Special Liquidity Scheme – providing short term liquidity relief for NBFCs

Timothy Lopes | Senior Executive

Vinod Kothari Consultants

finserv@vinodkothari.com

In light of the disruption caused by the pandemic, the Government of India announced a Rs. 20 lakh crores economic stimulus package. The first of the several reforms were announced on 13th May, 2020 which announced the Emergency Credit Line, the partial credit guarantee scheme 2.0 (PCG 2.0), TLTRO 2.0 and much more.

The PCG 2.0 scheme permitted banks to purchase CPs and bonds issued by NBFCs/MFIs/HFCs. These purchases were then guaranteed by the Government of India up to 20% of the first loss. For more details of the scheme see our write up here.

The announcement also proposed launching a Rs. 30,000 crores “Special Liquidity Scheme” for NBFCs/HFCs including MFIs. The Cabinet approved this scheme on 20th May, 2020[1].

On 1st July, 2020, RBI has released the details of the Special Liquidity Scheme[2]. The scheme is intended to avoid potential systemic risk to the financial sector. The scheme seems to be a short term relief for NBFCs acting as a bail-out package for near term maturity debt instruments. The scheme is intended to supplement the existing measures already introduced by the Government.

The scheme will provide liquidity to eligible NBFCs defined in the notification which is similar to the eligibility criteria specified under the PCG 2.0 scheme. The Government will implement the scheme through SBICAP which is a subsidiary of SBI. SBICAP has set up a SPV called SLS Trust to manage the operations. More details about the trust can be found on the website of SBICAP[3].

Under the scheme, the SPV will purchase the short-term papers from eligible NBFCs/HFCs.  RBI will provide liquidity to the Trust depending on actual purchases by the Trust. The utilisation of proceeds from the scheme will be only towards the sole purpose of extinguishing existing liabilities.

Eligible instruments

Instruments eligible for the scheme are relatively short term. The scheme specifies that CPs and NCDs with a residual maturity of not more than three months (90 days) and rated as investment grade will be eligible instruments. These dates, however, may be extended by Government of India. The SPV would invest in securities either from the primary market or secondary market subject to the conditions mentioned in the Scheme.

The actual investment decisions will be taken by the Investment Committee of the SPV.

Validity of the Scheme

The scheme is available only up to 30th September, 2020 as the SPV will cease to make purchases thereafter and would recover all the dues by 31st December, 2021 or any other date subsequently modified.

Investment by the SPV

The SPV set up under the scheme comprises of an investment committee. The investment committee will decide the amount to be invested in a particular NBFC/HFC. The FAQs available on the website of SBICAPs specifies that the Trust shall invest not more than Rs. 2000 crores on any one NBFC/HFC subject to them meeting conditions specified in the scheme. The Trust may have allocation up to 30% to NBFCs/HFCs with asset size of Rs. 1000 crores or less.

Rate of Return and collateral

Rate of Return (RoR) and other specifics under the scheme will likely be based on mutual negotiation between the NBFCs and the trust. According to the FAQs, the yield on securities invested by SPV shall be decided by the Investment Committee subject to the provisions of the scheme.

The Trust may also require an appropriate level of collateral from the NBFCs/ HFCs as specified under the FAQs.

Conclusion

The scheme is a welcome move likely to provide sufficient liquidity to the NBFC sector for the near term and act as a bail-out package for their short term liabilities.

The press release dated 20th May, 2020, approving the Special Liquidity Scheme states that “Unlike the Partial Credit Guarantee Scheme which involves multiple bilateral deals between various public sector banks and NBFCs, requires NBFCs to liquidate their current asset portfolio and involves flow of funds from public sector banks, the proposed scheme would be a one-stop arrangement between the SPV and the NBFCs without having to liquidate their current asset portfolio. The scheme would also act as an enabler for the NBFC to get investment grade or better rating for bonds issued. The scheme is likely to be easier to operate and also augment the flow of funds from the non-bank sector.”

