident Outside India;
  • PRII: Person Resident In India;
  • NRI: Non-Resident Indian;
  • OCI: Overseas citizen of India;

FIRMS: Foreign Investment Reporting & Management System.

Our other articles/channel can be accessed below:

1. Compounding of Contraventions under FEMA, 1999- RBI delegates further power to Regional Offices:

http://vinodkothari.com/wp-content/uploads/2017/03/Compounding_of_Contraventions_under_FEMA_1999_-_RBI_delegates_further_power_to_Regional_Offices.pdf

 

2. Other articles on FEMA, ODI & ECB may be access below:

http://vinodkothari.com/category/corporate-laws/

 

3. You Tube Channel:

https://www.youtube.com/channel/UCgzB-ZviIMcuA_1uv6jATbg

[1] https://www.rbi.org.in/scripts/Compoundingorders.aspx

[2] https://www.rbi.org.in/Scripts/NotificationUser.aspx?Id=10424&Mode=0

[1] https://www.rbi.org.in/Scripts/NotificationUser.aspx?Id=10424&Mode=0

[1] https://m.rbi.org.in/Scripts/FAQView.aspx?Id=80 (Q. 12)

[1] https://www.rbi.org.in/Scripts/BS_ViewMasDirections.aspx?id=10190

[2] https://www.rbi.org.in/Scripts/NotificationUser.aspx?Id=11253&Mode=0

[3] http://egazette.nic.in/WriteReadData/2019/213332.pdf

[4] https://www.rbi.org.in/Scripts/BS_FemaNotifications.aspx?Id=11723

[5]https://rbidocs.rbi.org.in/rdocs/notification/PDFs/APDIRS62545AA7432734B31BD5B59601E49AA6C.PDF

New Model of Co-Lending in financial sector

Scope expanded, risk participation contractual, borders with direct assignment drawn 

-Team Financial Services (finserv@vinodkothari.com)

Co-lending is coming together of entities in the financial sector – mostly, something that happens between banks and NBFCs, or larger banks and smaller banks. Financial interfaces between different financial entities may take the form of securitisation, direct assignment, co-lending, banking correspondents, loan referencing, etc.

While direct assignment and securitisation have been around for quite some time, co-lending was permitted by the RBI under its existing guidelines on ‘Co-origination of loans between banks and NBFC-SIs for granting loan to the priority sector’[1]. As per the Statement on Developmental and Regulatory Policies issued by the RBI dated October 9, 2020, it was decided to expand the scope of co-lending, currently permitted only for NBFC-SIs, to all NBFCs. Accordingly, the RBI came, vide notification on co-lending by banks and NBFCs (Co-Lending Model/CLM)[2] dated November 5, 2020, with a new regulatory framework for co-lending, of course, in case of priority sector loans. The CLM supersedes the existing guidelines on co-origination.

There is no clarity, still, on whether the non-priority sector loans (PSL  or Non-PSL) will also be covered by this regulatory discipline, or any discipline for that matter. In this write-up, we explore the key features of the co-lending regime, and also get into tricky questions such as applicability to non-PSL loans, the borderlines of distinction between direct assignments and co-lending, the sharing of risks and rewards, etc.

Applicability

The erstwhile Regulations for priority sector lending covered co-lending transactions of Banks and Systemically Important NBFCs. However, under the Co-Lending Model.The CLM covers all NBFCs (including HFCs) in its purview.

There is a whole breed of new-age fintech companies using innovative algo-based originations, and aggressively using the internet for originations, and these companies pass a substantial part of their lending to either larger NBFCs or to banks. Thus, the expanded ambit of the Co-Lending Model will increase the penetration and result into wider outreach, meet the objective of financial inclusion, and potentially, reduce the cost for the ultimate beneficiary of the loans. Smaller NBFCs have their own operational efficiencies and distribution capabilities; hence, this is a welcome move.

Further, the RBI has excluded foreign Banks, including wholly owned subsidiaries of foreign banks, having less than 20 branches, from the applicability of the CLM. Also, Small Finance Banks, Regional Rural Banks, Urban Cooperative Banks and Local Area Banks have been excluded from the applicability of CLM.

An interesting question that comes up here is whether such exclusion should be construed as a restriction on such entities from entering into co-lending transactions, or a relaxation from the applicability of the Co-Lending Model? It may be noted that the CLM a precondition for PSL treatment of the loans. This is clear from the title ‘Co-Lending by Banks and NBFCs to Priority Sector’. The intent is not to put a bar on existence of co-lending arrangements outside the CLM. That is to say, if the loan, originated by the principal co-lender, is a priority sector loan, then the participating co-lender will also be able to treat the participant’s share of the loan as a PSL, subject to adherence to the conditions specified in CLM. The implication of this is that where the loan does not meet the conditions of CLM, then the participating bank will not be able to accord a PSL status, even though the loan in question is a PSL loan.

With that rationale, in our view, there is no absolute prohibition in the excluded banking entities from being a co-lender. However, if the major motivation of the co-lending mechanism under the CLM is the PSL tag, that tag will not be available to the excluded banks, and hence, the very inspiration for falling under the arrangement may go away. This is also clear from the PSL Master Directions[3] which recognises co-origination of loans by SCBs and NBFCs for lending to the priority sector and specifically excludes RRBs, UCBs, SFBs and LABs.

Applicability date and the fate of existing transactions

In the absence of any specified timelines, the CLM supersedes the existing co-lending guidelines with immediate effect. However, it specifies that outstanding loans in terms of the erstwhile guidelines would continue to be classified under priority sector till their repayment or maturity, whichever is earlier.

This would mean grandfathering of existing loans, and not existing lending arrangements. That is to say, if there are existing co-lending arrangements, but the loan in question has not yet originated, even existing co-lending arrangements will have to abide with the Co-Lending Model. Needless to say, any new co-lending arrangements will nevertheless have to abide by the Co-Lending Model.

As we note below, one of the very important features of the Co-Lending Model is that risk-sharing and loan-sharing do not have to follow the same proportion. Additionally, it is possible for the participating bank to have an explicit recourse against the originating co-lender. This feature was not available under the earlier framework. This alone may be a sufficient motivation for existing CLMs to be revised or redrawn.

Co-lending, Outsourcing and Direct Assignment – new borderlines of distinction

For the purpose of entering into co-lending transactions, banks and NBFCs will have to enter into a ‘Master Agreement’. Such agreement may require the bank either to mandatorily take the loans originated by the NBFC on its books or retain discretion as to taking the loans on its books.

Where the participating bank has a discretion as to taking its share of the loans originated by the originating partner, the transaction partakes the character of a direct assignment. Para 1(c) of the CLM says that ”…if the bank can exercise its discretion regarding taking into its books the loans originated by NBFC as per the Agreement, the arrangement will be akin to a direct assignment transaction. Accordingly, the taking over bank shall ensure compliance with all the requirements in terms of Guidelines on Transactions Involving Transfer of Assets through Direct Assignment of Cash Flows and the Underlying Securities….with the exception of Minimum Holding Period (MHP) which shall not be applicable in such transactions undertaken in terms of this CLM.

That would mean, a precondition for the arrangement being treated as a CLM is that the participating bank takes the loans originated by the originating partner without discretion exercisable on a cherry-picking basis.

Does this mean that irrespective of whether the loan originated by the originating partner fits into the credit screen of the bank or not, the bank will still have to take it, lying low? certainly, this is not the intent of the CLM This is what comes form clause 1(a)- ‘…..the partner bank and NBFC shall have to put in place suitable mechanisms for ex-ante due diligence by the bank as the credit sanction process cannot be outsourced under the extant guidelines.’

Thus, even in case the bank gives a prior, irrevocable commitment to take its share of exposure, the same shall be subject to an ex-ante due diligence by the bank. Ex-ante obviously implies a prior  As per the outsourcing guidelines for banks[4], the credit sanction process cannot be outsourced. Accordingly, it must be ensured that the credit sanction process has not been outsourced completely and the bank retains the right to carry out the due diligence as per its internal policy. Notwithstanding the bank’s due diligence exercise, the co-lending NBFC shall also simultaneously carry out its own credit sanction process.

The conclusion one gets from the above is as follows:

  • The essence of co-lending arrangement is that the participating bank relies upon the lead role played by the originating bank. The originating bank is the one playing the fronting role, with customer interface. The credit screens, of course, are pre-agreed and it will naturally be incumbent upon the originating bank to abide by those. Hence, on a case by case basis or so-called “cherry picking” basis, the participating bank is not selecting or dis-selecting loans. If that is what is being done, the transaction amounts to a DA.
  • Subject to the above, the participating bank is expected to have its credit appraisal process still on. Where it finds deviations from the same, the participating bank may still decline to take its share.

It is important to note that if DA comes into play, the requirements such as MHP, MRR, true sale conditions will also have to be complied with. However, co-lending transactions do not have any MHP requirements, unlike in case of either DA or securitiastion. Of course co-lending transactions do have a risk retention stipulation, as the CLM require a 20% minimum share with the originating NBFC. Hence, the intent of the RBI is that co lending mechanism must not turn out to be a regulatory arbitrage to carry out what is virtually a DA, through the CLM.

Interest Rates

The erstwhile guidelines require that the interest rate charged on the loans originated under the co-lending guidelines would be calculated as per Blended Interest Rate Calculations, that is to say the rate shall be calculated by assigning weights in proportion to risk exposure undertaken by each party, to the benchmark interest rate of the respective lender.

The current guidelines require that the interest rate shall be an all inclusive rate that is mutually agreed by the parties. However it shall be ensured that the interest rate charged is not excessive as the same would breach the provisions of fair practice code, which is to be compulsorily complied.

This change would provide flexibility to the lenders and also ensure that the cost incurred in tracing and disbursals to remote sectors as well as enhanced risk exposure is appropriately compensated.

Determining the roles

Under the erstwhile provisions, it was mandatory that the share of the co-lending NBFC shall be at least 20%. The same has been retained in the CLM as well, requiring NBFCs to retain a minimum of 20% share of the individual loans on their books.

Under the CLM, the co-lending NBFC shall be the single point of interface for the customers. Further, the grievance redressal function would also have to be carried out by the NBFC.

Operational Aspects

Escrow Account

For the purpose of disbursals, collections etc. an escrow account should be opened. The co-lending banks and NBFCs shall maintain each individual borrower’s account for their respective exposures. It is only for the purpose of avoiding commingling of funds, that an escrow mechanism is required to be placed. The bank and NBFC shall, while entering into the Master Agreement, lay down the rights and duties relating to the escrow account, manner of appropriation etc.

Creation of Security

The manner of creation of charge on the security provided for the loan shall be decided in the Master Agreement itself.

