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Meeting priority sector lending shortfalls: One more option

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Aanchal Kaur Nagpal, Manager | finserv@vinodkothari.com

Background

All scheduled commercial banks (including Regional Rural Banks and Small Finance Banks) are required to undertake priority sector lending. RBI mandates PSL to account for at least 40% of a bank’s Adjusted Net Bank Credit (ANBC) or Credit Equivalent of Off‐Balance Sheet Exposure whichever is higher, in accordance with the RBI PSL guidelines[1].

The intent behind prescribing PSL limits for banks is to enable certain sections of the society, though fairly credit-worthy but unable to obtain credit from the formal financial/ banking system, to access adequate credit. These sectors do not seem to be economically lucrative but are indispensable for the overall development and growth of India’s economy.

Read more →

Inter-lender balance transfer of loans: understanding the nuances

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-Kanakprabha Jethani (kanak@vinodkothari.com)

A crucial feature of the financial sector industry is that the services provided by financial institutions, including the interest rates charged, are not identical and hence, the customer has a choice to approach the lender whose offerings suit the needs of the customer. The choice is influenced by various factors including the ease of onboarding process, information sought, interest and charges levied, customer redressal mechanism etc. In the lending industry, given the options available with the borrower, it has been a common practice to move to new lenders when they provide more favourable terms. Read more →

One stop RBI norms on transfer of loan exposures

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– Financial Services Division (finserv@vinodkothari.com)

[This version dated 24th September, 2021. We are continuing to develop the write-up further – please do come back]

The RBI has consolidated the guidelines with respect to transfer of standard assets as well as stressed assets by regulated financial entities under a common regulation named Reserve Bank of India (Transfer of Loan Exposures) Directions, 2021 (“Directions”).

The Directions divided into five operative chapters- the first one specifying the scope and definitions, the second one laying down general conditions applicable on all loan transfers, the third one specifying the requirements in case of transfer of loans which are not in default, that is standard assets, the fourth one provides the additional requirement for transfer of stressed assets and the fifth chapter is on disclosure and reporting requirements. Read more →

NBFCs licensed for KYC authentication: Guide to the new RBI privilege for Aadhaar e-KYC Authentication

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-Kanakprabha Jethani (kanak@vinodkothari.com)

Background

On September 13, 2021, the RBI issued a notification[1] (‘RBI Notification’) permitting all NBFCs, Payment System Providers and Payment System Participants to carry out authentication of client’s Aadhaar number using e-KYC facility provided by the Unique Identification Authority of India (UIDAI), subject, of course, to license being granted by MoF. The process involves an application to the RBI, onward submission after screening of the application by the RBI, then a further screening by UIDAI, and final grant of authentication by the MoF,

We discuss below the underlying requirements of the PMLA, Aadhaar Act and regulations thereunder (defined below) and other important preconditions for this new-found authorisation for NBFCs. Read more →

Dividend restrictions on NBFCs

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– Financial Services Division (finserv@vinodkothari.com)

Background

The Reserve Bank of India (RBI) vide a notification dated 24th June, 2021[1] imposed restrictions on distribution of dividends by non-banking financial companies (‘Notification’). The restrictions cover both systemically important NBFCs as well non-systemically important ones. The guidelines have been issued in line with the draft guidelines for the declaration of dividends by NBFC issued in December 2020. Restrictions on dividend payout essentially force financial sector entities to plough back a minimal part of their profits, and therefore, result in creation of a profit conservation. Such restrictions are common in case of financial institutions world-over, and are also imbibed as a part of Basel III capital adequacy requirements. Similar restrictions exist in case of banking entities[2]. In case of NBFCs, such restrictions were proposed by the RBI vide Draft Circular on Declaration of Dividend by NBFCs dated December 9, 2020[3]. Dividend Payout Ratio (DP Ratio) is an important policy measure for companies for shareholder wealth maximisation. A conservative dividend distribution policy ensures churning of profits thereby ensuring organic growth of the net worth, and assisted by leverage, a return on shareholders’ funds higher than what the shareholders can fetch on distributed money. On the other hand, aggressive dividend distribution policy entails that profits be returned to the shareholders as there are less business investment opportunities, thus wealth of shareholders be returned. The foregoing arguments does not encompass stictict dividend payout criteria, but a broad policy objective which organisations seek to achieve. However, in the case of financial institutions like Banks and NBFCs  the motivation of regulators to limit the dividend payout is from the perspective of prudential regulation. The limit on dividend distribution allows regulators to ensure that adequate capital conservation buffers are maintained at all times by the financial institutions. Most NBFCs follow very conservative dividend policies, and based on publicly available data, the DP Ratios of some of the NBFCs for FY 2019-20 are as follows:
  1. Manappuram- 18.86%
  2. Cholamandalam- 12.78%
  3. Bajaj Finserv- 11.93%
  4. Muthoot Finance- 19.91%
  5. Tata Capital Financial Services- 32.96%
  6. DCM Shriram- 17.19%