Our related write ups may be viewed below –

http://vinodkothari.com/2020/05/pcg-scheme-2-0-for-nbfc-pooled-assets-bonds-and-commercial-paper/

http://vinodkothari.com/2020/05/guaranteed-emergency-line-of-credit-understanding-and-faqs/

http://vinodkothari.com/2020/05/self-dependent-india-measures-concerning-the-financial-sector/

http://vinodkothari.com/2020/04/would-the-doses-of-tltro-really-nurse-the-financial-sector/

[1] https://pib.gov.in/PressReleasePage.aspx?PRID=1625310

[2] https://www.rbi.org.in/Scripts/NotificationUser.aspx?Id=11925&Mode=0

[3] https://www.sbicaps.com/index.php/sls-trust/

RBI guidelines on governance in commercial banks

Vinita Nair | Senior Partner

Vinod Kothari & Company

vinita@vinodkothari.com

Extension of FPC on lending through digital platforms

A new requirement or reiteration by the RBI?

– Anita Baid (finserv@vinodkothari.com)

Ever since its evolution, the basic need for fintech entities has been the use of electronic platforms for entering into financial transactions. The financial sector has already witnessed a shift from transactions involving huge amount of paper-work to paperless transactions[1]. With the digitalization of transactions, the need for service providers has also seen a rise. There is a need for various kinds of service providers at different stages including sourcing, customer identification, disbursal of loan, servicing and maintenance of customer data. Usually the services are being provided by a single platform entity enabling them to execute the entire transaction digitally on the platform or application, without requiring any physical interaction between the parties to the transaction.

The digital application/platform based lending model in India works as a partnership between a tech platform entity and an NBFC. The technology platform entity or fintech entity manages the working of the application or website through the use of advanced technology to undertake credit appraisals, while the financial entity, such as a bank or NBFC, assumes the credit risk on its balance sheet by lending to the customers who use the digital platform[2].

In recent times many digital platforms have emerged in the financial sector who are being engaged by banks and NBFCs to provide loans to their customers. Most of these platforms are not registered as P2P lending platform since they assist only banks, NBFCs and other regulated AIFIs to identify borrowers[3]. Accordingly, electronic platforms serving as Direct Service Agents (DSA)/ Business Correspondents for banks and/or NBFCs fall outside the purview of the NBFC-P2P Directions. Banks and NBFCs have th following options to lend-

  1. By direct physical interface or
  2. Through their own digital platforms or
  3. Through a digital lending platform under an outsourcing arrangement.

The digitalization of credit intermediation process though is beneficial for both borrowers as well as lenders however, concerns were raised due to non-transparency of transactions and violation of extant guidelines on outsourcing of financial services and Fair Practices Code[4]. The RBI has also been receiving several complaints against the lending platforms which primarily relate to exorbitant interest rates, non-transparent methods to calculate interest, harsh recovery measures, unauthorised use of personal data and bad behavior. The existing outsourcing guidelines issued by RBI for banks and NBFCs clearly state that the outsourcing of any activity by NBFC does not diminish its obligations, and those of its Board and senior management, who have the ultimate responsibility for the outsourced activity. Considering the same, the RBI has again emphasized on the need to comply with the regulatory instructions on outsourcing, FPC and IT services[5].

We have discussed the instructions laid down by RBI and the implications herein below-

Disclosure of platform as agent

The RBI requires banks and NBFCs to disclose the names of digital lending platforms engaged as agents on their respective website. This is to ensure that the customers are aware that the lender may approach them through these lending platforms or the customer may approach the lender through them.

However, there are arrangements wherein the platform is not appointed as an agent as such. This is quite common in case of e-commerce website who provide an option to the borrower at the time of check out to avail funding from the listed banks or NBFCs. This may actually not be regarded as outsourcing per se since once the customer selects the option to avail finance through a particular financial entity, they are redirected to the website or application of the respective lender. The e-commerce platform is not involved in the entire process of the financial transaction between the borrower and the lender. In our view, such an arrangement may not be required to be disclosed as an agent of the lender.