Accounting

Each of the lenders shall record their respective exposures in their books. The asset classification and provisioning shall also be done for the respective part of the exposure. For this purpose, the monitoring of the accounts may either be done by both the co-lenders or may be outsourced to any one of them, as agreed in the Master Agreement. Usually, the function of monitoring remains with the NBFC (since, it has done the origination and deals with the customer.)

Non-PSL loans: whether the framework would apply in pari materia?

The guidelines on CLM have been issued for co-lending of loans that qualify for the purpose of priority sector lending. This does not bar lenders from entering into co-lending transactions outside the purview of these guidelines. The only difference it would make is such loans would not be eligible to be classified as loans to the priority sector (which is the primary motive for banks to enter into co-lending transactions).

This seems to form a view that the guidelines would not at all be applicable in case of non-priority sector loans. However, for a transaction to be a co-lending transaction, there has to be adequate risk sharing between the co-lenders. Hence, the guidelines on CLM shall be applicable in pari-materia.

[1] https://www.rbi.org.in/Scripts/NotificationUser.aspx?Id=11376&Mode=0

[2] https://www.rbi.org.in/Scripts/NotificationUser.aspx?Id=11991&Mode=0

[3] https://www.rbi.org.in/Scripts/NotificationUser.aspx?Id=11959&Mode=0

[4] https://www.rbi.org.in/scripts/NotificationUser.aspx?Id=3148&Mode=0

 

Other related write-ups:

 

FAQs on restructuring of securitised loans

– Kanakprabha Jethani, Ass. Manager

(finserv@vinodkothari.com)

Background

The first half of this financial year came with lots of schemes to “apparently” support the financial sector during this time of crisis starting from moratoriums, restructuring, interest subvention and so much more. All these schemes were then adorned with an extension of their time limits, so much that at one point the borrower would altogether tend to forget he has an outstanding liability with some lender.

While the credit risk is an issue lenders cannot ignore, they also cannot ignore the fact that a huge chunk of their borrowers are not going to or will not be able to pay. Considering this, they are bound to allow moratoriums and offer restructuring benefits to them.

A lending transaction is between the lender and the borrower. Providing benefits such as moratorium, restructuring etc. is a matter of agreement between the two. However, in certain cases where there is an involvement of external parties, such as in the case of securitisation or direct assignment of a loan pool, practical dfficulties may arise.

The following FAQs intend to answer the basic questions regarding providing the restructuring benefit to borrowers of loans that have been securitised/assigned by the originator.

Stage1: While contemplating the decision to provide benefit of the schemes

1.     Can the originator provide such benefit?

The originator retains/invests in a very small portion of the portfolio. The rest of it is sold off to the assignee/SPV. The moment an originator sells off the assets, all its rights over the assets stand relinquished. However, after the sale, it assumes the role of a servicer. Legally, a servicer does not have any right to confer any relaxation of the terms to the borrowers or restructure the facility.

Therefore, if at all the originator/ servicer wishes to extend moratorium to the borrowers, it will have to first seek the consent of the investors or the trustees to the transaction, depending upon the terms of the assignment agreement.

On the other hand, in the case of the direct assignment transactions, the originators retain only 10% of the cash flows. The question here is, will the originator, with a 10% share, be able to grant moratorium? The answer again is No. With just 10% share in the cash flows, the originator cannot suo-moto grant moratorium, hence, approval of the assignee has to be obtained.

2.     Is approval of investors required?

As discussed above, when an asset is securitised/assigned, the investor becomes the ultimate owner of the asset to the extent of his/her investment in the said asset. Hence, any change in the terms of the loan impacts the rights/liabilities of such investors. Hence, the investors, being the actual owners of the asset, must agree to offer the benefit of any restructuring, moratorium etc.

As for schemes which provide an additional/separate credit facility to the existing borrower such as ECLGS scheme[1], such facilities are treated as separate facilities and are not linked with the existing loans (the one which is securitised). Hence, in such cases, the approval of the investor or trustee shall not be required. However, it is recommended that a NOC is obtained from the investor or trustee to the effect that the originator is providing the additional funding based on the existing lending exposure on the borrower.

3.     How will the approval be obtained ?

The investors may decide on the manner of providing approval. The originator, in the capacity of the investor (to the extent of retention in the transaction), may propose and initiate the process and obtain approval of other investors.

4.     Is it mandatory for the investor to approve?

The investors, like in any other investment, has the right to consider their benefits and losses and accordingly decide on whether to approve. Further, investors may also give conditional approvals, say a change in payout structure, alteration of interest rate etc., considering the increased risk and the fact that investor is, for the time being, foregoing its returns.

5.     What happens if investors do not agree?

In case the investors do not agree, no benefit of restructuring/moratorium can be provided to the borrower. But, considering the liquidity crunch in the economy, it is very likely that the borrower will fail to pay the loan instalments, thereby resulting in reduced cashflows from the borrower. However, in case the investors did not agree to grant restructuring benefits and amend the payout structure, they will have to be paid. This would call for the credit support to be utilised. Over time, when credit enhancement is utilised, the rating of the PTCs may be downgraded.

6.     What happens if investors agree?

In case the investors agree for providing the benefit to the borrower, the same shall come be put into effect by a revision in payout structure for the investors. The payout structure will be revised as per the terms of restructuring or moratorium as the case may be.

7.     What happens with the remaining investors if the majority  agrees?

The assignment agreement usually provides the nature of approval required to amend the payment terms- either majority or else 100% of the investor, either in number or in value (usually 100%). Hence, in case the majority has agreed, the rest of the investors shall have to bear the outcome of moratorium/restructuring.

Implementation stage:

8.     What will be the immediate impact on investors agreeing to provide the benefit?

When the investors agree for providing any such benefits, they simultaneously agree for an added arrangement concerning the payout structure. Hence, the immediate impact shall be on the cashflows arising out of the underlying assets.

9.     What will be the impact on the agreed payout structure?

The payouts may be reduced or deferred or structured in any other way as per the restructuring terms.

10. Can the investors in a securitisation transaction agree for moratorium/restructuring but not for reschedulement or recomputation of payout structure?

In case the investors agree for moratorium/restructuring, such approval would inherently come with reschedulement or recomputation of the payout structure. This is because, if moratorium/restructuring benefit is provided, the cashflows on the underlying asset would be impacted. This, in turn, would affect the cashflows in the securitisation transaction. Hence, when agreeing to provide the benefit to the borrower, investors must bear in mind that there would be a simultaneous change in their payout structure as well.

11. Can the credit enhancements be used to make payments to the investors in case they have agreed to provide the benefit?

Credit enhancements are utilised usually when there is a shortfall due to credit weakness of the underlying borrower(s). In case the investor have agreed for the restructuring, consequently the payout structure must have also been revised and hence, avoiding any default leading to utilisation of the credit enhancement. Irrespective of granting the restructuring benefit,  if there is still default, though credit enhancements can be utilised, however, it will reduce the extent of support, weaken the structure of the transaction and may lead to rating downgrade.

12. What will be the impact on the rating of the transaction?

Usually, any delays in payout, defaults etc. lead to a downgrade in the rating of the transaction. However, here it is important to consider that in a securitisation or a direct assignment, the transaction mirrors the quality of the underlying pool. Now, in case of moratorium, there will be a standstill on asset classification and in case of restructuring, the asset classification will be upgraded to standard. Hence, there is no impact on the credit quality of the underlying asset.

If the credit quality of the loans remain intact, then there is no question of the securitisation or the direct assignment transaction going bad. Therefore, we do not see any reason for rating downgrade as well.

Further, the SEBI had on March 30, 2020, issued a circular[2] directing rating agencies to not consider delays/defaults caused due to COVID disruption, as a default event for the purpose of rating.

After implementation:

13. What will be the impact in the books of the investor?

In case of securitisation, the income will be booked by the investor as per the revised payout structure. In case of direct assignment, the assignee shall take the impact of restructuring in its books. Say, in case there is a reduction in interest rate, the asset must be booked at such revised interest rate in the books.

14. What will be the impact on asset classification and provisioning for such loans?

In case of moratorium, the asset classification will be on a standstill for the period for which moratorium is granted. After the moratorium period is over, the asset classification as per IRAC norms shall be applied. Further, as per the RBI guidelines for moratorium[3], additional provisions shall be required to be maintained.

In case of restructuring, the asset classification shall be on the revised loan, as per the IRAC norms.

15. Who will be required to maintain additional provisions?

Usually, investors maintain provisions corresponding to the PTCs held by them. The asset classficiation and provisioning is done on the basis of payout from such PTCs. Similarly, any additional provision that is required to be maintained, shall be maintained by the investor corresponding to the value of PTCs held.

Further, in the case of DA,both the assignee and assignor shall maintain the provisions, in their respective share of interest in the loan.

16. Suppose, after restructuring, the borrowers still fails to pay as per the restructured terms, what will be the impact on the rating?

In case the borrower fails to repay as per the restructured terms, it is a case of default beyond the moratorium/restructuring allowed by the RBI. This would result in a downgrade in the quality of the underlying asset. Hence, it is quite probable that the rating of the transaction may downgrade.

17. In case there is a rating downgrade, can the size of classes/tranches be changed?

The prime motivation for tranching a securitisation transaction is to obtain high rating for atleast a part of the transaction. Hence, the upper class, say class A, gets the maximum amount of credit support and is sized in a manner that it is able to get superior rating.

Now, when there is a threat of rating downgrade, the size of classes/tranches cannot be changed to maintain the rating. It is crucial to consider that the rating is allotted based on the structure of the transaction and not the other way round.

Hence, if at all, the originator intends to maintain the rating to the transaction, it may introduce further credit support to the transaction, but the size of classes should not be changed.

_____________________________________________________________________________________________________________________________________

[1] Refer our write-up on http://vinodkothari.com/2020/05/guaranteed-emergency-line-of-credit-understanding-and-faqs/

[2] https://www.sebi.gov.in/legal/circulars/mar-2020/-relaxation-from-compliance-with-certain-provisions-of-the-circulars-issued-under-sebi-credit-rating-agencies-regulations-1999-due-to-the-covid-19-pandemic-and-moratorium-permitted-by-rbi-_46449.html

[3] Refer: https://www.rbi.org.in/Scripts/NotificationUser.aspx?Id=11872&Mode=0

Compound interest burden taken over by the Central Government: Lenders required to pass on benefit to borrowers

-Team Vinod Kothari Consultants P. Ltd. (finserv@vinodkothari.com)

While compound interest is the unquestionable reality of the world of banking and finance, somehow, courts have always been disapproving of the idea of “interest on interest”. After some months of litigation in the Apex Court and a lot of confusion surrounding interest on interest being charged by the lenders on loan accounts whose payments were deferred under the Covid-induced moratoriums, the Central Government (CG) has come up with a scheme whereby the CG will take over the differential interest, that is, difference between compound interest and simple interest during the 6 month period starting 01.03.2020. The lending institutions will have to pass on this benefit to the borrowers. Of course, the scheme, called Scheme for grant of ex-gratia payment of difference between compound interest and simple interest for six months to borrowers in specified loan accounts (1.3.2020 to 31.8.2020) [Ex-Gratia Scheme or EGS]  is limited only to smaller borrowers, that is, borrowers falling under the specified category loan accounts, classified as standard and having an aggregate exposure of not exceeding Rupees 2 (two) crores as on 01.03.2020.

