Co-lending arrangement between Banks and NBFCs for PSL

By Simran Jalan (finserv@vinodkothari.com)

Introduction

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

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

Categories of priority sector

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

PSL target

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

Existing Scenario

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

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

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

Co-lending regulations awaited

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

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

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

Conclusion

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


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

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

Credit Cards and EMI Cards From an NBFC Viewpoint

By Vishes Kothari (vishes@vinodkothari.com)

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

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

Credit Card: Defining features

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

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

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

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

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

(c) a trading check; 

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

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

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

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

 

Who can issue credit cards?

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

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

  1. Issue of Credit Card

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

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

The case of virtual credit-cards

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

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

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

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

 

EMI CARDS

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

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

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

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

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

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

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

GST council throws cold water on financial lease transactions

By Abhirup Ghosh(abhirup@vinodkothari.com) & Anita Baid(anita@vinodkothari.com)

Read more

Transitory liberalisation of asset classification norms for MSMEs

by Yutika Lohia and Anita Baid (finserv@vinodkothari.com)

With the advent of GST in the Indian economy, all three sectors i.e. Agriculture, Industry and Service, have been facing several challenges. Majority of small entities in the country have been impacted in some way or the other, irrespective of whether they required registration under GST or not. MSMEs requiring registration faced difficulties due to disruption of their business for ensuring compliance with the new regime. Even unregistered MSMEs faced complications as they were dealing with businesses which were directly disrupted due to GST implementation eventually effecting their cash flows to honour financial obligations. In response to the worries of small enterprise, the government has introduced several relaxation so as to enable them to adopt themselves with the revolutionary change of indirect taxation scheme being implemented in the country. Certainly the cash flows of the micro, small, medium enterprises (MSMEs) sector has been adversely affected with this new GST regime and such entities whether registered or not under GST, who have taken financial assistance are definitely facing problems to pay off their debts. Read more

Governmment NBFCs to stand on equal footing

 

Anita Baid, Senior Manager (anita@vinodkothari.com)
Rajeev Jhawar, Executive (finserv@vinodkothari.com)

 

Section 2(45) of the Companies Act, 2013 defines a Government Company as –

“any company in which not less than fifty-one per cent of the paid-up share capital is held by the Central Government, or by any State Government or Governments, or partly by the Central Government and partly by one or more State Governments, and includes a company which is a subsidiary company of such a Government company.”

A Government Company registered with the Reserve Bank of India (RBI) as a Non-Banking Finance Company (NBFC) is referred to as Government-owned NBFC or Government NBFC. As on March 2017, the count of Government NBFCs-NDSI was around 15 with an asset size of Rs.6280 billions and there were 2 deposit accepting NBFCs with an asset size of Rs.273 billion[1]. These Government NBFCs were earlier exempted from various regulatory and statutory provisions issued by the RBI for NBFCs.

In view of a regulatory regime for the financial sector, it has been a long drawn proposal of RBI to bring all deposit taking and systemically important government owned companies under the provisions of the same guidelines. Considering the same the RBI has eliminated regulatory exemptions for government-owned NBFCs vide its notification no. DNBR (PD) CC.No.092/03.10.001/2017-18 dated May 31, 2018[2]. The RBI has specified a roadmap, extending till 2021-22, for the Government NBFCs to meet the norms on capital adequacy, provisioning and corporate governance at par with the other NBFCs. The NBFC regulations shall be applicable to Government NBFCs as per the timeline indicated in the notification.

Previously, Government NBFCs were advised vide DNBS.PD/CC.No. 86/03.02.089/2006-07 dated December 12, 2006 to submit to the Reserve Bank [Department of Non-Banking Supervision – (DNBS)] a road map for compliance with the various elements of the NBFC regulations, in consultation with the Government. Hence, the current notification provides that Government NBFCs that are already complying with the prudential regulation as per the road map submitted by them shall continue to follow the same.

We have tried to list down the major provisions and the applicability on Government NBFCs post the withdrawal of exemption:

Relevant provision With exemption Without exemption
Reserve Bank of India Act, 1934
Sections 45-IB

Maintenance of percentage of assets – 15% of the outstanding deposits

Not required Government NBFCs will be required to maintain a percentage of asset as investment in unencumbered approved securities as per the following timeline:

 

March 31, 2019 – 5% of outstanding deposits

March 31, 2020 – 10% of outstanding deposits

March 31, 2021 – 12% of outstanding deposits

March 31, 2022 – 15% of outstanding deposits

 

Section 45-IC

Every non-banking financial company shall create a reserve fund and transfer therein a sum not less than twenty per cent of its net profit every year as disclosed in the profit and loss account and before any dividend is declared.

Not required By March 31, 2019, the Government NBFCs shall be required to transfer at least 20% of its net profit to the statutory reserve fund
Master Direction – Non-Banking Financial Company – Systemically Important Non-Deposit taking Company and Deposit taking Company (Reserve Bank) Directions, 2016
Income Recognition

The income recognition shall be based on recognized accounting principles. The income recognition shall be based on recognized accounting principles. Income including interest/ discount/ hire charges/ lease rentals or any other charges on NPA shall be recognized only when it is actually realized. Any such income recognized before the asset became non-performing and remaining unrealized shall be reversed.

Not Required Government NBFC-SI and deposit taking, will be required to recognize income in accordance with accounting principles for FY ending March 31, 2019.
Asset Classification

An asset, in respect of which, interest has remained overdue for a period of 90 days or more shall be classified as NPA.