Applicability

Who all are covered? The opening statement of the Notification provides that the Notification is applicable on all NBFCs regulated by RBI. Further, reference is made to the term ‘Applicable NBFCs’  as defined under the respective RBI Master Directions on NBFC-ND-SI and NBFC-ND-NSI. The concept of Applicable NBFC is relevant to determine the applicability of the provisions of the aforesaid RBI Master Directions. Accordingly, it can be understood that, along with the ‘Applicable NBFCs’, the following categories of NBFCs shall be covered under the ambit of the Notification-
  1. Housing Finance Companies (HFCs),
  2. Core Investment Companies (CICs),
  3. Government NBFCs,
  4. Mortgage Guarantee Companies,
  5. Standalone Primary Dealers (SPDs),
  6. NBFC-Peer to Peer Lending Platform (NBFC-P2P)
  7. NBFC- Account Aggregator (NBFC-AA).
  8. NBFC-D (deposit taking NBFCs)
  9. NBFCs-ND (non-deposit taking NBFCs) (both SI and NSI)
  10. NBFC-Factor (both SI and NSI)
  11. NBFC-MFI (both SI and NSI)
  12. NBFC-IFC (both SI and NSI)
  13. IDF-NBFC
However, it is to be noted that For NBFCs that do not accept public funds and do not have any customer interface no limit has been imposed with regards to the dividend payout ratio. Effective from which financial year? Effective for declaration of dividend from the profits of the financial year ending March 31, 2022 and onwards. Which all dividends are covered? Proposed dividend shall include both dividend on equity shares and compulsorily convertible preference shares. However, other than CCPS, dividends declared on preference shares are not included under the Notification. Note that the issue of bonus shares is, in essence, capitalisation of profits, and therefore, is not affected by the present requirement.

Computation of dividend payout ratio:

Besides the upfront conditionalities such as capital adequacy ratio, leverage ratio, etc., the stance of the present Notification is limitation on dividend payout ratio. Hence, the meaning of the DP ratio becomes important. The Notification defines the same as : ‘the ratio between the amount of the dividend payable in a year and the net profit as per the audited financial statements for the financial year for which the dividend is proposed.’ As we discussed elsewhere, the word “dividend” shall be restricted to only equity and CCPS dividend. Hence, dividend on redeemable preference shares shall be excluded. Also note that the word “profit for the year” refers to profits after tax. There is no question of adding the brought forward profits of earlier years, whether parked in reserves or retained as surplus in the profit and loss account. In case of companies adopting IndAS, there are always questions on what constitutes distributable profits – whether the gains or losses on fair valuation, taken to P/L are a part of the distributable profits or not. The relevant provisions of the Companies Act, viz., proviso to sec. 123 (1) shall have to be borne in mind.

Eligibility Requirement and Quantum Restrictions

Category Eligibility Requirement Quantum*
NBFCs (including SDPs) meeting prudential requirements ●  Complies with applicable regulatory capital adequacy requirements/leverage restrictions/Adjusted net-worth for each of the last three financial years including the financial year for which the dividend is proposed

○ For SPDs, minimum CRAR of 20% to be maintained for the financial year for which dividend is proposed.

● Net NPA ratio shall be less than 6% in each of the last three years, including as at the close of the financial year for which dividend is proposed to be declared.