Disclosure of lender’s name

Just like the lender is required to disclose the name of the agent, the agent should also disclose the name of the actual lender. RBI has directed the digital lending platforms engaged as agents to disclose upfront to the customer, the name of the bank or NBFC on whose behalf they are interacting with them.

Several fintech platforms are involved in balance sheet lending. Here, the lending happens from the balance sheet of the lender however, the fintech entity is the one assuming the risk associated with the transaction. Lender’s money is used to lend to customers which shows up as an asset on the balance sheet of the lending entity. However, the borrower may not be aware about who the actual lender is and sees the platform as the interface for providing the facility.

Considering the risk of incomplete disclosure of facts the RBI mandates the disclosure of the lender’s name to the borrower. In this regard, the loan agreement or the GTC must clearly specify the name of the actual lender and in case of multiple lender, the name along with the loan proportion must be specified.

Issuance of sanction letter

Another requirement prescribed by the RBI is that immediately after sanction but before execution of the loan agreement, a sanction letter should be issued to the borrower on the letter head of the bank/ NBFC concerned.

Issue a sanction letter to the borrower on the letterhead of the NBFC may seem illogical since the lending happens on the online platform. The sanction letter may be shared either through email or vide an in-app notification or otherwise. Such sanction letter shall be issued on the platform itself immediately after sanction but before execution of the loan agreement.

Further, the FPC requires lender NBFCs to display annualised interest rates in all their communications with the borrowers. However, most of the NBFCs show monthly interest rates in the name of their ‘marketing strategy’. This practice though have not been highlighted by the RBI must be taken seriously.

Sharing of loan agreement

The FPC laid down by RBI requires that a copy of the loan agreement along with a copy each of all enclosures quoted in the loan agreement must be furnished to all borrowers at the time of sanction/ disbursement of loans. However, in case of lending done over electronic platforms there is no physical loan agreement that is executed.

Given that e-agreements are generally held as valid and enforceable in the courts, there is no such insistence on execution of physical agreements. The electronic execution versions are more feasible in terms of cost and time involved. In fact in most of the cases, the loan agreements are mere General Terms and Conditions (GTC) in the form of click wrap agreements.

Usually, the terms and conditions of the loan or the GTC is displayed on the platform wherein the acceptance of the borrower is recorded. In such a circumstance, necessary arrangements should be made for the borrower to peruse the loan agreement at any time. The loan agreement may also be in the form of a mail containing detailed terms and conditions, along with an option for the borrower to accept the same.

The requirement from compliance perspective is to ensure that the borrower has access to the executed loan agreement and all the terms and conditions pertaining to the loan are captured therein.

Monitoring by the lender

Effective oversight and monitoring should be ensured over the digital lending platforms engaged by the banks/ NBFCs. As RBI does not regulate the platform entities, hence the only way to regulate the transaction is though the lenders behind these platforms.

The outsourcing guidelines require the retention of ultimate control of the outsourced activity with the lender. Further, the platform should not impede or interfere with the ability of the NBFC to effectively oversee and manage its activities nor shall it impede the RBI in carrying out its supervisory functions and objectives. These should be captured in the servicing agreement as well as be implemented practically.

Grievance Redressal Mechanism (GRM)

Much of the new-age lending is enabled by automated lending platforms of fintech companies. The fintech company is the sourcing partner, and the NBFC is the funding partner. However, the grievance of the customer may range from issue with the usage of platform to the non-disclosure of the terms of loan.

A challenge that may arise is to segregate the grievance on the basis of who is responsible for the same- the platform or the lender. There must be proper mechanism to ensure such segregation and adequate efforts shall be made towards creation of awareness about the grievance redressal mechanism.