We have earlier submitted that the government is best placed to provide any relief to borrowers on issues concerning interest on interest.[1] The issue has finally been addressed via Notification dated 23.10.2020 providing the “Scheme for grant of ex-gratia payment of difference between compound interest and simple interest for six months to borrowers in specified loan accounts (1.3.2020 to 31.8.2020)”.[2]

This ex-gratia payment scheme is another COVID-19 related relief and incentive by the Government to bear additional interest on certain small specified loan accounts. The total estimated burden on the exchequer by virtue of the Scheme may be about Rs 7500 crores.

The Ministry of Finance (MoF), GOI has also issued four clarifications to date on EGS via FAQs dated 26.10.2020, 29.10.2020, 03.11.2020, and 04.11.2020 respectively.[3]

In this write-up, we have highlighted some of the important aspects of the scheme in form of FAQs below:

Objective/Nature and Scope of the Scheme

  1. What is the objective of this Ex-gratia Scheme?

This Ex-gratia Scheme seems to be the CG’s answer to the resentment that was quite obvious in the Supreme Court proceedings in the matter of Gajendra Sharma Vs Union of India.[4] The Scheme says it clearly that the payment under EGS is not a contractual, legal or equitable liability of the CG and is only an only an ex-gratia payment to the following designated class of borrowers in view of the COVID-19 pandemic.

The essential idea of the EGS is to provide the benefit of having to pay simple interest by the borrowers covered under the Scheme. The period covered by the two moratoriums is to be taken into consideration under this Ex-gratia Scheme, that is the period from 01.03. 2020 to 31.05.2020[5] and 01.06.2020 to 31.08.2020[6]. The underlying philosophy of the EGS seems that the central purpose of the moratorium was to grant relief to smaller borrowers whose business/earnings were disrupted by the Pandemic. However, the grant of moratorium did not provide any relief from payment of interest. Thus, interest continued to be compound even while the borrower availed of the moratorium. In many cases, thus, the moratorium hardly helped, as it resulted in mounting of interest burden, which may have even worsened the situation of the  borrower.

The Scheme now transforms compound interest into simple interest during the Moratorium Period, that is, the period commencing from 01.03.2020 to 31.08.2020 (‘Moratorium Period’).

As our workings (See in next question) have demonstrated the impact of the EGS on the borrower depends on two factors – (a) the rate of interest on the facility; and (b) the size of the funded facility.

  1. How will the Ex-gratia payment be impacted with varying interest rates and outstanding amounts?

Please refer to the table at the end of this write-up.

  1. Is the payment of the ex gratia amount under the scheme, optional for lending institutions or the same has to be complied mandatorily by the lending Institutions?

The payment to the specified loan accounts of eligible borrowers is mandatory under the Scheme. The language of Ex-gratia Scheme clearly provides that the lending institutions shall credit the difference between simple interest and compound interest for a period between 1,03,2020 to 31.08.2020 in specified loan accounts of eligible borrowers.

Further the RBI notification dated 26.10.2020 clearly advises the lending institutions to be guided by the provisions of the scheme and take necessary action within stipulated timeline.

  1. Can a Lending Institution be selective in terms of granting the benefit or denying it to certain Borrowers?

The applicability of the scheme is not optional. As per the RBI notification, all lending institutions are advised to be guided by the provisions of the Scheme and take necessary action within the stipulated timeline. Hence, the lending institution is obligated to extend the benefit of the EGS to all the eligible borrowers. See below for the meaning of “eligible borrowers.”

Scope of “Lending Institutions”

  1. Which Lending Institutions have to pass the benefits to borrowers under this Scheme?

The following is the list of the lenders have to comply with the operational guidelines of the scheme (“Lending Institutions”) :

  • Banking Companies
  • Public Sector Banks (PSB)
  • Co-operative Banks – Urban Co-operative Banks,or a State Co-operative Bank, or a District Co-operative Bank
  • Regional Rural Banks (RRB)
  • All India Financial Institutions
  • Non-Banking Financial Companies registered with the RBI
  • Non-Banking Finance Company being a Micro Finance Institution, also a member of Self Regulatory Organisation (SRO) registered with RBI
  • Housing Finance Companies registered with RBI, or National Housing Bank
  1. Are all types of NBFCs covered under the Scheme irrespective of the asset size?

The Government intends to pass on the benefit of the Scheme through the Lending Institutions including all NBFCs involved in lending to the specified category of borrowers irrespective of the asset size of the NBFCs.

  1. Is this scheme applicable on co-lending?

The EGS scheme does not exclude loans originated by two or more Lending Institutions. The objective of the scheme is to pass the benefit of the EGS to eligible borrowers. Therefore,  in case the borrower is eligible, the benefit under the EGS shall be extended taking blended rate of interest as the reference rate for differential computation of CI and SI during the moratorium period. The rates of interest charged by the respective lenders may be different inter-se; however, the benefit of interest differential will be given to the borrower based on the blended interest rate.

  1. In case of co-lending, what if there is one eligible Lending Institution, and one who is not eligible?

Current guidelines of the RBI on co-lending do not seem to be extending to co-lending arrangements between one lender who is in the list of Lending Institutions above, and one who is not. It will be difficult to think of one of co-lenders passing on the benefit, while the other does not.

  1. Does this Scheme cover the loans which have been securitised?

The fact that a specified loan account has been securitized does not deny the borrower from availing the benefit under this Scheme. Therefore, the servicer/originator should pass the benefit of ex-gratia payment to the eligible borrower even in case of securitised loans. The interest rate differential is essentially credited to the account of the Eligible Borrower – therefore, it is treated as if it is a cash inflow from the borrower, and should accordingly become a part of the waterfall, as and when the same is received from SBI.

9A. In case of securitisation, the original lender is simply a servicer. Is it envisaged that the servicer will still be empowered/required to pass on the benefit of the Scheme to the borrower, and claim the same from the Govt, even though technically the loan is not on the books of the lender?

Given the benevolent and borrower-centric intent of the Scheme, we are of the view that the benefit of the Scheme cannot be denied to a borrower whose loans have been assigned. Technically, whether the originator is still holding the loan or has sold it away to an SPV or other assignee should not matter. The benefit can easily be passed on as a payment from the customer.

  1. Does this scheme include specified loan accounts which have been subject to direct assignment?

The same treatment as in case of securitisation should apply in case of direct assignments as well. The benefit of interest differential should be given to the borrower. The amount received from the CG through SBI should be treated as a payment received from the borrower, and should be shared between the assignor/assignee in their ratio of sharing the inflows.

A subsequent clarification in MoF FAQs dated 03.11.2020 in FAQ No. 2, specifies the eligibility of loans under EGS which have been bought as part of pool buyouts by one lending institution from another. [Updated on 04.11.2020]

  1. The amount received from the CG by way of interest differential may be treated as payment made by the borrower. Should it be treated as payment of principal, payment of interest, or payment of any other dues from the borrower?

In our view, the contractual appropriation rules should be applicable to the amount received from the CG. The amount received from the CG is essentially the amount received from the borrower. Hence, appropriation rules as contained in the loan agreement should apply to this amount as well.

  1. Does this Scheme cover Core Investment Companies?

Question does not arise as CICs are intended to provide financial support to “group companies only.

Scope of “Eligible Borrowers”

  1. Which all borrowers are eligible to be benefitted under the Scheme?

The borrowers falling under any or more of the “Facilities” (see below) are eligible under Ex-gratia Scheme “Eligible Borrower”. However, such facilities need to satisfy the following conditions:

  • Such borrower should not have sanctioned limit and the outstanding amount exceeding Rs. 2 (two) crores in aggregate with all the lending institutions as on 29.02.2020. That is, the sum of borrowings of such a borrower from specified loan accounts and borrowings other than that under specified loan account shall also be taken into account while arriving at aggregate exposure of Rs. 2 Crores.

For computation of the borrowing cap, see further questions below.

  • Such an eligible category loan account should be standard (less than 90 DPD) as on 29.02.2020.
  • Whether such borrower availed complete moratorium, partial moratorium, or did not avail any moratorium benefit in respect of such eligible category loan account is irrelevant for the purpose of extending benefit under the Ex-gratia Scheme.
  1. Will the Non Fund Based Limits as on 29.02.2020 be included for arriving at the borrower eligibility of amount upto Rs. 2 crore?

No, the fund based limits shall not be included for arriving at the eligibility criteria for the purpose under EGS. The same has also been clarified by the MoF in its FAQs.

  1. Whether the Rs. 2 crore limit applies for borrowings across all lending institutions?

Yes, the 2 crore limit shall be considered across all the lending institutions.

  1. In case of working capital facility, for the purpose of limit of Rs 2 crores, the lending institution shall consider the actual amount availed or the sanctioned limit?

The language and intent of the EGS is very clear that the aggregate of sanctioned and outstanding amount of loan in respect of a particular eligible borrower is to be considered. Hence, the sanction limit shall be considered.

  1. As on 29.02. 2020, a borrower is standard with one lender, but is not standard with another. What will be the eligibility of the borrower in such a case?

In our view, the condition for eligibility for the benefit is that the borrower is standard as on the reference date. Additionally, we need to aggregate the facilities enjoyed by the borrower with other lending institutions. We do not have to read any further conditions. That is, if the borrower is not standard with a particular lending institution, then such lending institution shall not grant the benefit to the borrower. However, the lending institution with which the borrower is standard should not be precluded from granting the benefit of the Scheme.

The same has also been subsequently clarified in MoF FAQs dated 03.11.2020 in FAQ No. 1. [Updated on 04.11.2020]

  1. How does a lending institution get to know how much facilities a borrower is availing from other lending institutions, in order to arrive at the borrowing cap?

Lending institutions are to assess this on the basis of information available with them as well as information accessible from credit bureaus. This has also been clarified by the MoF in its FAQs.

  1. A borrower has availed a loan of Rs 1 crore from an NBFC. Additionally, the borrower has taken a home loan of Rs 1.50 crores from the company where he is currently working. Is he eligible?

We need to aggregate the borrowings from Lending Institutions. Employee loan taken from the company where the borrower is working does not fall under the list of facilities for the purpose of the Scheme. Hence, no question of aggregating the same.