○ Calculation of NNPA

● Complies with the provisions of Section 45 IC of the RBI Act/ Section 29 C of the NHB Act, as the case may be, that is to say, has transferred 20% of its net profits to the regulatory reserve fund ● No explicit restrictions placed by the regulator on declaration of dividend		 ●  Type I NBFCs- No limit●  CICs and SPDs- 60% ●  Other NBFCs- 50%
NBFCs (other than SPDs) not meeting prudential requirements ● Complies with the applicable capital adequacy requirements/ leverage restrictions in the financial year for which dividend is proposed to be paid● Has net NPA of less than 4% as at the close of the financial year. 10%
As regards NBFC-ND-NSI, the applicable regulatory capital requirement, as mentioned in Annex I[4] of the Notification,  seems to suggest that if there is a breach of leverage ratio at any time since 2015, the NBFC is disqualified. This however, does not seem to be the intent of the regulator. The meaning of the aforesaid restriction should be that the provision became applicable from 2015; however, it should not be leading to a conclusion that a dividend distribution will ensure that there is no breach of leverage ratio at any time in the history of the said NBFC. We are of the view that each of the ratios (CRAR or Leverage of Adjusted Net worth, as the case may be) need to be observed ideally at the time of distribution (last three FYs including the year for which dividend is declared), and even conservatively, during the year in question. *The Notification has prescribed the same limits on quantum for a certain class of NBFCs, however, the draft guidelines had prescribed the limits based on the CRAR or adjusted net-worth of the NBFCs. (Refer Annex I of draft guidelines)

Reporting Requirements

NBFC-D, NBFC-ND-SIs, HFCs & CICs declaring dividend shall report details of dividend declared during the financial year as per the prescribed format within a fortnight after declaration of dividend to the Regional Office of the RBI/Department of Supervision of NHB, as the case may be. There seems to be a lack of clarity w.r.t. the disclosure requirement for NBFC-MFIs and NBFC-IDFs. Though they are covered under the definition of ‘Applicable NBFCs’ under the RBI Master Directions, however, they are not generally classified as NBFC-ND-SI. Hence, whether the disclosure requirement is applicable to them or not seems to create confusion. In our view, going by prudence, this must be adhered to by such systemically important MFI and IDFs as well. Accordingly, it can be inferred that the disclosure requirements shall not be applicable to following:
  • Mortgage Guarantee Companies,
  • Standalone Primary Dealers (SPDs),
  • NBFC-Peer to Peer Lending Platform (NBFC-P2P)
  • NBFC- Account Aggregator (NBFC-AA).
  • NBFCs-ND-NSIs

Comparison with the dividend regulations on Banks

Criteria Bank NBFCs
Eligibility Only those banks would be eligible to declare dividends who have a CRAR of at least 9% for preceding two completed financial years and the accounting year for which it proposes to declare dividend and Net NPA less than 7% NBFC-ND-NSI with leverage upto 7 times and NBFC-ND-SI with a CRAR of not less than 15% for last three years (including the FY for which dividend is declared) and Net NPA less than 6% in each of the last three years
In case not meeting eligibility In case any bank does not meet the above CRAR norm, but has a CRAR of at least 9% for the accounting year for which it proposes to declare dividend, it would be eligible to declare dividend provided its Net NPA ratio is less than 5% In case any NBFC does not meet the above eligibility criteria for each of the previous three FY, but meets the capital adequacy for the accounting year, for which it proposes to declare dividend and has a Net NPA ratio of less than 4% at the close of the FY, it shall be allowed to declare dividend, subject to a maximum of 10% on the DP ratio.
Quantum Dividend payout ratio shall not exceed 40 % and shall be as per the prescribed matrix CIC’s and SPDs shall ensure the maximum dividend payout ratio does not exceed 60%, while the other NBFCs shall not exceed 50% of the DP ratio. For Type I NBFCs there is no limit.
Reporting All banks declaring dividends should report details of dividend declared during the accounting year as per the proforma furnished by RBI NBFC-Ds, NBFC-ND-SIs, HFCs & CICs declaring dividend should report the details of dividend within a fortnight after declaration of dividend to RBI/NHB, as may be applicable.