[1] Read our detailed write up here- http://vinodkothari.com/2020/03/moving-to-contactless-lending/

[2] Read our detailed write up here- http://vinodkothari.com/2020/03/fintech-regulatory-responses-to-finnovation/

[3] RBI’s FAQs on P2P lending platform- https://www.rbi.org.in/Scripts/FAQView.aspx?Id=124

[4] Read our detailed write up here- http://vinodkothari.com/2019/09/the-cult-of-easy-borrowing/

[5] https://www.rbi.org.in/Scripts/NotificationUser.aspx?Id=11920&Mode=0

 

 

Draft Guidelines on Securitisation & Sale of Loans with respect to RMBS transactions

Comparison on Draft Framework for sale of loans with existing guidelines and task force recommendations

On 8th June, 2020, RBI issued the Draft Comprehensive Framework for Sale of loan exposures for public comments. This draft framework has brought about major changes in the regulatory framework governing direct assignment. One of the major changes is that the framework has removed MRR requirements in case of DA transactions. The framework covers both Sale of Standard Assets as well as stressed assets in separate chapter. We shall be coming up with a separate detailed analysis of sale of stressed assets under the draft framework.
In continuation of our earlier brief write-up titled Originated to transfer – new RBI regime on loan sales permits risk transfer, here we bring a point by point comparative along with our comments on the changes. Further, we have covered the Draft Directions on sale of loans in a Presentation on Draft Directions Sale of Loans.

Read more

Originated to transfer- new RBI regime on loan sales permits risk transfers

Team, Vinod Kothari Consultants P. Ltd.

finserv@vinodkothari.com

Major changes have been proposed by the RBI in the regime on what has become a major part of the business model of NBFCs and MFIs in the country – direct assignments (DAs). We have separately dealt with the Draft Directions on Securitisation of Standard Assets in a write up titled “New regime for securitisation and sale of financial assets

The term DA is so very typical of the Indian scene – globally, the practice of loan trading, loan sales or so-called whole-loan transfers has largely been out of the regulatory domain. However, in India, the motivation to shift from securitisation to DAs were partly the RBI Guidelines of 2006 which regulated securitisation but did not regulate DAs, and partly, the tax issues on securitisation that began prominent around 2011-12 or so. However, the DA model has, over the years, been a sizeable part of securitisation volumes in India, and is the mainstay of transfer of priority-sector loans from NBFCs to banks. Now that NBFCs have been permitted a major push for MSE lending by several GoI schemes, NBFCs are eagerly looking for another round of DA drive, and therefore, it is important to see whether the proposed regulatory regime for loan sales will facilitate NBFC-originated loans to end up on the books of banks and other investors.

Read more

RBI grants additional 3 months to FPIs under Voluntary Retention Route

Shaifali Sharma | Vinod Kothari and Company

corplaw@vinodkothari.com

In March, 2019, the RBI with an objective to attract long-term and stable FPI investments into debt markets in India introduced a scheme called the ‘Voluntary Retention Route’ (VRR)[1]. Investments through this route are in addition to the FPI General Investment limits, provided FPIs voluntarily commit to retain a minimum of 75% of its allocated investments (called the Committed Portfolio Size or CPS) for a minimum period of 3 years (retention period).However, such 75% of CPS shall be invested within 3 months from the date of allotment of investment limits. Recognizing the disruption posed by the COVID-19 pandemic, RBI vide circular dated May 22, 2020[2], has granted additional 3-months relaxation to FPIs for making the required investments. The circular further addresses the questions as to which all FPIs are covered under this relaxation and how the retention period will be determined.

This article intends to discuss the features of the VRR scheme and the implications of RBI’s circular in brief.

What is ‘Voluntary Retention Route’?

RBI, to motivate long term investments in Indian debt markets, launched a new channel of investment for FPIs on March 01, 2019[3] (subsequently the scheme was amended on May 24, 2019[4]), free from the macro-prudential and other regulatory norms applicable to FPI investment in debt markets and providing operational flexibility to manage investments by FPIs. Under this route, FPIs voluntarily commit to retain a required minimum percentage of their investments for a period of at least 3 years.

