Archive for category: NBFCs

By Simran Jalan (finserv@vinodkothari.com)

Introduction

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

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

Categories of priority sector

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

PSL target

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

Existing Scenario

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

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

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

Co-lending regulations awaited

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

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

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

Conclusion

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

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

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

By Vishes Kothari (vishes@vinodkothari.com)

Updated by Kumari Kirti | Finserv | July 06, 2022 | finserv@vinodkothari.com

With the proliferation of retail lending NBFCs offering a variety of traditional and innovative products, there has been a rise in the number of credit backed card based payment instruments in the market. These instruments are issued in different shapes and forms. Some are structured as credit cards, some as virtual cards, some as prepaid instruments, and some as EMI cards.

But while structuring any of the above, one inevitable question that everyone has to face is – is the card taking a shape of credit card? This is because NBFCs naturally are not allowed to issue credit cards, and issuance of credit cards by NBFCs are highly regulated.

Though this write-up aims to discuss each of the above structures, however, the central theme will revolve around the meaning of credit card, and whether or not each of the aforementioned instruments will fit into the definition of credit cards.

Credit Card: Defining features

Before examining the payment instruments, other than credit cards, prevalent in the market, it may be worthwhile to lay down the defining features of credit cards.

Despite being in use for quite some time now, the definition of term ‘credit card’ was introduced only in 2022 under the Reserve Bank of India (Credit Card and Debit Card – Issuance and Conduct) Directions, 2022^[1] (Directions) dated April 21, 2022. Clause 3 (a) (xii) of the Directions defines ‘credit card’ as

 “a physical or virtual payment instrument containing a means of identification, issued with a pre-approved revolving credit limit^[2] that can be used to purchase goods and services or draw cash advances, subject to prescribed terms and conditions.”

Hence, an instrument shall be treated as a credit card if fulfills the following features:

1. There is a payment instrument^[3]-it may be either physical or virtual;
2. It contains a means of identification – typically, the identification is done by the card number which has the BIN, as well as unique identification of the card;
3. It implies a conferment of a pre-approved credit line by the issuer to the cardholder;
4. The line of credit is revolving^[4] in nature;
5. Instrument can be used to (a) purchase goods and services;  or (b) draw cash advances.

The above mentioned definition contains some of the key features which brought about clarity in one’s understanding of what a credit card is. Further, as far as credit card business for NBFCs is concerned, the said Direction provides a complete guideline on eligibility and permissibility of an NBFC to issue credit cards. We have our detailed write-up on ‘Credit Card Business for NBFCs’^[5] with respect to the said Directions.

As already mentioned, prior to this, there was no direct definition of the credit card to be found in Indian laws and regulations issued by the RBI. This is because before the advent of new technologies resulting in new products, it was generally quite clear as to what was meant by a credit card facility. A card meant what looked like a card – the piece of plastic that one would keep in one’s pocket or wallet and use for making payments at merchant outlets.. There are, however, definitions provided by certain authorities which appeared quite convenient to apply in the financial services sector. Some are discussed below:

 1.    UK Law

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

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

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

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

(c) a trading check;

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

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

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

The features of a credit card one could get from the above definition are:

1. A payment card;
2. Holder permitted to discharge (i.e. to make payments) up to the limit of outstanding balance on his card;
3. Utilisation of amount on or before the expiry of specified period.

However, the said definition did not provide for certain clarifications:

1. Whether the virtual card should also be included in ‘payment card’?
2. Is the permissible limit as mentioned therein means revolving line of credit?
3. Can the card be used for cash withdrawals? (use of card not clearly mentioned)

2.    International Monetary Fund (IMF)

Another definition has been provided in the  Financial Access Survey Guidelines and Manual, March 2019 of IMF^[6]. It states that:

“Credit cards are a type of payment card indicating that the holder has been granted a line of credit. It enables the holder to make purchases and/or withdraw cash up to a prearranged ceiling; the credit granted can be settled in full by the end of a specified period or can be settled in part, with the balance taken as extended credit. Interest is charged on the amount of any extended credit and the holder is sometimes charged an annual fee.”

 The credit card thus would be such cards which fulfills following:

1. A payment card;
2. Backed by a line of credit;
3. Can be used to make purchases and/or withdraw cash up to a prearranged ceiling, that is to say, upto the extent of credit provided by the issuer during the time of issue.

It is more specific than that provided under UK law above, but still lacks the clarity on following:

1. Whether the virtual card should also be included in ‘payment card’?
2. Is the line of credit revolving or not?

3.    ‘A glossary of terms used in payments and settlement systems’ by Basel Committee

Further, there is a definition provided by Basel Committee in ‘glossary of terms used in payments and settlement systems’^[7]  which states that:

“Credit Card: a card indicating that the holder has been granted a line of credit. It enables the holder to make purchases and/or withdraw cash up to a prearranged ceiling; the credit granted can be settled in full by the end of a specified period or can be settled in part, with the balance taken as extended credit. Interest is charged on the amount of any extended credit and the holder is sometimes charged an annual fee.”