Immediate Actionables

NBFCs, who already have a Dividend Distribution Policy in place, may have to amend the policy in line with the Notification. As per SEBI LODR Regulations, top 1000 listed companies are mandatorily required to have a dividend distribution policy.  Further, NBFCs may also have voluntarily adopted a policy. The dividend distribution policy includes the following parameters:
  • the circumstances under which the shareholders may or may not expect dividend;
  • the financial parameters that shall be considered while declaring dividend;
  • internal and external factors that shall be considered for declaration of dividend;
  • policy as to how the retained earnings shall be utilized; and
  • parameters that shall be adopted with regard to various classes of shares
The eligibility requirements and limits on quantum of dividend, as provided in the Notification,  may be additional criterias for such NBFCs to declare dividend. In such a case, the existing dividend distribution policy shall be required to be amended in order to include the additional parameters. It is noteworthy here that, as per regulation 43A of the LODR, if a listed entity proposes to amend its dividend distribution policy, it shall disclose the changes along with the rationale for the same in its annual report and on its website. [1] https://www.rbi.org.in/Scripts/NotificationUser.aspx?Id=12118&Mode=0 [2] https://www.rbi.org.in/scripts/FS_Notification.aspx?Id=2240&fn=2&Mode=0 and other associated circulars [3] https://rbi.org.in/Scripts/BS_PressReleaseDisplay.aspx?prid=50777 [4] https://rbidocs.rbi.org.in/rdocs/content/pdfs/NBFCS24062021_A1.pdf Our related write-ups:
FAQs on Dividend Distribution Policy
Our presentation on dividends – https://vinodkothari.com/2021/09/an-overview-of-the-regulatory-framework-of-dividends/ Watch our YouTube video on Restrictions on dividend distribution on NBFCs

Various forms of Secured Lending

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-Anita Baid, anita@vinodkothari.com

In this era of ever-increasing demand and continuous urge for developments, limitation of financial resources come as the biggest constraint in overall satisfaction of an individual or entity’s needs. Financial or funding options provided by various financial institutions such as banks and NBFCs come as a solution to such financial constraints. Loans from such financial institutions can be availed depending upon one’s immediate requirement and repayment capacity.

From the consumer’s perspective, funding is granted and resource constraint is sort out. However, there is always a fear of default in repayment of loans faced by the lenders. Thus, the position of the lender becomes ambiguous and unsafe in granting such loans. Here, comes the concept of secured financing. Secured financing is one in which the lender has security rights over certain collateral that the borrower makes available to support the loan. The borrower agrees that should he not repay the loan as agreed, the lender has a right to seize the collateral to satisfy the debt.

There are various instruments offered under secured financing depending upon the collateral the borrower is willing to provide. Some of the commonly used instruments have been discussed herein this article[1].

Loan Against Property (LAP)

A loan against property is a loan given or disbursed against the mortgage of a property. LAP belongs to the secured loan category where the credit evaluation of the borrower is done keeping his property as a security. The property can be commercial or residential.[2]

Immovable property being one of the most non-volatile security is mortgaged with the financial institution for obtaining required funds. Borrowers willing to purchase a residential/commercial property can obtain loan by keeping such desired property as the underlying security. The underlying security can be the property for which loan is being taken and/or a separate property as well. The loan is given as a certain percentage of the property’s market value, usually around 40% to 60%.

Here the loan is granted based on the quality of the collateral and less importance is given to the credit quality of the borrowers. Also, usually, these loans do not come with any end use restriction, that is to say, the borrowers get a free hand with respect to utilization of funds.

Loan Against Securities (LAS)

A loan against securities (LAS) is a loan given against the collateral of shares or securities. LAS enables one to borrow funds against listed securities such as shares, mutual funds, insurance and bonds to meet current financial needs. Borrowers can opt for this loan when they need instant liquidity for their personal/business needs and are sure to pay it back in few months.

There are however, specific regulations issued by RBI with respect to loan against shares of listed entities,

As per the [3]Master Directions applicable on NBFC-NSI-ND issued by RBI, NBFCs with asset size of Rs.100 crore and above who are lending against the collateral of listed shares shall, maintain a Loan to Value (LTV) ratio of 50% for loans granted against the collateral of shares. Additionally, for LAS in case where lending is being done for investment in capital markets, only Group 1 securities (specified in SMD/ Policy/ Cir – 9/ 2003 dated March 11, 2003 as amended from time to time, issued by SEBI) shall be accepted as collateral for loans of value more than Rs5 lakh, subject to review by the Bank. The lender shall also be required to report on-line to stock exchanges on a quarterly basis, information on the shares pledged in their favour, by borrowers for availing loans in the prescribed format.