The VRR scheme was further amended on January 23, 2020[5], widening its scope and provides certain relaxations to FPIs.

Key features of the VRR Scheme:

  1. The FPI is required to retain a minimum of 75% of its Committed Portfolio Size for a minimum period of 3 years.
  2. The allotment of the investment amount would be through tap or auctions. FPIs (including its related FPIs) shall be allotted an investment limit maximum upto 50% of the amount offered for each allotment, in case there is a demand for more than 100% of amount offered.
  3. FPIs may, at their discretion, transfer their investments made under the General Investment Limit, if any, to the VRR scheme.
  4. FPIs may apply for investment limits online to Clearing Corporation of India Ltd. (CCIL) through their respective custodians.
  5. Investment under this route shall be capped at Rs. 1,50,000/- crores (erstwhile 75,000 crores) or higher, which shall be allocated among the following types of securities, as may be decided by the RBI from time to time.
    1. ‘VRR-Corp’: Voluntary Retention Route for FPI investment in Corporate Debt Instruments.
    2. ‘VRR-Govt’: Voluntary Retention Route for FPI investment in Government Securities.
    3. ‘VRR-Combined’: Voluntary Retention Route for FPI investment in instruments eligible under both VRR-Govt and VRR-Corp.
  6. Relaxation from (a) minimum residual maturity requirement, (b) Concentration limit, (c) Single/Group investor-wise limits in corporate bonds as stipulated in RBI Circular dated June 15, 2018[6] where exposure limit of not more than 20% of corporate bond portfolio to a single corporate (including entities related to the corporate) have been dispensed with. However, limit on investments by any FPI, including investments by related FPIs, shall not exceed 50% of any issue of a corporate bond except for investments by Multilateral Financial Institutions and investments by FPIs in Exempted Securities.
  7. FPIs shall open one or more separate Special Non-Resident Rupee (SNRR) account for investment through the Route. All fund flows relating to investment through the VRR shall reflect in such account(s).

What are the eligible instruments for investments?

  1. Any Government Securities i.e., Central Government dated Securities (G-Secs), Treasury Bills (T-bills) as well as State Development Loans (SDLs);
  2. Any instrument listed under Schedule 1 to Foreign Exchange Management (Debt Instruments) Regulations, 2019 other than those specified at 1A(a) and 1A(d) of that schedule; However, pursuant to the recent amendments, investments in Exchange Traded Funds investing only in debt instruments is permitted.
  3. Repo transactions, and reverse repo transactions.

What are the options available to FPIs on the expiry of retention period?

Option 1

 

Continue investments for an additional identical retention period
 

 

 

Option 2

 

Liquidate its portfolio and exit; or

 

Shift its investments to the ‘General Investment Limit’, subject to availability of limit under the same; or

 

Hold its investments until its date of maturity or until it is sold, whichever is earlier.

Any FPI wishing to exit its investments, fully or partly, prior to the end of the retention period may do so by selling their investments to another FPI or FPIs.

3-months investment deadline extended in view of COVID-19 disruption

As discussed above, once the allotment of the investment limit has been made, the successful allottees shall invest at least 75% of their CPS within 3 months from the date of allotment. While announcing various measures to ease the financial stress caused by the COVID-19 pandemic, RBI Governor acknowledged the fact that VRR scheme has evinced strong investor participation, with investments exceeding 90% of the limits allotted under the scheme.

Considering the difficulties in investing 75% of allotted limits, it has been decided that an additional 3 months will be allowed to FPIs to fulfill this requirement.

Which all FPIs shall be considered eligible to claim the relaxation?

FPIs that have been allotted investment limits, between January 24, 2020 (the date of reopening of allotment of investment limits) and April 30, 2020 are eligible to claim the relaxation of additional 3 months.

When does the retention period commence? What will be the implication of extension on retention period?