  1. A borrower satisfies all other conditions but is classified as NPA as on 29.02.2020 and subsequently becomes standard. Will the borrower be eligible under the Scheme?

The subsequent movement of the NPA to standard will not make the account eligible under the scheme. As per the eligibility conditions, the loan account must be classified as standard as on 29.02.2020.

  1. A borrower account was standard as on 29.02.2020 and also satisfies all the other eligibility conditions under the scheme, but as on date is an NPA. Can the benefit still be availed?

Yes, the benefit shall still be given to the borrower based on the fact that the loan account was eligible as on 29.02.2020.

  1. A borrower under a specified loan account is having a sanctioned limit of Rs. 2.5 Crores as on 29.02.2020, however its aggregate outstanding borrowing with respect to such loan account as on 29.02.2020 is less than 2 crore, will such borrower be eligible under the Ex-gratia Scheme?

The Ex-gratia Scheme clearly specifies that the ‘sanctioned limit’ and ‘outstanding amount’ with respect to loan accounts should not exceed Rs. 2 Crore. The aggregate of the borrower’s sanctioned limit and outstanding loan amount from all lending institutions to such a borrower should be less than Rs. 2 Crores. Hence, in our view, the borrower shall not be eligible.

  1. A borrower under specified loan account has an aggregate outstanding loan facility as on 29.02.2020 less than Rs. 2 Crores with a lending institution. Additionally it also has a Bank Guarantee in its favour with the same or any other lending institution. Will such a borrower be eligible under the Ex-gratia Scheme? 

The FAQs issued by the Department of Financial Services clearly states that non fund based limits will not be included for arriving at the eligibility. Accordingly, the borrower shall be eligible under the EGS.  

  1. Is there any requirement for eligible borrowers under specified loan accounts which needs to be fulfilled for the purpose of availing ex-gratia payment benefit?

No, as per the ex-gratia scheme guidelines all lending institutions under the scheme have to credit the difference between compound interest and simple interest in specified loan accounts of the eligible borrowers.

However, it is always prudent on part of borrowers and the lending institutions to exchange confirmation about the credit of such payment under the scheme.

  1. Will the eligibility be determined as on the date of this scheme or as on 29.02.2020?

The borrower account must fall in the category of specified loan account as on 29.02.2020. For example, a loan account was classified as an MSME as on 29.02.2020 and later on a subsequent change in definition has moved it out of the category of MSME, the benefit under the scheme shall still be given to the said borrower account, subject to fulfilment of the eligibility conditions.

Scope of “Facility”

  1. Which all classes or categories of loans/facilities are eligible under this Scheme?

The loans falling under any of the categories mentioned below are ‘specified loan accounts’ under this Ex-gratia Scheme.

  • MSME loans
  • Education loans
  • Consumer durable loans
  • Credit Card Dues
  • Automobile loans
  • Personal loans to professionals
  • Consumption loans
  • Housing Loans
  1. Does the specified loan account also include all personal loans, or personal loans given only to professionals?

RBI has defined the term “personal loans” in its circular dated 04.01.2018 as follows:

“Personal loans refers to loans given to individuals and consist of (a) consumer credit, (b) education loan, (c) loans given for creation/ enhancement of immovable assets (e.g., housing, etc.), and (d) loans given for investment in financial assets (shares, debentures, etc.).”

The circular dated 04.01.208 also defines “consumer credit”, and the extant definition is as follows:

Consumer credit refers to the loans given to individuals, which consists of (a) loans for consumer durables, (b) credit card receivables, (c) auto loans (other than loans for commercial use), (d) personal loans secured by gold, gold jewellery, immovable property, fixed deposits (including FCNR(B)), shares and bonds, etc., (other than for business / commercial purposes), (e) personal loans to professionals (excluding loans for business purposes), and (f) loans given for other consumptions purposes (e.g., social ceremonies, etc.). However, it excludes (a) education loans, (b) loans given for creation/ enhancement of immovable assets (e.g., housing, etc.), (c) loans given for investment in financial assets (shares, debentures, etc.), and (d) consumption loans given to farmers under KCC.

Therefore, from conjoining the above two definitions and comparing it with the list of specified loan accounts under the Scheme, we understand that Personal Loans given to individuals in respect to; a) education loans, b) credit cards dues, c) loans for consumer durables, d) auto loans, e) Personal loans to professionals, f) loans for consumption purposes g) Housing Loans shall qualify as specified loan accounts from personal loan category for the purpose under the scheme.

The expression “consumption loan” is quite wide. A loan which is not for business purposes, or for purchase of any specific asset or durable, may qualify as a “consumption loan”.

27A.  Whether loans given to doctors for business purposes are covered under the head ‘personal loan to professional’?

Going by the literal interpretation it seems that personal loans to professionals shall not include loans given for business purposes. The same is also specified in the definition of ‘consumer credit’ provided hereinabove. However, consumption loans are also not for business purposes and a personal loan by any person, including a professional, will be classified as a consumption loan. Hence, in essence there would not be a difference between the category ‘personal loan for professionals’ and ‘consumption loans’, the later being a broader term. Such an interpretation would reder this category as meaningless.

Further, restricting the meaning to only personal loan would mean that a loan given to a professional, for the profession, will disqualify on the ground that it is not a “personal loan. However, in our view, the intent seems to be cover loans to professionals. The word ‘personal’ loan seems to be a surplusage and should not be taken restrictively.

  1. A salaried employee / self-employed professional had availed of a personal loan from bank which has some amount outstanding as on 29.02.2020. Is the loan eligible for ex-gratia payment under the scheme?

Yes. Loans for consumption purposes (e.g., social ceremonies, personal expenditure, etc.) are also eligible for coverage under the scheme, besides other specified categories of loans like consumer durables, automobiles, education, credit card dues, housing and personal loans to professionals.

28 A. In case of education loans where students pay part of the interest and the remaining interest gets capitalised. Will such cases also qualify under this scheme?

In case of education loans, generally, the repayment starts after a deferment or moratorium period (say 1 or 2 years). EGS covers education loan under specified loan category, however it does not specify, whether the status of the loan account of repayment under such loans have commenced or not, or has been partially paid or not as of 29.02.2020. Therefore, in our view, education loan accounts have to be given benefit under EGS irrespective of the fact whether loan is under deferred period, or the re-payment has commenced or loan is partially being re-paid. Further, the reference date to be borne in mind for determining the outstanding amount on such loan account shall be 29.02.2020.

28B.  Will loans to Education Institutes be eligible under education loans?

No, loans given to education institutes will not be covered under the head ‘education loans’.

  1. Is there a distinction between secured loans and unsecured loans for the purpose of the Scheme?

No. There is no such distinction. As long as the loan is covered by the list of “facilities” above, it does not matter whether the loan is secured or unsecured.

  1. A business loan has been given to an MSME (private limited company), and is secured by pledge over shares of the company? Will this loan be eligible?

As per FAQ no. 20 of the FAQs issued by MoF, loans against shares shall not qualify for the Scheme. However, in our view, the intent of the MoF is to exclude loans against the financial assets, that is, loans where the intent is to use the proceeds of the loan for investing in financial assets. In the instant case, the loan is a loan taken for business purposes. The mere fact that the loan has been collateralised by pledge over shares, whether of the entity in question or any other shares, should not matter. This is our view.

  1. Will a loan taken for business purposes by a non-MSME qualify?

Loans to non- MSME for business purpose is not falling under any eligible category of Facilities, and hence not covered under the Scheme

  1. A borrower falls under the MSME category as per the new MSME classification. But such a borrower has not availed Udyam Registration, will it be eligible under the scheme?

The borrower must be classified as an MSME on 29.02.2020 irrespective of the classification under the new definition. Further, it is recommended that in case the borrower continues to be classified as an MSME, it may submit its proof of Udyam registration to the lending institution.

32.A    Is Udhyam Registration mandatory for MSME     classification?

As per the eligibility conditions, the lender has to ensure that the borrower account was a classified as MSME loan as on 29.02.2020. Further, on the said reference date, obtaining udhyam registration was not mandatory for the purpose of MSME classification. However, a declaration may be sought from the borrower in this regard that they were eligible to be classified as an MSME on such reference date.

  1. What if an auto loan for commercial use has been given by a Lending Institution? Does it mean that such auto loan is not covered under the specified loan account category?

All automobile loans are covered by the Scheme, whether the vehicle in question is used for personal or for business purposes.

Therefore, auto loans for commercial use shall also qualify as eligible “facility” for the purpose of the scheme.

A similar clarification has been issued subsequently  in MoF FAQs dated 03.11.2020 in FAQ No. 3. [Updated on 04.11.2020]

  1. Will lease transactions be included under the purview of this scheme?

Financial leases or operating leases are not covered under the Scheme.

  1. Will the loan against property (LAP) to individuals qualify as a specified loan account under the scheme?

Loan against property (LAP) is a market term, implying the nature of the security in case of the loan. For the purpose of determining whether the loan is an eligible facility or not, we are not concerned with the nature of the collateral or security. We are concerned with the end-use of the money. Hence, a LAP loan may be a consumption loan, or a business loan to an MSME, or a personal loan to a professional. Therefore, merely because the loan is a LAP, we cannot judge whether it is a qualifying facility or not.

On the other hand, a LAP loan may be given as a business purpose loan to an entity which may not be qualifying as an MSME. In that case, the facility will not qualify.

35A.  Whether loans availed against term deposits are eligible for ex-gratia payment?

Lenders have to consider that the loan account should fall under the specified loan category based on the end use of the loan as well as the type of borrower. The collateral securing such loan is irrelevant.

35B.  Whether micro loans guaranteed by Joint Liability Group (JLG) are covered under the Scheme? 

Individual loans from the eight eligible categories of borrowers, including those categorised as Micro, Small and Medium Enterprises (MSME) by the lending institution, are covered under the scheme irrespective of the nature of
guarantee.  [Mof FAQs dated 04.11.2020]

  1. What is the meaning of the word “professionals” in case of personal loans?

In technical parlance, the word “profession” has a narrow meaning. It mostly means those regulated professions where there is a professional body for the purpose of a recognised profession which entitles the professional to practice the same. Examples may be doctors, chartered accountants, architects, etc. However, in the context of the Scheme, it appears that the word “profession” has been used in the wider sense of a profession, vocation or calling, not being in the nature of business. Such a wide meaning is prevalent under taxation laws for recognition of income under the head “business” or “profession”. There does not seem to be sufficient reason for restricting the meaning of the word “profession” for the purpose of the Scheme to only regulated professions.