Difference between LAP and LAS

The underlying security for LAP and Las is different which is prevalent from the respective names itself. Apart from this major difference there are other areas of difference between the two as well. The basic differences between the two are highlighted hereunder:

 

Features Loan against securities Loan against property
Nature of facility A loan against securities (LAS) is a loan given against the collateral of shares or securities. A loan against property (LAP) is a loan given or disbursed against the mortgage of a property.
Exposure In case of LAS the exposure is based on the value of securities In case of LAP it is based on the value of property.
Volatility The value of securities, in case it is listed shall fluctuate very frequently and hence the value of security is very volatile. The value of property is less volatile as compared to LAS.
Type of security The shares or securities can either be listed or unlisted. The property can either be movable or immovable.
End use Usually the end use of the facility extended is for investment in the securities. There is no end use restriction in case of LAP.
Regulations from RBI As per the Master Directions applicable on NBFC-NSI-ND issued by RBI, all Applicable NBFC with asset size of Rs.100 crore and above who are lending against the collateral of listed shares shall, maintain a Loan to Value (LTV) ratio of 50% for loans granted against the collateral of shares. No specific regulatory guideline has been prescribed regarding LTV ratio for granting loan against property by an NBFC.

 

 
LTV Ratio Further, as per the statutory provision, if the value of listed securities falls down thereby increasing the LTV ratio, additional security must be provided to maintain such LTV ratio. The Applicable NBFC must ensure that any shortfall in the maintenance of 50% LTV occurring on account of movement in the share prices is to be made good within 7 working days. In case of LAP, such reinstating is not statutory. However, the lender may revise the sanctioned limit in case the loan agreement provides for such discretionary right to the lender.

 
Statutory Requirement Additionally, for LAS in case where lending is being done for investment in capital markets, only Group 1 securities (specified in SMD/ Policy/ Cir – 9/ 2003 dated March 11, 2003 as amended from time to time, issued by SEBI) shall be accepted as collateral for loans of value more than Rs5 lakh, subject to review by the Bank. The lender shall also be required to report on-line to stock exchanges on a quarterly basis, information on the shares pledged in their favour, by borrowers for availing loans in the prescribed format. No such regulatory requirement.

 

IPO Funding

IPO or Initial Public Offer is a rewarding experience for individuals and companies as it offers substantial return to investors on the shares subscribed by them. However, it may so happen that an investor might not possess the requisite funds to subscribe to IPOs. In such a situation, inflow of funds from another source may become necessary. Here comes the concept of IPO funding which bridges the deficit between the resources at hand and the funds needed in aggregate. The lender creates a right of lien on the shares to be allotted to the investor/borrower in the IPO. This shall form the underlying security against the loan which can be liquidated in case of non-payment of principle and/or interest.[4]

Similar to LAS, IPO Financing is loan against acquiring shares and making a short-term profit that is expected at the time of initial price discovery of the shares once the shares are listed. However, unlike LAS, it is specifically for funding subscriptions to IPOs. In case of an IPO Financing, the exposure is based on the borrower and the securities/ shares, if allotted, are taken as collateral for securing the obligations under the loan. The transaction forces the applicant to sell the shares once listed, hence, the idea cannot be to finance an investment in shares.

The financial institution demands for an upfront payment of the margin amount based on the assessment of subscription levels. For example, if an investor applies for 100 shares and gets allotted only 10 shares due to oversubscription, the refund on 90 shares is divided between the borrower and lender proportionately. The shares allotted are held as lien by the lender.

Recently, the RBI had released a Discussion Paper on the Revised Regulatory Framework for NBFCs on 22nd January, 2021[5], wherein it has been proposed to fix a ceiling of Rs. 1 crore per individual in case of IPO financing by any NBFC.

Equipment Finance

Equipment financing is yet another type of secured financing wherein loan is given for purchase of commercial or office equipment. The underlying asset is the equipment for which loan is advanced and/or any other equipment. The loan is secured by way of a hypothecation over the equipment financed. For efficient and smooth functioning of various units of a commercial enterprise, existence of upgraded machinery is of utmost importance. Such acquisitions may require additional funds from external sources. Hence, equipment finance helps in improving the overall production levels.