The retention period of 3 years commence from the date of allotment of investment limit and not from date of investments by FPIs. However, post above relaxation granted, the retention period shall be determined as follows:

FPIS

 

RETENTION PERIOD
*Unqualified FPIs Retention period commence from the date of allotment of investment limit

 

**Qualified FPIs opting relaxation

 

 

Retention period commence from the date that the FPI invests 75% of CPS
Qualified FPIs not opting relaxation

 

Retention period commence from the date of allotment of investment limit

*Unqualified FPIs – whose investments limits are not allotted b/w 24.01.2020 and 30.04.2020

**Qualified FPIs to relaxation – whose investments limits not allotted b/w 24.01.2020 and 30.04.2020 

What will be the consequences if the required investment is not made within extended period of 3 months?

Since no separate penal provisions are prescribed under the circular, in terms of VRR Scheme, any violation by FPIs shall be subjected to regulatory action as determined by SEBI. FPIs are permitted, with the approval of the custodian, to regularize minor violations immediately upon notice, and in any case, within 5 working days of the violation. Custodians shall report all non-minor violations as well as minor violations that have not been regularised to SEBI

Concluding Remarks

The COVID-19 disruption has adversely impacted the Indian markets where investors are dealing with the market volatility. Given this, FPIs are pulling out their investments from the Indian markets (both equity and debt). Thus, relaxing investments rules of VRR Scheme during such financial distress, will help the foreign investors manage their investments appropriately.

You may also read our write ups on following topics:

Relaxations to FPIs ahead of Budget, 2020, click here

Recommendations to further liberalise FPI Regulations, click here

RBI removes cap on investment in corporate bonds by FPIs, click here

SEBI brings in liberalised framework for Foreign Portfolio Investors, click here 

For more write ups, kindly visit our website at: http://vinodkothari.com/category/corporate-laws/

To access various web-lectures, webinars and other useful resources useful for the Corporate and Financial sector, visit and subscribe to our Youtube channel: https://www.youtube.com/channel/UCgzB-ZviIMcuA_1uv6jATbg

[1]https://www.rbi.org.in/Scripts/NotificationUser.aspx?Id=11561&Mode=0

[2]https://www.rbi.org.in/Scripts/NotificationUser.aspx?Id=11896&Mode=0

[3]https://www.rbi.org.in/Scripts/NotificationUser.aspx?Id=11492&Mode=0

[4]https://www.rbi.org.in/Scripts/BS_CircularIndexDisplay.aspx?Id=11561

[5]https://rbidocs.rbi.org.in/rdocs/notification/PDFs/APDIR19FABE1903188142B9B669952C85D3DCEE.PDF

[6] https://rbidocs.rbi.org.in/rdocs/notification/PDFs/NT199035211F142484DEBA657412BFCB17999.PDF

Resources on MSME financing

Major reforms have been introduced for the MSMEs, providing the required boost to the sector. MSMEs have recently been put into the limelight with several regulatory and financial reforms concerning them.

We have put up this page to provide the access to all relevant resources on the subject at one place, along with our analysis. Hope that the readers find it useful.

Another couple of step ladders for the MSMEs

Primer on MSME Financing

IBC and related reforms: Where do MSMEs stand?

Self-dependent India: Measures concerning the financial sector

Regulator’s move to repair the NBFC sector

Recent changes in MSME sector

FAQs on delayed payment to MSMEs

Interest subvention scheme for MSMEs

Filing of return for delayed payment to MSMEs- Effective or frittering?

Snapshot of the initiatives for MSMEs

Transitory liberalisation of asset classification norms for MSMEs

Slew of measures for MSME sector

Help in the hour of need: RBI relaxes asset classification norms for MSME accounts

MSME factoring gets a priority sector status: Likely to give boost to sagging factoring volumes

Waking up from slumber: Government notifies revival and rehabilitation scheme for MSMEs

Reviving an MSME – The New Way

Will the Companies Act 2013 impede MSMEs from bond markets?