Not Required Government NBFC-SI and deposit taking shall classify an asset as a NPA if the interest has remained overdue for a period of

1.       120 days or more for the financial year ending March 31, 2019

2.       90 days or more for the financial year ending March 31, 2020 and thereafter.

 

Provisioning Requirement

Every applicable NBFC shall make provisions for

·         standard assets at 0.40 per cent by the end of March 2018 and thereafter of the outstanding, which shall not be reckoned for arriving at net NPAs.

·         loss asset: the entire asset shall be written off.

·         sub-standard assets: A general provision of 10 percent of total outstanding shall be made.

·         doubtful asset: 100% provision to the extent to which the advance is not covered by the realizable value of the security to which the applicable NBFC has a valid recourse shall be made. The realizable value is to be estimated on a realistic basis and also

Period for which the asset has been considered as doubtful
Up to one year 20%
One to three years 30%
More than three years 50%

 

 

Not Required Government NBFC-SI and deposit taking, will be required to comply with the prescribed requirement in totality for the financial year ending March 31, 2019 and thereafter.
Capital Adequacy

The NBFC shall maintain CRAR of 15 percent (with a minimum Tier I capital of 10 percent)

Not Required Government NBFC-SI and deposit taking will have to comply with capital adequacy ratio as mentioned in the table below:

CRAR of 10% (min Tier I – 7%;  March 31, 2019
CRAR of 12% (min Tier I – 8%) March 31, 2020
CRAR of 13% (min Tier I – 9%) March 31, 2021
CRAR of 15% (min Tier I – 10%) March 31, 2022

 

 

Concentration of Credit Investment

No applicable NBFC shall,

(i) lend to

(a) any single borrower exceeding fifteen per cent of its owned fund; and

(b) any single group of borrowers exceeding twenty-five per cent of its owned fund;

(ii) invest in

(a) the shares of another company exceeding fifteen per cent of its owned fund; and

(b) the shares of a single group of companies exceeding twenty-five per cent of its owned fund; (iii) lend and invest

(loans/investments taken together) exceeding (a) twenty five per cent of its owned fund to a single party; and (b) forty per cent of its owned fund to a single group of parties.

 Not Required Government NBFCs, set up to serve specific sectors may approach the RBI for exemptions, if any.

 

For other NBFC-SI and deposit taking, the timeline for ensuring the compliance is FY March 31, 2022

Corporate Governance

All applicable NBFCs shall adhere to following requirements in order to ensure good corporate governance

·         Formation of various committees

·         Fit and proper criteria for directors

·         Disclosure and Transparency

·         Rotation of partners of the Statutory Auditors Audit Firm

·         Framing of Internal Guidelines

Not required Government NBFC-SI and deposit taking, are required to adhere to corporate governance guidelines for the financial year March 31, 2019 and thereafter.
Conduct of Business Regulations (Fair Practices Code) Not required Government NBFC-SI and deposit taking, are required to adhere to fair practices code for the financial year March 31, 2019 and thereafter.
Master Direction – Non-Banking Financial Company – Non-Systemically Important Non-Deposit taking Company (Reserve Bank) Directions, 2016
Income Recognition

The income recognition shall be based on recognized accounting principles. Income including interest/ discount/ hire charges/ lease rentals or any other charges on NPA shall be recognized only when it is actually realized. Any such income recognized before the asset became non-performing and remaining unrealized shall be reversed.

Not Required Government NBFC-NSI will be required to recognize income in accordance with accounting principles dated March 31,2019
Asset Classification

An asset, in respect of which, interest has remained overdue for a period of 180 days or more shall be classified as NPA.

Not Required Government NBFC-NSI shall classify an asset as a NPA if the interest has remained overdue for a period of

1.       180 days or more for the financial year ending March 31, 2019 and thereafter.

 

Leverage Ratio

The leverage ratio of an applicable NBFC shall not be more than 7 at any point of time, with effect from March 31, 2015.

Not Required A roadmap for adherence by March 31, 2022 to be prepared by the Government NBFC-NSI.
Master Direction – Non-Banking Financial Companies Acceptance of Public Deposits (Reserve Bank) Directions, 2016
Minimum Credit Rating

To get rated by approved Credit Rating Agencies

Not Required Government NBFC-D shall obtain Investment Grade Credit rating for acceptance of public deposits- March 31, 2019.

 

A Government NBFC-D having investment grade credit rating can accept deposits only up to 1.5 times of its NOF. Government NBFCs holding deposits in excess of the limit shall not access fresh deposits or renew existing ones till they conform to the limit, the existing deposits will be allowed to run off till maturity.

Other Deposit Directions Not required All other directions shall apply from Balance Sheet dated March 31, 2019.

 

The removal of exemption benefits for Government NBFCs shall ensure that both types of NBFCs stand at par in terms of compliance with specific RBI regulations. This would also result in intensifying the competition between the two types of ownership structures.


[1] RBI Annual Publication- Trend and Progress of Banking in India

[2] https://www.rbi.org.in/Scripts/NotificationUser.aspx?Id=11283&Mode=0

FDI in financial services sector: restrictions brought back but for unregulated entities

RBI’s First Monetary Policy for FY 2018-19

Anita Baid

finserv@vinodkothari.com

 

The Reserve Bank of India (RBI) released its first monetary policy statement for FY 2018-19 on April 05, 2018[1] (‘Policy Statement’). The aforesaid statement sets out various developmental and regulatory policy measures for the financial sector. It aims at strengthening regulation and supervision; broadening and deepening financial markets; improving currency management; promoting financial inclusion and literacy; and, facilitating data management. Some of the major issues from the Policy Statement have been discussed herein below: Read more