Secured Working Capital Finance

Fulfilment of working capital requirements is perhaps the most integral responsibility of a company. Adequate working capital is needed to meet the day-to-day activities of an enterprise and enable it to function smoothly. Financing options for meeting working capital limits is also available. Loan is given for maintaining such working capital by placing a floating charge on the assets of the company. No fixed asset is kept aside as the underlying security. In case of any default, an asset of sufficient value shall be a seized and liquidated to meet the default.

Here, it is important to understand the difference between LAS or LAP and a regular secured working capital loan. For instance, in case of LAS or LAP the exposure is based on the value of securities or the property, as the case may be, and not on the borrower. Whereas, in case of a secured loan the exposure is based on the borrower and the securities or property are taken as collateral for securing the obligations under the loan. Such a secured loan shall not be classified as LAS or LAP and hence maintaining the prescribed regulatory LTV ratio will also not be applicable in this case.

At a Glance

 

Features

 LAP LAS IPO Funding Equipment Financing Working Capital Financing
Nature of facility Loan disbursed against the collateral of property Loan disbursed against the collateral of shares Loan extended for investing in IPO Loan advanced for purchase of equipment against the collateral of the same and/or any other equipment Loan advanced for meeting working capital requirements and accordingly a floating charge is created
Nature of security Property Shares Shares subscribed in IPO Equipment Floating charge on the assets.
Exposure Property Shares Investor Borrower Borrower
Volatility Very less Volatile Volatile Less volatile Less volatile
Regulatory Framework No specifications but additions can be made in the loan agreement as per discretion As per the Master Directions applicable on NBFC-NSI-ND issued by RBI, all Applicable NBFC with asset size of Rs.100 crore and above who are lending against the collateral of listed shares shall, maintain a Loan to Value (LTV) ratio of 50% for loans granted against the collateral of shares. No specifications but additions can be made in the loan agreement as per discretion No specifications but additions can be made in the loan agreement as per discretion No specifications but additions can be made in the loan agreement as per discretion

Conclusion

Secured financing comes as a relief to both borrowers and lenders. The borrower avails the required funds for meeting its financial or domestic purpose and the lender ensures security against the loan advanced by creating a mortgage or lien on the borrower’s property/shares.

Read our other relevant articles and books on the subject matter:

1. Securitisation, Asset Reconstruction & Enforcement of Security Interest-
http://vinodkothari.com/arcbook/
2. Fragmented framework for perfection of security interest-
http://vinodkothari.com/2021/03/fragmented-framework-for-perfection-of-security-interest/
3. Vehicle financing: Multiple Security Interest Registrations & its Impact by Vinod Kothari
https://www.youtube.com/watch?v=CeXqlsrEDYI

[1] The discussion on the regulatory aspects have been restricted to the regulations applicable to NBFCs only.

[2] Read our article titled- Sitting comfy in the lap of LAP: NBFCs push loans against properties-  http://vinodkothari.com/wp-content/uploads/2017/03/sitting_comfy_in_the_lap_of_LAP.pdf

[3] https://rbidocs.rbi.org.in/rdocs/notification/PDFs/MD44NSIND2E910DD1FBBB471D8CB2E6F4F424F8FF.PDF

[4] http://www.thehindubusinessline.com/opinion/the-risky-game-of-ipo-financing/article9631176.ece

[5] https://rbidocs.rbi.org.in/rdocs/Publications/PDFs/DP220121630D1F9A2A51415B98D92B8CF4A54185.PDF

Restructuring of restructuring: Post 1st April NPAs may be upgraded as Standard under ResFra 2.0

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– Anita Baid (anita@vinodktohari.com)

Source: FIDC’s letter to RBI dated June 3, 2021 seeking clarification on clause of Resolution framework – 2.0 relating to Individuals and Small Businesses and disclosures in the balance sheet read along with the RBI response via email dated June 7, 2021. Though called a clarification it actually makes a substantive positive change which is a silent realisation that there is substantial deterioration of performance of loans during the second wave of Covid-19.

The Reserve Bank of India (RBI) had proposed two restructuring frameworks on May 05, 2021- one for individuals and small businesses (‘Notification 31’) and the other one for MSMEs (‘Notification 32’). The intent of both frameworks is to allow restructuring of the loan account in distress due to the second wave of Covid-19.