Hence, there are two types of loans – business loans, and personal loans. Business loans will qualify for the Scheme if the same is extended to MSMEs. Personal loans, to entities other than those engaged in businesses, may either be a personal loan given to a professional, or a consumption loan to a salaried employee. In our view, both the latter categories will qualify.

  1. A large number of NBFC loans are given to retail and wholesale traders. Do they qualify?

The fact that retail and wholesale traders are excluded from the definition of MSME would imply that they shall not fall under the category of ‘MSME loans’. However, in case the end use of the loan is for consumption by the trader, the same can qualify as ‘consumption loans’

  1. Will a loan given to a practising CA or CS firm qualify as a personal loan to professionals? Can it be classified under the head “MSME loans” in case the firm is registered as MSME?

The loan given to a practicing CA or CS (for purposes other than business) shall qualify as a personal loan to professionals. Further, a loan given to a practising CA/CS firm for business purposes can be classified as ‘MSME loan’ provided the firm is registered as an MSME.

  1. Will the gold loans to individuals fall under the specified loan account category?

The answer to this question is far from clear. On one hand, it is possible to contend that most of the gold loans are, in fact, consumption loans. We have discussed above that what should matter for the purpose of the Scheme is the end use of the loan and not the nature of the collateral. On the other hand, the MoF FAQs have specifically excluded loans taken for investment in financial assets. Gold is not one of the financial assets referred to in the FAQs. However, if the underlying philosophy of the Scheme is considered, gold loans do not seem to be those which were disrupted by the Covid pandemic. In most of the gold loans, there are no periodic payments too – therefore, if the underlying spirit of the Scheme is to relieve the borrower from the burden of compound interest for availing the moratorium, one may have a divergent view in case of gold loans.

Please also see our FAQs on the Covid Moratorium for further discussion about gold loans- http://vinodkothari.com/2020/03/moratorium-on-loans-due-to-covid-19-disruption/

 

Nevertheless, the ministry has also clarified in its FAQs dated 04.11.2020 that Consumptions loans, including those backed by gold as collateral, are eligible under the scheme. [updated on 05.11.2020]

 

  1. Will agri loans/ tractor loans be covered?

Our initial view was that agricultural loan is not specified in the category of specified loans under EGS. However, tractor loans may qualify under the head ‘automobile loans’.

However, FAQs issued by the MoF dated 29.10.2020 has clarified that crop loans and tractor loans etc. are agriculture and allied activities loans and are not part of specified loan accounts. Hence will not qualify under EGS. The ministry’s view seems to be on the presumption that tractors are used for agricultural purposes, whereas it can be used for transport as well. [Revised answer on 30th October 2020].

40A.   Will a tractor loan always be considered as agri loan?

A tractor has dual usage- both for cultivation as well as for travelling. In case a farmer has availed tractor loan and same has been categorised as auto loan considering the end use to be for travelling, there is no reason to exclude such loans from ambit of the Scheme. However, the MoF in its FAQs seems to have taken a view that tractor loans, irrespective of the end use shall not qualify under the Scheme.

  1. Are loans for construction equipment falling under the specified loan account category?

In case the construction equipment loan is availed by an MSME, the same may be categorised under the head ‘MSME loans’. Further, in case the equipment is wheel mounted, the same may be classified as ‘Automobile loans’. Apart from the aforesaid, loan for construction equipment shall not be covered under the Scheme.

  1. What should be the meaning of the term “automobile loans”? Should the word “automobile” be read in the same sense as a vehicle under the Motor Vehicles Act?

In typical industry parlance, the word “automobile loan” or “auto loan” is read in the sense of a loan to purchase a motor vehicle. Hence, for want of a better definition, the word “motor vehicle” as defined in sec. 2 (28) of the Motor Vehicles Act may guide the meaning.

  1. Are working capital loans getting covered under any category?

To the extent the WC loan is to an MSME, the same shall be eligible, otherwise it may not fall in specified loan category under EGS.

  1. Does the specified loan accounts cover unsecured loans given by fintech entities?

Loans given by Fintech entities or Micro Finance Institutions (MFI) may qualify under the EGS as they may be classified as specified loans under ‘consumption loans’ category.

  1. Does EGS cover loans against securities or other movable properties?

As clarified by the MoF in its FAQs, loans against fixed deposits [including Foreign Currency Non-Resident (Bank) {(FCNR(B)} account, bonds and other interest bearing instruments], and shares etc., and loans given for investment in financial assets (shares, debentures etc.) are not eligible for coverage under the EGS.

  1. Will Inter Corporate Deposits (ICD) qualify as specified loan accounts for the purpose of the scheme?

Inter Corporate Deposits made by the lending Institutions to MSMEs shall qualify as specified loan accounts under the Scheme. Any other ICD to non-MSME entity shall not be eligible under EGS.

Other qualifying conditions

  1. A borrower was having standard account classification as on 01.03.2020, but is currently an NPA and the Lending Institution has initiated a recovery mechanism. Is the Lending Institution still required to pass on the benefit of the EGS to such Borrower?

While the benefit of the Scheme is applicable, it does not imply that the ex gratia payment is an outflow to the borrower. That is, the Lending Institution may retain the amount as a payment received from the borrower. Hence, even in case of initiation of recovery proceedings against an eligible borrower, the ex-gratia payment can be retained by the lender and such credit amount could be set off from such lender’s claim.

  1. Assume a borrower had not opted for the moratorium or the moratorium was not granted to the borrower. Hence, EMIs continued to become payable during the Reference Period. The CI is now replaced by SI. Does that mean retrospectively, the CI will have to be replaced by SI, so that the overdue interest or other consequences for default during the Reference Period will also have to be recomputed?

There is no provision for recomputation of the loan obligations. The benefit by the CI shall be provided to the eligible borrowers by transferring their burden of paying interest on interest during the Reference Period only. However, the computation of overdue interest or other consequence based on the then prevailing EMIs will not be reversed.

  1. If a Lending Institution has not charged compound interest on the loan, is it still possible to compute CI and avail of the benefit of the Scheme?

If the terms of the loan are clear that the interest shall be simple interest, then the benefit under the Scheme is not even called for.

  1. In case of EMI-based loans, where there is no formal declaration or disclosure of a compound interest, but an IRR or effective interest rate is computed, can it be implied that there is a compound interest? In essence, can it be contended that IRR and compound interest are the same?

In the cases where an IRR or effective rate is charged from the borrower, the EMI computation already factors the interest compounded over the loan tenure. In case the borrower has availed moratorium, the amount is accrued but not payable.Therefore, interest charged over the interest component of the amount accrued during moratorium period shall be the ex-gratia amount and the same will be credited to borrowers account. In case the borrower has not availed moratorium, the borrower pays the amount on its accrual. The EMI computation however, already considered the compounding effect of the interest. Hence, the ex-gratia amount shall be the interest compounded during the Reference Period.

  1. In several forms of lending, it is a common practice for lenders to charge a “flat rate”, that is, a rate of interest computed with reference to the original loan, even though the borrower continues to pay the EMIs over time. In such a case, is the EGS applicable?

The RBI specifically instructs the lenders to disclose an annualised rate of interest, irrespective of the payment terms. The annualised rate is the IRR which is the contractual term agreed between the parties. Hence, the EGS benefit shall be applicable and the computation of simple interest and compound interest shall be based on such IRR.

51A. What if the contractual rate is 0%, will benefit under the Scheme still be provided?

In case the contractual rate is NIL or 0%, there is no question of granting any benefit to the borrower, given that the borrower has not paid any interest at all. However, in case the loan account falls under the category of consumer durable loan and no interest is charged for a specified period, then lender’s base rate or marginal cost of funds based Lending Rate (MCLR) whichever is applicable shall be considered as on 29.02.2020 to calculate the differential amount of interest. [Updated as of 02.11.2020]

  1. The Scheme provides that in case of consumer loans where there is no interest, there may still be an imputed interest based on the lender’s base rate / MCLR whichever is applicable. Can the same principle be applied in case of loans where only simple interest is charged?

The EGS specifically mentions the treatment in case of consumer durable loans where there is no interest charged by the lender for a specified period. However, in case simple interest has been charged that would essentially mean that the lender has forgone its interest over the accrued interest. Hence, the same shall not be eligible for benefit under the EGS.

  1. What will be eligibility of a borrower under EGS in any of two scenarios covered below?

Scenario 1: The borrower has taken moratorium benefit until the first three months under moratorium scheme, i.e. from 01.03.2020 till 31.05.2020.

Scenario 2: The borrower has taken the moratorium benefit for the last three months of the moratorium scheme, i.e. from 01.06.2020 till 31.08.2020.

Yes, the borrower shall be eligible for ex-gratia payment in both of the scenarios mentioned above. The Ex-gratia scheme is applicable on all the specified loan accounts, whether moratorium benefit is completely availed, or partially availed, or not availed at all.

All the payments made by such a borrower towards its eligible loan account between 01.03.2020 and 31.08.2020 will be ignored. For the purpose of uniformity, the difference between compound interest and simple interest is to be reckoned at an outstanding amount as on 29.02.2020 for a period of six months.

  1. Will it be right to say that all specified accounts of eligible borrowers are entitled for Ex-gratia payment under the scheme, irrespective of whether payment deferment have been availed or not under the moratorium scheme?

Yes, all the specified loan accounts of eligible borrowers are entitled to ex gratia payment under the Ex-gratia Scheme.

  1. Will the lending institutions continue to charge over dues and other penal interest on borrower’s account even including those to whom the benefit is granted under the scheme?

Yes. The ex-gratia scheme’s objective is to pass the differential benefit of compound interest and simple interest in specified loan accounts by crediting such loan accounts of eligible borrowers.

All the over dues charges and other penal interest shall continue to apply on all borrowers as may be applicable.

  1. What are the rates of interest on which the difference between compound interest and simple interest on the amount outstanding as on 29.02.2020 will be calculated?

The rate of interest would be prevailing as on 29.02.2020, any change thereafter shall not be reckoned for purpose of computation. Additionally penal interest rate or late payment penalty not to be included as contracted rate or WALR.

A ready reference on manner of determining the rate of interest on eligible loans has been provided in image below:

Time Periods under the Ex-gratia Scheme

  1. What is the time period for credit/payment of an ex-gratia amount by the lender?

The scheme provides that the exercise of crediting the amount under the scheme shall be completed by respective lending institutions on or before 05.11. 2020.

Therefore, the amount under this Ex-gratia scheme has to be credited to the borrower’s account by the lending institutions within the stipulated time.

  1. What shall be the compounding frequency if the loan agreement/document provides that interest shall be compounded semi-annually or quarterly?

The operational guidelines of the scheme in para 7 provides the manner of claiming reimbursement. As under the scheme compound interest shall be reckoned on a monthly basis, except where the contrary is provided. Therefore, where a contractual term specifically provides that the annualised rate should have quarterly or semi annually resets then in all such cases the adjustment shall be given to the same. If the contract or document is silent on the same the compound interest shall be calculated based on monthly resets.