 The features if credit card that we get from above definition are:

1. A card;
2. Holder granted with a line of credit;
3. Can be used to make purchases and/or withdraw cash up to a prearranged ceiling, that is to say, upto the extent of credit provided by the issuer during the time of issue.

This definition is more or less similar to what has been defined by the IMF. Therefore, the issue remains the same as mentioned above.

4.    Regulation (EU) 2015/751 of the European Parliament and of the Council of 29 April 2015 on interchange fees for card-based payment transactions ^[8]

The term ‘credit card’ has also been defined under this regulation. It states that:

“Credit card’ means a category of payment instrument that enables the payer to initiate a credit card transaction.

 ‘Credit card transaction’ means a card-based payment transaction where the amount of the transaction is debited in full or in part at a pre agreed specific calendar month date to the payer, in line with a prearranged credit facility, with or without interest.”

The above definitions bring out the following features of a credit card:

1. A category of payment instrument;
2. Enables payer (holder) to initiate transaction;
3. Has a prearranged credit facility.

It again does not give a clear definition of credit card. The areas which remain unclear under this definition are:

1. Whether the payment instrument includes a virtual card?
2. Payment transaction does not specify where the said card can be used.
3. Is the credit facility revolving in nature or not?

 5.    15 U.S. Code § 1602 – Definitions and rules of construction

Further, one could find credit cards defined in U.S. code.^[9] It states that:

“(l) The term “credit card” means any card, plate, coupon book or other credit device existing for the purpose of obtaining money, property, labor, or services on credit.

 The term “credit” means the right granted by a creditor to a debtor to defer payment of debt or to incur debt and defer its payment.”

The definition in this case is ambiguous. It says that any card used for the purpose of obtaining money, property, labor, or services on credit is a credit card. There are many cards with a credit line that can be used for payment, such as prepaid card or Buy Now Pay Later cards. The said definition can mean to include these cards as well. Further, the credit facility is of revolving nature or not is also not clarified.

6.    Supreme Court of United States

The supreme court of the US in the case of OHIO v. American Express Co.^[10] provides for certain features of a credit card. Para IA states following:

“Credit cards have become a primary way that consumers in the United States purchase goods and services. When a cardholder uses a credit card to buy something from a merchant, the transaction is facilitated by a credit card network. The network provides separate but interrelated services to both cardholders and merchants. For cardholders, the network extends them credit, which allows them to make purchases without cash and to defer payment until later. Cardholders also can receive rewards based on the amount of money they spend, such as airline miles, points for travel, or cash back. For merchants, the network allows them to avoid the cost of processing transactions and offers them quick, guaranteed payment. This saves merchants the trouble and risk of extending credit to customers, and it increases the number and value of sales that they can make.”

A credit card thus will be having following features:

1. Can be used to buy something from a merchant;
2. Transaction is facilitated by credit card network;
3. The network extends a credit to cardholder.

Even though the said case does not explicitly define what a credit card is, one could refer to the case while interpreting the meaning of credit card..

7.    The Truth in Lending Act (TILA)

The definition provided under TILA, 1968 which is a United States Federal Law, is as under:

“(15)(i) Credit card means any card, plate, or other single credit device that may be used from time to time to obtain credit.

(ii) Credit card account under an open end (not home-secured) consumer credit plan means any open-end credit account that is accessed by a credit card, except:

(A) A home-equity plan subject to the requirements of §226.5b that is accessed by a credit  card; or

(B) An overdraft line of credit that is accessed by a debit card or an account number.

 (20) Open-end credit means consumer credit extended by a creditor under a plan in which:

(i) The creditor reasonably contemplates repeated transactions;

(ii) The creditor may impose a finance charge from time to time on an outstanding unpaid balance; and

(iii) The amount of credit that may be extended to the consumer during the term of the plan (up to any limit set by the creditor) is generally made available to the extent that any outstanding balance is repaid. “

The features of credit card one can get from above  definitions are:

1. It is any card, plate, or other single credit device;
2. Can be used to obtain credit;
3. Open-ended credit can be accessed with such cards.

Going through the above definitions, we can say that these did not have very clearly defined credit cards but have provided for details which one could refer to in the financial service sector earlier. Further, with the notification of Master Direction and an explicit definition of ‘Credit Card’ has solved many issues pertaining to defining features of a credit card, at least in India.

Having established the essential features of a credit card, let us examine the different credit products as discussed earlier.

The case of virtual credit-cards

New technologies have led to the development of various new products and variants of traditional credit card facilities. One such development is the ‘virtual credit cards’ which function via a downloadable app or other software and eliminate the need for a plastic card altogether. Because there was no specific definition provided for credit cards in any of the Indian Laws and regulations issued  by RBI, earlier, and that the NBFCs were restricted to issue credit cards, the question that sprung up then was whether such virtual cards to be considered as ‘credit cards’ and hence, is it that only the NBFCs eligible to issue credit cards may issue the virtual variants?