Pursuant to the restructuring of the eligible loan account (under the respective framework) the standard classification of the assets can be retained. However, there are certain disparities between the two notifications in terms of eligibility criteria, process, etc.

One of the major distinctions is the fact that under Notification 31, there is no relaxation provided to borrowers who have slipped into NPA between the period from March 31, 2021 to the date of invocation. Hence, such loan accounts, which have become NPA from 1st April to the invocation date, irrespective of being restructured in compliance with the provisions of  Notification 31 will continue to be classified as NPA. However, whereby the loan account slipped into NPA classification between the date of invocation and implementation of resolution plan, such account can be upgraded to standard classification as on date of implementation of resolution plan. This position is different in case of MSMEs coming under Notification 32, wherein the borrowers who have slipped into NPA between the period from March 31, 2021, till the date of implementation shall be upgraded to standard.

The aforesaid interpretation was coming clear from the language of para 16 of Notification 31, which states as follows-

  1. If a resolution plan is implemented in adherence to the provisions of this circular, the asset classification of borrowers’ accounts classified as Standard may be retained as such upon implementation, whereas the borrowers’ accounts which may have slipped into NPA between invocation and implementation may be upgraded as Standard, as on the date of implementation of the resolution plan.

As per the language, the asset classification can be retained as standard- this would mean the account which was standard as on the date of implementation has to be retained as standard. However, if the same has degraded to sub-standard category, the upgradation as standard is allowed only if it slipped into NPA between invocation and implementation. Hence, it could be inferred that the slippage before the invocation would not get the relief of upgradation upon restructuring.

This was a huge demotivation of the lenders who intend to restructure the loan accounts under Notification 31. Consequently, representation was made by the Finance Industry Development Council (FIDC) bringing to the notice of RBI that the restructuring notification for individuals and small businesses omits, though maybe unintentionally, to benefit the customers who may have slipped into NPA between April 1 and May 5 as it refers to invocation date and implementation date.

The eligible loan accounts of individuals and small businesses which were standard as on March 31, 2021 can be restructured under Notification 31 if the restructuring is invoked by September 30, 2021. Further, there is a likelihood that such an account may have slipped into NPA between April 1, 2021 till the date of invocation. Though Notification 32  for MSMEs clearly provides for an upgradation to account which might have slipped into NPA from March 1, 2021 till the implementation, however, similar relief was missing from Notification 31.

The RBI has, however, vide an email communication to the FIDC on June 7, 2021, clarified that the loan accounts that may have slipped into NPA between April 1, 2021 and the date of implementation, on the same lines as mentioned in Notification 32 for MSMEs, can be upgraded as standard assets on implementation of the resolution plan.

This would be a relief for not just the borrower but also the lenders who would not hesitate to restructure eligible and potential loan accounts, even if they have turned into NPA by the time the RBI notifications were issued.

Refer to our article on restructuring:

RBI means to halt second wave of borrower defaults: Announces ResFra 2.0

 

Rationalisation of KYC- Measures for relief or technical advancement?

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-Kanakprabha Jethani and Anita Baid (finserv@vinodkothari.com)

Background

Considering the resurgence of the Covid-19 pandemic on the economy, the RBI Governor, on May 5, 2021, announced several measures with a view to infuse liquidity in the economy, avoid another wave of borrower defaults[1] as well as aid in ease of business during the lockdown.

Out of the several measures announced by the Governor, one was to simplify the KYC process, which is the initial step of any lending transaction. Some of the amendments seem to provide immediate relief from compliance requirements and some are intended to encourage carrying out KYC compliances electronically, given the social distancing norms.

In this regard, the RBI has issued the following notifications:

  1. Periodic Updation of KYC – Restrictions on Account Operations for Non-compliance dated May 5, 2021[2]
  2. Amendment to the Master Direction (MD) on KYC dated May 10, 2021[3]

In this article we intend to discuss the prima facie implications of the amendments introduced by the aforesaid notifications. Read more →

CKYCR becomes fully operational: The long-awaited format for legal entities’ information finally introduced

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-Kanakprabha Jethani (kanak@vinodkothari.com)

Background

The Central KYC Registry (CKYCR) is a registry that serves as a central record for KYC information of all the customers of financial institutions. In India, the Central Registry of Securitisation Asset Reconstruction and Security Interest of India (CERSAI) has been authorised to carry out the functions of CKYCR. It was operationalised in 2016 beginning with collecting information on ‘individual’ accounts. Until now, the CKYCR did not have a feature to collect KYC information of legal entities.