  1. What would be the change in ex-gratia payout if loan installments are payable quarterly or semi-annually?

The payment of loan installment interval i.e. either monthly / semi-annually or  quarterly will have no effect on ex-gratia payment computation if the interest rate is compounded with monthly resets.

Modus operandi for passing on the benefit to the Borrowers

  1. Does this Ex-gratia Scheme mean that no interest will be charged by the lending institutions for the period of 01.03.2020 till 31.08.2020 on specified loan accounts?

No, this Ex-gratia scheme is in the form of waiver of interest on interest in the specified loan account category, irrespective of whether moratorium benefit was extended/availed completely, partially or not availed at all on such loan accounts.

Therefore, all the eligible borrowers in specified loan accounts will receive payment under the Scheme from their respective lending institution. The credit amount would be such part of interest which would have been chargeable by the lending institutions on the accrued interest component during the six months deferment period from 29.02.2020 till 31.08.2020. That is the difference between the Compound interest and Simple Interest on the outstanding amount will be payable by the lending institution which shall be reimbursed to them by the Government.

Illustration:

Outstanding loan amount in the specified loan account as on 29.02.2020 was Rs. 1,00,000 (Rupees One Lakh).

Interest Rate as applicable on such a loan account as on 29.02.2020 is taken @ 10% annualised rate, compounded monthly.

Therefore, the balance 105.33/- shall be credited to the specified account of the borrower by the lending institution.

  1. What is the exact manner of passing on the benefit to the borrower? Is it merely a credit to the account of the borrower, or does it lead to any cash benefit being transferred to the borrower?

In our view, the Scheme is simply a limited relief on compound interest. The interest differential as computed under the Scheme is simply credited to the account of the borrower by the 05.11.2020 as specified. Crediting the amount does not mean any actual cash transfer. The interest differential is treated as an amount paid by the borrower. The question of any refund will arise only if the outstanding amount by the borrower is less than the amount of the differential, or the account is fully squared off.

  1. The borrower’s account has a principal outstanding, but no EMIs or other sums are currently due. In that case, what is the treatment of the interest differential?

If there are no currently dues by the borrower, the interest differential may be treated as a payment of principal by the borrower. Of course, it will be counter-intuitive to apply the clauses pertaining to prepayment, for instance, a prepayment penalty..

  1. A borrower loan account has been closed in the books of the lending institution as on 30.04.2020. However, the borrower was eligible under the scheme as on 29.02.2020. Will the borrower receive any benefit under the Scheme?

Since the eligibility is to be determined as on 29.02.2020, the fact that the loan account has been closed should not deprive the borrower of the benefit under the Scheme.

Such borrowers are eligible for refund of differential interest from 01.03.2020 upto the date of closure of account.

Illustration

The outstanding amount in a specified loan account as on 29.02.2020 is Rs. 1,00,000 (Rs. One Lakhs Only). The borrower paid all the dues towards the loan amount by 30.04. 2020. The contracted annualised rate compounded monthly as on 29.02.2020 is at 10%.

The ex-gratia payment as under the scheme guidelines should be as follows:

Therefore, the borrower shall be entitled to Rs. 6.94 under the ex-gratia scheme.

It will be credited to the borrower’s savings/ current account. If no such account is maintained by the borrower with the lending institution, the borrower can advise the lending institution the details of the account in other banks where the amount can be credited /remitted to.

63A. Will the treatment of loans that have matured during 01.03.20 to 31.08.20 but are still active in system due to some pending charges, be same as closed loans?

If the loan has been closed during the reference period, and there are pending charges, the treatment shall be the same as a foreclosed account. Accordingly, the credit for differential interest amount can be adjusted with the overdues.

63B.  What if the loan is closed in between the month (say 20th of April) how to compute compound interest in such a situation?

The interest shall be computed for the broken period by converting the number of days into a fraction of the month. The same can be done by dividing the number of days by 30 (considering a month has 30 days on average).

63C. A specified loan account is transferred to another lending institution during the period between 01.03.2020 to 31.08.2020. Which lending institution will provide ex-gratia benefit to the customer?

The transferor lending institution shall provide the benefit to the customer. The reference period for calculating compound interest and simple interest differential amount will be from 01.03. 2020 till the date such loan account is tranferred.

  1. In case the borrower account has been closed, can the difference amount be retained by the Lending Institution as repayment by Borrower?

Yes, if there is an amount pending to be paid by the borrower.

64A. In case the account is foreclosed during the Reference Period, will the benefit of this scheme be applicable?

On October 29, 2020, the Department of Financial Services issued a set of FAQs, which state that for the accounts foreclosed during the Reference Period, the benefit of the scheme shall be available.

  1. Does the outstanding amount as on 29.02.2020 include overdue instalments or any other overdue charges such as overdue interest, penalty, etc?

The amount outstanding as on 29th Feb would include all amounts showing as outstanding from the borrower. If the overdue interest or any other charges have been debited to the loan account, and are shown as a part of the outstanding, in the loan account of the borrower, in our view, the same should form part of the reference amount, both for reckoning the limit of Rs 2 crores, as also for computing the interest differential. [Revised answer on 29th October 2020]

  1. Will it be possible for the lenders to ensure the credit of the differential amount to all the borrowers before 05.11.2020?

The determination of the eligible borrowers, the computation of the differential amount and the process of crediting the same to their respective accounts will be a cumbersome and lengthy process. It will be a burden for the lending institutions and seemingly the Government may have to extend the timelines.

Modus operandi for claiming the payment from the CG

  1. Where shall the lending institutions file their reimbursement claims after crediting the ex-gratia amounts in specified accounts of eligible borrowers?

The claims shall be submitted to the designated officer (s) /cell   at State Bank of India (SBI). The SBI shall act as a nodal agency of the Central Government for settlement of all the claims of lending institutions.

  1. What are the procedures to be followed by lending institutions for reimbursement of claims processing?

The following timelines and procedures need to be complied by all the lending institutions falling under the scheme.

  • The last date for filing claims of reimbursement of amounts credited to specified loan accounts of eligible borrowers is by 15.12.2020.
  • The reimbursement claim amount should be pre-audited by a statutory auditor of the lending institution.
  • A certificate by an auditor shall be attached with the claim.

68A.  In co-lending transactions, can one entity pass on the benefit to borrower and get the  credit from CG?, or same shall be availed from CG in the ratio of disbursement?

In co-lending transaction, the primary co-lender may pass on the benefit to the borrower on behalf of both the lenders and reclaim the same from the CG at the blended rate of interest. The claim amounts once received from CG shall be shared subsequently in the ratio agreed under the terms of co-lending.

Grievance Redressal Mechanism

  1. What is the timeline for lending institutions to address grievances of borrowers? 

As under the operational guidelines of the EGS, each lending institution is required to put in place a grievance redressal mechanism for eligible borrowers within one week from date of issuance of ex-gratia guidelines i.e. latest by 30.10.2020.

  1. Lending institutions usually have a grievance redressal mechanism in place. Is there a need to establish a separate mechanism for the purpose of this scheme?

The scheme does not require the lenders to develop a separate mechanism for redressal of grievances arising due to the scheme. The same may be a part of the existing grievance redressal mechanism of the lender. However, the scheme states that the lenders can consider communication dated 1.10.2020 from the Indian Banks’ Association (IBA) in respect of the resolution framework for COVID-19 related stress.

​For the purpose of incorporating the ​aforesaid​ in the existing grievance redressal mechanism, ​necessary ​communication in this regard may be circulated internally​ by the Nodal Officer or such other personnel authorised under the Grievance Redressal Policy of the lending institution​.

  1. What are the requirements under the abovementioned communication from IBA?

The said communication form the IBA lays down the following:

  • A web-based platform shall be developed for automatic lodgement and handling of grievances. The grievances may be received on the said portal/branch office of the lender. Grievances received at the branch should also be fed into the portal and the system shall generate a digital receipt for the customer.
  • The grievances should be directly handled at zonal/circle level based on the hierarchical structure of the lender. Preliminary remarks should be provided to the customer within a maximum of 72 hours by the Nodal Officer and final response should be provided within 7 working days.
  • Escalation matrix may be provided separately for different kinds of loans such as for retail and commercial banking customers. The grievance related to commercial loans may be handled at a higher level.
  • The framework should provide for re-opening of the grievance if the customer is not satisfied by the response.
  • A dashboard on the status of grievances viz. no. of grievances received, pending status etc. should also be made available to controllers/regulators for close monitoring.
  1. Is it mandatory to abide by the above guidelines provided by the IBA?

The scheme does not mandate compliance of the guidelines from the IBA. However, the same may be mandatory for the banks who are members of the IBA (owing to their membership) and recommendatory for other lending institutions.

  1. What are the remedies for a lending institution having grievances concerning the Scheme?

Grievances of lending institutions shall be resolved through designated cell at State Bank of India (SBI) in consultation with the Ministry of Finance, GoI. However in respect to the issues/queries related to interpretation of the scheme, the decision of GoI shall be final.

 

The timeline below summarises the important dates to be abided by Lending Institutions under the ex-gratia scheme.

 

Calculation Table-

 

[1] Our write up ‘Moratorium Scheme: Conundrum of Interest on Interest’ dated 16-09-2020, <http://vinodkothari.com/2020/09/moratorium-scheme-conundrum-of-interest-on-interest/>

[2] Operational guidelines on ex-gratia payment scheme  dated 23-10-2020, <https://financialservices.gov.in/sites/default/files/Scheme%20Letter.pdf>

[3] Department of Financial Services GOI notification dated 26.10.2020 < https://financialservices.gov.in/sites/default/files/FAQs%20on%20Ex%20gratia%20Package_26.10.2020_v1.pdf>; Department of Financial Services GOI notification dated 29.10.2020 <https://financialservices.gov.in/sites/default/files/FAQs.pdf>;

Department of Financial Services GOI notification dated 03.11.2020

<https://financialservices.gov.in/sites/default/files/FAQs%20dated%203.11.2020.pdf>; Department of Financial Services GOI notification dated 04.11.2020 <https://financialservices.gov.in/sites/default/files/FAQ_4.11.2020-converted.pdf>

[4] Writ Petition(s)(Civil) No(s). 825/2020; Supreme Court of India

[5] FAQs on moratorium- http://vinodkothari.com/2020/03/moratorium-on-loans-due-to-covid-19-disruption/

[6] FAQs on moratorium 2.0- http://vinodkothari.com/2020/05/moratorium-2-0-on-term-loans-and-working-capital/

 

Other Related Write-ups:

 

 

RBI all set to regulate the HFCs

Introduction

The provisions of National Housing Bank Act, 1987 were amended w.e.f August 09, 2019 pursuant to the Finance Act, 2019 thereby shifting the power to govern Housing finance Companies (HFCs) from National Housing Bank (NHB) to the Reserve Bank of India (RBI). Consequently, the RBI on June 17, 2020, issued a draft for review of extant regulatory framework for HFCs[1] (‘Proposed Framework’), and had invited comments from the industry on the same. After considering the inputs received from the industry, the RBI, on October 22, 2020 issued the Regulatory Framework for HFCs[2] (‘Regulations’).