Now, with the notification of the master direction on credit & debit card issuance on April 21, 2022, the clarity on the same has also been provided. The direction precisely defines a credit card as any physical or ‘virtual’ instrument. The features, therefore, of these cards are similar to that of a physical credit card but  will have a digital/virtual presence. One positive point of virtual credit cards is that it reduces risk of exposing the underlying card details to vendors or anyone.

The said Master Direction will regulate the virtual credit card as well. As such, all the restrictions or approval requirements which are on NBFCs, will be the same in case of issuance of virtual credit cards. 

EMI Cards

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

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

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

An EMI card is an instrument which is mostly used to finance purchase consumer goods by the holder of the card, whereas credit card are being used to pay for any kind of expenses of the holder. The issuer of an EMI card is able to have greater control over its usage by the holder as compared to a credit card issuer. The usage of such cards would be restrictive.

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

In light of the definition of the credit card under the Master Directions, an EMI card will not be treated as a credit card because even though the card is backed by a line of credit, but not a revolving one. Also, unlike credit cards, which do not come with restrictions on usage, EMI cards can be used only at places which have arrangements with the issuer.

Loan-Loaded Prepaid Payment Instruments

Another type of card prevailing in the market is the Prepaid Payment Instruments (PPIs) backed by credit or the Loan-loaded Prepaid Payment Instruments. The common structure of such cards entails the following:

• There is a payment instrument, either physical or virtual
• Instrument can be used to purchase goods and services or draw cash advances
• Such payment instruments is backed by credit lines

There is no specific recognition of Loan-Loaded PPIs provided by the regulator under RBI regulation. However, RBI has provided definition for PPIs in the Master Direction for PPI dated August 27, 2021^[11]. It defines PPIs as:

“Instruments that facilitate purchase of goods and services, financial services, remittance facilities, etc., against the value stored therein. PPIs that require RBI approval / authorisation prior to issuance are classified under two types viz. (i) Small PPIs, and (ii) Full-KYC PPIs.”

The PPIs may be issued by  banks, as well as non-banks, however, based on prior authorisation of the RBI.

The functioning of loan-load PPIs is that the card is issued to a holder and provided with an option to load  the same with a credit line given by a third party. The structure of loan-loaded PPIs are intended to mimic or functionally equate with a credit card issued by banks. Even though these structures have been prevailing in the Indian Market since long, RBI has raised concerns on the same. ​RBI’s concern is that the main purpose of a PPI license is to act as a payment instrument and not as a credit instrument, however, fintechs have been using this as a channel to load credit. As per RBI, entities not permitted to issue credit cards are providing these PPIs that resemble the features of a credit card without complying with the provisions of Credit Card Directions. We have discussed in detail on ‘The future of Loan-Loaded Prepaid Instruments’ in our write-up^[12].

Conclusion

Currently, there are a variety of credit backed payment instruments prevailing in the market that are structured in different forms. The involvement of NBFCs as credit facility providers in such structures has raised questions on the legal nature of these cards- whether they fall under the category of Credit Card or not. With the notification of RBI’s Master Direction on credit and debit card issuance on April 21, 2022, it seems that the clarity on the same has been provided. The direction explicitly defines what a credit card is and how it will be regulated. Henceforth, the issuer may determine whether any such credit-backed payment instruments qualify as credit cards by comparing their features to those of credit cards offered in accordance with these guidelines.

 

^[1] https://rbi.org.in/Scripts/BS_ViewMasDirections.aspx?id=12300

^[2] Credit Limit has been defined as the maximum amount of revolving credit determined and notified to the cardholder to transact in the credit card account. [para 3(a)(xiii)]

^[3] Payment Instrument: any instrument enabling the holder/user to transfer funds. (Glossary terms used in PSS by BIS)

^[4] A revolving line of credit is a mode of lending wherein the lender agrees to lend an amount equal to or less than a pre-determined credit limit, as approved for the borrower.  In our write-up on Personal revolving lines of credit by NBFCs: nuances and issues, a clear distinction was established between revolving lines of credit and credit cards

^[5] Our write-up on The credit card business for NBFCs

^[6] https://data.imf.org/api/document/download?key=60927737

^[7] https://www.bis.org/cpmi/glossary_030301.pdf

^[8] https://eur-lex.europa.eu/legal-content/EN/TXT/?uri=celex%3A32015R0751

^[9] https://www.law.cornell.edu/uscode/text/15/1602

^[10]https://www.supremecourt.gov/opinions/17pdf/16-1454_5h26.pdf    

^[11] https://www.rbi.org.in/Scripts/BS_ViewMasDirections.aspx?id=12156#MD

^[12] Our write up on The future of loan-loaded PPIs.

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