The CERSAI has, in consultation with the RBI, prepared a template for submission of KYC information of legal entities (the same is yet to be published by CERSAI). The RBI has, through a notification dated December 18, 2020[1] (‘Notification’) directed financial institutions to begin submitting KYC information of legal entities w.e.f April1, 2021 (‘Notified Date’). The Master Direction – Know Your Customer (KYC) Direction, 2016 (‘KYC Directions’) have been updated in line with the said notification.

In this note we have discussed the implications for NBFCs, having customer interface, specifically.

Actionables for financial entities

In compliance with the existing KYC provisions on CKYCR and the Notification, NBFCs shall be required to take the following steps:

For customer who are legal entities, other than individuals and FPIs

  • Ensure uploading KYC data of legal entities whose loan account has been opened after the Notified Date; within 10 days of commencement of an account-based relationship with the customer. It is to be noted that the existing time limit for uploading the documents of individual accounts was 3 days.
  • Ensure uploading KYC records of legal entities on CKYCR, whose accounts are opened before the Notified Date, while undertaking periodic updation[2] or otherwise on receipt of updated KYC information from the customers. (When KYC information is uploaded during periodic updation or otherwise, it must be ensured that the same is in accordance with the CDD process as prevailing at such time.) Such uploading may not be required for loan accounts that are closed before undertaking the first periodic updation after the Notified Date.
  • Communicate the KYC identifier generated after uploading of KYC information to the customer.

 For individuals

  • Ensure that the existing KYC records of individual customers pertaining to loan accounts opened prior to April 01, 2017, should be incrementally uploaded on CKYCR at the time of periodic updation or earlier when the updated KYC information is obtained/received from the customers. (When KYC information is uploaded during periodic updation or otherwise, it must be ensured that the same is in accordance with the CDD process as prevailing at such time.) Such uploading may not be required for loan accounts that are closed before undertaking the first periodic updation after the Notified Date.
  • Ensure uploading KYC data of individual loan account opened after the Notified Date; within 10 days of commencement of an account-based relationship with the customer.
  • Communicate the KYC identifier generated after uploading of KYC information to the customer.

Clarification with respect to identity verification through CKYCR

There has been a confusion regarding validity of identity verification done by fetching KYC details from the CKYCR. While the provisions of the Prevention of Money Laundering Act, 2002 (PMLA) and rules thereunder as well as the operating guidelines clearly state that if the customer submits KYC identifier for identity and address verification, no other documents need to be obtained.

The KYC Directions have remained silent on the same for long. The Notification also clarified that-

“Where a customer, for the purpose of establishing an account based relationship, submits a KYC Identifier to a RE, with an explicit consent to download records from CKYCR, then such RE shall retrieve the KYC records online from CKYCR using the KYC Identifier and the customer shall not be required to submit the same KYC records or information or any other additional identification documents or details, unless –

  • there is a change in the information of the customer as existing in the records of CKYCR;
  • the current address of the customer is required to be verified;
  • the RE considers it necessary in order to verify the identity or address of the customer, or to perform enhanced due diligence or to build an appropriate risk profile of the client.”

Hence, for the purpose of verification, what is necessary is the KYC Identifier and an explicit consent from the customer to download his/her KYC information from the CKYCR.

Conclusion

The template for uploading KYC information of legal entities on the CKYCR portal has been formulated and shall be live on CERSAI Platform shortly. Financial institutions shall be required to ensure uploading of KYC information of legal entities w.e.f. the Notified Date. Further, additional obligations have been placed on financial institutions in terms of uploading KYC documents for existing customers and intimation of KYC identifier to all customers. Clarification regarding the validity of KYC verification using data from CKYCR is a welcome move.

 

[1] https://www.rbi.org.in/Scripts/NotificationUser.aspx?Id=12008&Mode=0

[2] As per para 38 of the KYC Directions- Periodic updation shall be carried out at least once in every two years for high risk customers, once in every eight years for medium risk customers and once in every ten years for low risk customers as per the prescribed procedure.