The Regulations intend to align the regulatory framework for HFCs with the one prevalent for NBFCs. In this write-up we bring out the significant features of the regulatory framework for HFCs.

Existing regulations to continue

The Regulations state that the existing guidelines issued by the NHB applicable to HFCs shall continue to be applicable unless the relevant provision has been provided for in the Regulations.

Though all major provisions have already been covered in the Regulations, however, certain aspects shall continue to be governed by NHB regulations such as provisions relating to transfer to reserve fund, maintenance of percentage of assets and concept of Tier I and Tier II capital. Better clarity in regards to the extant regulations that would continue to apply to HFCs would be apparent once the revised Master Directions for HFCs is issued.

Are exemptions from provisions of the RBI Act really exemptions?

The Regulations exempt HFCs from complying with the provisions of Chapter III B of the Reserve Bank of India Act, 1934 (RBI Act), except for the registration and Net Owned Funds (NOF) requirements. Further, specific exemption has been granted from the provisions of section 45-IB and 45-IC of the RBI Act, in place of which section 29B and 29C of the National Housing Bank Act, 1987 (NHB Act) shall continue to remain applicable.

Sections 29B and 29C of the NHB Act contain the same provisions as that of sections 45-IB and 45-IC of the RBI Act respectively. Hence, in essence there is no separate requirement for HFCs and the same is in line with the corresponding provisions applicable on NBFCs.

Accordingly, both NBFCs and HFCs will be on the same page since the provisions of section 45-IB and 45-IC of RBI Act are corresponding to that of section 29B and 29C of NHB Act.

Harmonisation in phased manner

Para 3 of the Proposed Framework stated that harmonisation of certain provisions such as capital adequacy requirements, Income Recognition, Asset Classification and Provisioning (IRACP) norms, concentration norms, limits on exposure to Commercial Real Estate (CRE) & Capital Market (CME) etc. shall be done in a phased manner. The Regulations, with respect to para 3, have remained silent for the time being and have stated that the same shall be issued in the upcoming two years.

Principal Business Criteria (PBC)

 

As per the Regulations, in order to be classified as an HFC, following criteria shall be required to be satisfied:

  • A company incorporated under the Companies Act, 2013;
  • Must be an NBFC i.e. financial assets are more than 50% of total assets and financial income is 50% or more of total income;
  • Housing Finance Assets should be 60% or more;
  • At least 50% of total assets should be towards housing finance for individuals;

Prior to the amendment in the Finance Act, the term ‘principal business’ was not referred to in the NHB Act. For the purposes of registration, NHB was recognizing companies as HFCs if such a company had, as one of its principal objects, transacting the business of providing finance for housing (directly or indirectly).  Now, the identification and registration of an HFC shall be based on meeting the PBC rather than just mentioning the same as one of the principal objects in its charter documents. Further, the requirement of minimum concentration towards ‘individuals’ is a new concept and possibly to protect the HFCs from systemic exposures.

The PBC prescribed in the Proposed Framework stated that at least 50% of ‘net assets’ shall be in the nature of qualifying assets. However, the income criteria was based on total income. Net assets means total assets reduced by cash and bank balances and money market instruments. However, gross income would include interest and other income earned from bank balances and money market instruments as well, that have been excluded from the computation of net assets. Hence, there was no parity between both the comparative bases. Vinod Kothari Consultants (VKC) had sent recommendation to the RBI suggesting to bring both the bases at parity. The RBI has considered the same and has accordingly revised the bases to total asset and total income. A company will be treated as an NBFC if its financial assets are more than 50 per cent of its total assets (netted off by intangible assets) and income from financial assets should be more than 50 per cent of the gross income. Further, for an HFC, it must have 60% of the total asset towards providing finance for housing and 50% of the total assets towards individual housing finance.

Timeline for achieving the PBC

The proposed framework provides the following timelines for achieving the aforesaid PBC

Timeline Minimum percentage of total assets towards housing finance Minimum percentage of total assets towards housing finance for individuals
March 31, 2022 50 40
March 31, 2023 55 45
March 31, 2024 60 50

Existing HFCs, which currently do not fulfill the said criteria shall meet the same within the above mentioned timelines. For this purpose, the HFCs shall be required to submit a Board approved roadmap (as discussed in the ‘Actionables Box’). In case of failure to do so/achieve the PBC specific to housing loans as per the timelines, the HFC shall be treated as NBFC – Investment and Credit Companies (NBFC-ICC) and shall be required to approach the RBI for conversion to NBFC-ICC.

Definition of Housing Finance

The definition of Housing Finance provided in the Regulations is the same as that provided in the Proposed Framework for ‘qualifying asset’. Further, there is a clarification provided in the Regulations stating- “Integrated housing project comprising some commercial spaces (e.g. shopping complex, school, etc.) can be treated as residential housing, provided that the commercial area in the residential housing project does not exceed 10 percent of the total Floor Space Index (FSI) of the project.”

The aforesaid concept of integrated housing project has been drawn from the NHB Directions.

The detailed analysis of the definition of qualifying asset as compared to the erstwhile definition of Housing Finance may be referred here- http://vinodkothari.com/2020/06/comparison-between-the-proposed-and-existing-regulatory-framework-for-hfcs/

NOF requirement

The Proposed Framework stated that HFCs shall maintain a minimum NOF of Rs. 20 crores of more. The same has been retained in the Regulations. The existing NOF requirements for HFCs is Rs. 10 crores and hence, existing HFCs having a lower NOF shall be required to increase their NOF to Rs. 15 crores by March 31, 2022 and Rs. 20 crores by March 31 2023. Further, they are required to submit a statutory auditor’s certificate (as discussed in the ‘Actionables Box’). In case of failure to do so, the registration of the HFC shall be cancelled/ converted into NBFC-ICC upon request of the HFC for the same.

Definition of Tier I and Tier II Capital

The Proposed Framework provided for inclusion of PDIs in the definition of TIer I and Tier II Capital. The Regulations are silent on the same, hence, the existing definition as per the NHB Directions shall continue to be applicable

Liquidity Risk Framework (LRM) and Liquidity Coverage Ratio (LCR)

The Proposed Framework extended the applicability of the provisions of LRM and LCR to HFCs. VKC had recommended that the same should be made applicable in a phased manner. Considering the said recommendation, the RBI has clarified that the provisions of LCR are required to be met in a phased manner as per the following timelines:

 

It is noteworthy here that while the milestones for NBFC start from December 1, 2020, the milestones for HFCs shall commence from December 1, 2021. The LRM and LCR framework for NBFCs was introduced on November 4, 2020 and NBFCs were given a time period of more than a year to implement the LCR. Similarly, HFCs have also been given time to implement the same.

Exposure to group companies

The Proposed Framework provided for restriction on dual financing i.e. HFCs may choose to lend only at one level. That is, the HFC can either undertake an exposure on the group company in real estate business or lend to retail individual home buyers in the projects of group entities, but not do both.

The Proposed Regulations lacked clarity as to whether it extends to all kinds of group entities or only such entities which are engaged in real estate. VKC had made a recommendation to clarify the same since the Proposed Regulations used the phrase “HFC decides to take any exposure in its group entities”. It now seems clear that the intention is to cover in general all companies in a group engaged in real estate business and not just the group of the respective HFC.

Further, the language of the Regulations refers to group companies, however, the same shall also include any company engaged in real estate business. Hence, the HFC may either have an exposure towards a company engaged in real estate business or lend to retail individual home buyers in the projects of such company.

Considering the requirement for HFCs to do lend a major part of their portfolio to individuals and this restriction on dual financing, it seems that builder lending will be discouraged. In the present state of housing industry in the country, this should not be the intention of the regulator.

Further, the maximum exposure an HFC may have on a single entity in a group of companies shall be 15% of its owned funds and for the group shall be 25% of owned funds. These provisions are similar to the concentration norms applicable to NBFCs. However, these refer to exposure to a group engaged in real estate business. Further, the RBI shall release concentration norms for all exposures of HFCs in due course of time.

Loan To Value Ratio (LTV) requirements

The following LTV requirements have been laid down in the Regulations:

  • For loan against shares (LAS) – 50%
  • Loans against security of gold jewellery – 75%

The LTV requirement for LAS is in line with the guidelines for NBFCs and the Proposed Framework, however, the LTV requirement for gold loans was not specified in the Proposed Framework and is a new insertion.

Levy of Foreclosure Charges

The Regulations bar HFCs from charging foreclosure charges on floating rate term loans sanctioned for purposes other than business to individual borrowers. Below figure explains how foreclosure charges may/may not be charges by HFCs:

Immediate Actionables for HFCs

 

S.no. Actionable
1. All HFCs shall submit RBI a Board approved plan within three months including a roadmap to fulfil the Principal Business Criteria and timeline for such transition
2 HFCs whose NOF is currently below Rs 20 crore, will be required to submit a statutory auditor’s certificate to RBI within a month evidencing compliance with the prescribed levels as at the end of the period mentioned by RBI for complying the same. That is in the month of April, 2022 and April, 2023.

 

3. The HFCs to whom LRM framework would be applicable (more than 100 cr asset size) shall make public disclosures on quarterly basis on their website in the format given in Appendix-1 of the guidelines

HFC Vs NBFC’

A quick comparative of the provisions applicable for HFCs and NBFCs can be seen below:

Provisions/Guidelines NBFCs HFCs Similarity/

Difference

PBC 50-50 criteria In addition to 50-50 criteria, 60-50 criteria also applicable Different- Additional criteria to be fulfilled
NOF Requirement 2 crores 20 crores Different
Applicable guidelines for fraud control Master Direction – Monitoring of Frauds in NBFCs (Reserve Bank) Directions, 2016 Master Direction – Monitoring of Frauds in NBFCs (Reserve Bank) Directions, 2016 Same
Applicability of guidelines on Information Technology Master Direction – Information Technology Framework for the NBFC Sector dated June 08, 2017. Master Direction – Information Technology Framework for the NBFC Sector dated June 08, 2017. Same
Definition of public deposits As per Master Directions on Acceptance of Public Deposits Similar to that for NBFCs along with an additional point- any amount received from NHB or any public housing agency shall also be exempted from the definition of public deposit. Similar- except for an additional insertion
Implementation of Indian Accounting Standards Circular on Implementation of Indian Accounting Standards dated March 13, 2020[3] Circular on Implementation of Indian Accounting Standards dated March 13, 2020 Same
LTV Requirements for Loan Against Shares 50% 50% Same
LTV Requirements for Gold Loans 75% 75% Same
Levy of foreclosure charges NBFCs shall not impose foreclosure charges/ pre-payment penalties on any floating rate term loan sanctioned for purposes other than business to individual borrowers HFCs shall not impose foreclosure charges/ pre-payment penalties on any floating rate term loan sanctioned for purposes other than business to individual borrowers Same
Guidelines on Securitization Transactions and reset of Credit Enhancement As per Master Directions for NBFCs and other applicable circulars As applicable to NBFCs Same
Managing Risks and Code of Conduct in Outsourcing of Financial Services As per Master Directions for NBFCs As applicable to NBFCs Same
Guidelines on Liquidity Coverage Ratio As per Master Directions for NBFCs As applicable to NBFCs, as per timelines mentioned above Same
Guidelines on Liquidity Risk Management Framework: As per Master Directions for NBFCs As applicable to NBFCs Same
Exposure of HFCs to group companies engaged in real estate business: 15% of Owned Funds to single entity 25% to a group There are similar concentration norms for lending and investment Similar

 

[1] https://www.rbi.org.in/Scripts/PublicationReportDetails.aspx?UrlPage=&ID=959

[2] https://rbidocs.rbi.org.in/rdocs/notification/PDFs/NT605BE165AA9E8043EFA087339829CCF469.PDF

[3] https://www.rbi.org.in/Scripts/NotificationUser.aspx?Id=11818&Mode=0

Our related write-ups:

One-stop guide for all Regulatory Sandbox Frameworks

-Kanakprabha Jethani (kanak@vinodkothari.com)

Background

The International Financial Services Centres Authority Act, 2019 was enancted on December 19, 2019, providing powers to the International Financial Services Centres Authority (IFSCA) to regulate financial products, financial services and financial institutions in the International Financial Services Centres. Under such powers, the IFSCA has on October 19, 2020, introduced a Regulatory Sandbox (RS) framework[1], to develop a world-class FinTech hub at the IFSC located at GIFT City in Gandhinagar. Under the said framework, entities operating in the capital market, banking, insurance, and financial services space shall be granted certain facilities and flexibilities to experiment with innovative FinTech solutions in a test environment. The framework details among other things the eligibility criteria, applicability, process of application, and regulatory exemption for operating in the RS..

Further, there are already separate RS frameworks issued by the sectoral regulator for various market participants. Hence, it becomes crucial to understand the unique offering of this IFSC framework. The below write-up intends to discuss the same.

What is Regulatory Sandbox?

Regulatory sandboxes or RS is a framework that allows innovative projects to undergo live testing in a controlled environment where the regulator may or may not permit certain regulatory relaxations or may provide certain additional facilities for testing.

The objective is to allow new and innovative projects to conduct live testing and enable the approach of learning by doing. RSs are created to facilitate the development of potentially beneficial innovations, which are otherwise barred to operated due to the construct of the existing regulatory framework of the country.

We have a separate write-up on the concept, benefits, limitations and the history of RS, which may be referred here- http://vinodkothari.com/2019/04/safe-in-sandbox-india-provides-cocoon-to-fintech-start-ups/

Basic features of the IFSC RS Framework

The framework allows any person, including individuals, to make an application under the RS. This is a unique feature that allows not only businesses but students, researchers as well as professionals to apply. However, there is a geographical limit to this RS. It can only operate within IFSC GIFT city. Further, considering the need for information in such projects, the framework, as an additional step, shall provide the participants with access to market-related data, particularly, trading and holding data, which is otherwise not readily available, to enable them to test their innovations effectively before the introduction of such innovations in a live environment.

Comparison of basic features of various RS frameworks

Features IFSC framework RBI framework[2] SEBI framework[3] IRDA framework[4]
Frequency of application This is an on-tap framework. Hence, an application may be made anytime. Based on the cohort framework i.e. end-to-end sandbox. The RBI rolls out a theme based cohort, say digital payments, under which fintech intending to provide services relating to the theme shall apply.[5]

 

Applications can be made only when a cohort is live.

This is an on-tap framework. Hence, an application may be made anytime Based on the cohort approach.[6]
Applicability/Eligibility to apply Following intending to operate in the IFSC GIFT city.

·   All entities registered with SEBI, RBI,  IRDAI and PFRDA

·   All startups registered with Startup India and meeting the criteria of a start-up[7]

·   Companies incorporated and registered in India

·   Companies  incorporated  and  regulated  in FATF compliant  jurisdictions

·   Individuals who are citizens of India

·   Individuals from FATF compliant jurisdiction[8]

Fintech companies including startups, banks, financial institutions and any other company partnering with or providing support to financial services businesses which satisfies the detailed eligibility criteria laid down.[9] Entities registered with SEBI under section 12 of SEBI Act, 1992 ·   Insurers

·   Insurance intermediaries

·    any person (other than individual) having net worth of Rs. 10 lakhs or more in the previous financial year

·   Any other person recognized by IRDAI

Purpose Adding significant value to the existing offering in the capital market, banking, insurance or pensions sector in India/IFSC. For the introduction of innovative Products/Services in retail payments, money transfer services, marketplace lending, digital KYC, financial advisory services, wealth management services, digital identification services, smart contracts, financial inclusion products, cybersecurity products, mobile technology applications, data analytics, API services, applications under blockchain technologies, Artificial Intelligence and Machine Learning applications Adding  significant  value to the existing offering in the Indian securities market For promoting or implementing innovation in

insurance in India in any one or more of the following categories:

(a) Insurance Solicitation or Distribution

(b) Insurance Products

(c) Underwriting

(d) Policy and Claims Servicing

(e) Anv other category recognised by the Authority.

Timeline for review of the application 30 working days Around 4 weeks + 4 weeks + 3 weeks (including preliminary screening, test design, and application assessment) 30 days No timeline prescribed under the regulations
Testing duration Maximum 12 months, extendable upon request Maximum 12 weeks, extendable on request Maximum 12 months, extendable upon request Maximum 6 months, extendable on request
Exclusions No such exclusions

 

 

 

 

 

 

 

 

 

 

RS  shall not be available for the following:

·       Credit registry

·       Credit information

·       Crypto currency/Crypto assets services

·       Trading/investing/settling in crypto assets

·       Initial Coin Offerings, etc.

·       Chain marketing services

·       Any product/services which have been banned by the regulators/Government of India.

 

No such exclusions No such exclusions
Extending or exiting the RS ·      At the end of the testing period, relaxations provided on regulatory requirements shall expire.

·      Upon completion of testing, IFSCA shall decide whether to permit the innovation to be introduced.

·      The applicant may request for an extension period

·      The applicant may exit the sandbox on its own by giving a prior notice to IFSCA.

·      At the end of the sandbox period, the relaxations provided will expire and the entity must exit the RS.

·      In case an extension is required, the entity should apply to the RBI at least 1 month before the expiration thereof extended period.

·      The entity may also exit from the RS by informing the RBI, 1 month in advance.

·      At the end of the testing period, relaxations provided on regulatory requirements shall expire.

·      Upon completion of testing, SEBI shall decide whether to permit the innovation to be introduced.

·      The applicant may request for an extension period

·      The applicant may exit the sandbox on its own by giving a prior notice to SEBI.

·      Applicant may request IRDAI for extension for a maximum of 6 months

·      Applicant shall submit a report within 15 days of completion of testing period on how the proposal met the stated objectives, based on which the project may be launched under the extant regulatory framework

Revocation of the approval IFSCA may revoke the approval at any time before the end of the testing period, if the applicant:

·   fails to carry out risk mitigants.

·   Submits false information or conceals material facts in the application

·   Contravenes any applicable law

·   Suffers a loss of reputation

·   Undergoes into liquidation

·   Carries on business in a manner detrimental to users or the public

·   Fails to   address any   defects in the   project

·   Fails to implement directions given by IFSCA

The testing will be discontinued any time at the discretion of the RBI:

·   if the entity does not achieve its intended purpose

·   if the entity is unable to comply with the relevant regulatory requirements and other conditions

·   if the entity has not acted in the best interest of consumers

SEBI may revoke the approval at any time before the end of the testing period, if the applicant:

·   fails to carry out risk mitigants

·   Submits false information or conceals material facts in the application

·   Contravenes any applicable law

·   Suffers a loss of reputation

·   Undergoes into liquidation

·   Carries on business in a manner detrimental to users or the public

·   Fails to   address any   defects in the   project

·   Fails to implement directions given by IFSCA

The Chairperson of the IRDAI may revoke the permission so granted at any time, if it is of the view that the

activities carried out are not meeting the prescribed conditions/ are in violation of the provisions of applicable laws.

 

Conclusion

The IFSC RS framework seems to be drafted on lines of the RS framework issued by the SEBI. The only differentiating factor is the inclusion of all kinds of applicants operating for various purposes. Each of the frameworks discussed above has their peculiarities, and hence, the suitability to one’s design of business may vary. None of the RSs other than the ones introduced by IRDAI have been able to reap any concrete results lately. However, with the growing acceptance of technology, it is only a matter of time before we see various kinds of innovations in the way we transact every day.

 

[1] https://ifsca.gov.in/Viewer/Index/99

[2] https://www.rbi.org.in/Scripts/PublicationReportDetails.aspx?UrlPage=&ID=938

[3] https://www.sebi.gov.in/legal/circulars/jun-2020/framework-for-regulatory-sandbox_46778.html

 

[4] https://www.irdai.gov.in/ADMINCMS/cms/frmGeneral_NoYearLayout.aspx?page=PageNo3886

[5] After the introduction of the framework in August 2019, only 1 cohort has been announced i.e. in November 2019 themed ‘Retail Payments’ (https://www.rbi.org.in/Scripts/BS_PressReleaseDisplay.aspx?prid=48550)

[6] After introduction of Insurance Regulatory and Development Authority of India (Regulatory Sandbox) Regulations, 2019 in July 2019, 2 cohorts have been introduced:

[7] Definition of startups- https://www.startupindia.gov.in/content/dam/invest-india/Templates/public/198117.pdf

[8]List of FATF compliant jurisdictions- https://www.fatf-gafi.org/countries/

[9] Refer- http://vinodkothari.com/2019/04/safe-in-sandbox-india-provides-cocoon-to-fintech-start-ups/

 

Other related write-ups:

 

 

Modes of Restructuring of Stressed Accounts

Our detailed write-ups on these frameworks may be referred here: