Posts

A comprehensive framework for compromise settlement and technical write offs

Dayita Kanodia | Executive finserv@vinodkothari.com

The first bad bank loan was, no doubt, made around the time as the opening of the first bank.

James Grant[1]

Background

RBI  released the Framework for Compromise Settlements and Technical Write-offs[2] (Framework) on June 8 2023. This framework, issued exactly four years after the release of the Prudential Framework for Resolution of Stressed Assets[3] (PFRSA), aims to rationalize and harmonize the instructions earlier issued. Additionally, while PFRSA was applicable only to banks and systemically important NBFCs (among others), the present Framework is applicable across all REs, including base layer NBFCs.

Subsequently, to clear the ambiguities that may have arisen after the issuance of the Framework, the RBI also released a set of Frequently Asked Questions[4] on the topic: of these, these FAQs were largely intended to respond to certain questions of intent that were being thrown at the regulator in releasing the Framework.

This article discusses the Framework along with its applicability, as also it intends to help REs to make a calculated decision on choosing between compromise settlements, writedowns, restructuring, or doing nothing at all. For either of the options, the article also discusses  the other requirements which need to be ensured while pursuing the option. 

Read more

Embracing a Wider Scope for TReDS

Transfer of Factoring Units to come under the purview of TLE in lieu of the regulator’s move to enhance TReDs Platform

– Anita Baid, Vice President | finserv@vinodkothari.com

The concept of Trade Receivables Discounting System (TReDS) was introduced by RBI to enable discounting of invoices of MSME sellers against large corporates, including government departments and public sector undertakings, through an auction mechanism to ensure prompt realisation of trade receivables at competitive market rates. 

TReDS transactions fall under the umbrella of “factoring business.” Factoring is a financial practice where a company sells its trade receivables, or outstanding invoices, to a third party at a discount in exchange for immediate cash. TReDS platforms provide a digital infrastructure for facilitating such transactions, enabling efficient invoice discounting and promoting liquidity for MSMEs.(Our FAQs on TReDS and the India Factoring Report 2023 can be read here and here)

In a move to further strengthen the TReDS and promote smoother financial transactions, the RBI has announced significant enhancements to the TReDS guidelines. These enhancements are in line with the announcement made by RBI in the Statement on Developmental and Regulatory Policies dated February 8, 2023, to address certain challenges faced by financiers while bidding for low-rated buyers’ payables on TReDS platforms. (Our article on the same can be read here)

This article intends to discuss the RBI notification dated June 7, 2023 on Expanding the Scope of Trade Receivables Discounting System, introducing the said enhancements.

Read more

FAQs on Default Loss Guarantee in Digital Lending

An understanding of the Guidelines issued by RBI

Team Finserv | finserv@vinodkothari.com

On September 02, 2022, the RBI issued the “Guidelines on Digital Lending” (“DL Guidelines”), which had essentially put a bar on “Loss sharing/ structured default guarantee arrangements” such as First Loss Default Guarantees, likening their nature to that of “synthetic securitisation” as defined under the Master Direction – Reserve Bank of India (Securitisation of Standard Assets) Directions, 2021 (“SSA Directions”). This caused a disruption in the digital lending industry as most of the arrangements ran on some form of loss-sharing arrangement. (Refer to our FAQs on the Digital Lending Guidelines here)

In its Statement on Developmental and Regulatory Policies dated June 8, 2023, the RBI announced its intention to issue a regulatory framework for permitting Default Loss Guarantee arrangements in Digital Lending[1]. The same day, the Guidelines on Default Loss Guarantee (DLG) in Digital Lending have been issued by the regulator (‘DLG Guidelines’).

We have developed a set of FAQs on the DLG Guidelines, where we intend to answer some of the critical questions relating to the default guarantee arrangements.

Read more

Securitisation: Indian market grows amidst global volume contraction

Timothy Lopes, Manager

finserv@vinodkothari.com

Global Securitisation Volumes, 2022

The global securitisation market in 2022[1] saw a decline in volumes as compared to record issuance volumes seen in the year 2021. The decline was mainly driven by 24% year-on-year decline in volumes in the United States, obviously because of inflation, general economic conditions and low level of business confidence,  coupled with supply chain disruptions and uncertainty caused by the Russia-Ukraine conflict[2].

Read more

Penal charges not a cash-cow for lenders

RBI issues draft guidelines on fair lending practices for penal charges

Aanchal Kaur Nagpal, Manager and Dayita Kanodia, Executive | finserv@vinodkothari.com

Introduction

Levying of penal interest/ charges is a punitive measure adopted by lenders on borrowers defaulting in making repayments and/ or breaching any terms and conditions mutually agreed in the loan agreement. The Reserve Bank of India also allows lenders to charge such rates as long as the same are communicated to the borrower and are in accordance with the Board approved policy framed in this behalf.

However, lenders, cashing in on such autonomy and flexibility, have adopted varied practices which are often prejudicial to the borrower. These include charging exorbitant rates, capitalisation of penal charges, charging of penal interest on the loan amount and not the defaulted portion etc.

The RBI, in its Statement on Developmental and Regulatory Policies dated February 08, 2023[1], announced policy measures for introduction of guidelines for regulating the penal charges levied by financial institutions[2]. Pursuant to the same, RBI, on April 12, 2023 has issued a draft circular on Fair Lending Practice – Penal Charges in Loan Accounts (‘Draft Circular’) to persuade lenders to use penal charges for their true compensatory nature and not as a revenue enhancement tool. 

While the Draft Circular comes with good intentions, there are certain provisions that may seem ambiguous and contradictory, and the final guidelines would need to provide sufficient clarity to achieve the desired execution.

Read more

RBI regulates outsourcing of IT Services by financial entities

-Anirudh Grover, Executive | finserv@vinodkothari.com

1. Introduction

With the penetration of the internet in India, newer and more efficient technologies are being built and these dynamic technologies are being leveraged by various sectors of the economy, and the financial sector is one of them. Financial institutions have extensively been outsourcing their IT services requirements to third parties in order to get easier access to newer technologies. In this process of availing the services of a third party, financial institutions expose themselves to significant financial, operational, and reputational risk as the Reserve Bank of India has pointed out.

Accordingly, the RBI in the year 2022 had in its Statement on Developmental and Regulatory Policies proposed to issue draft directions on outsourcing of IT services since the existing Directions on Managing Risks and Code in Outsourcing of Financial Services (‘Guidelines on Outsourcing of Financial Services’) as provided for in the Master Direction- Non Banking Financial Company- Systemically Important Non Deposit taking Company and Deposit taking Company (Reserve Bank) Directions, 2016 (Updated as on December 29, 2022) (‘SI Directions’)  specifically excluded IT services from its ambit. Following which on June 23, 2022 the RBI issued Draft Master Direction on Outsourcing of IT Services (‘Draft IT Outsourcing Directions’) for public comments. We had briefly in our previous write up discussed the introduction of the Draft IT Outsourcing Directions. 

Read more

RBI Framework for Green Deposits

– Team Finserv | finserv@vinodkothari.com

Climate change is clearly one of the most pertinent regulatory themes in recent times, as the move to sustainable business practices and energy efficient technologies need massive funding.  The availability of finance for move to sustainability has an important role to play in mitigating climate change. To this effect, RBI also conducted a survey in January 2022 to assess the status of climate risk and sustainable finance in leading scheduled commercial banks, and observed a need for concerted effort and further action in this regard. Following the same, RBI conducted a discussion, and released a press release indicating its intention to release a framework for acceptance of green deposits in India. On 11th April, 2023, RBI released the Framework for Acceptance of Green Deposits (“Framework”) for banks and deposit-taking NBFCs/HFCs, to be applicable from 1st June, 2023.

Our video lecture on the topic is available here: https://youtu.be/7rRhVYR-zT0

As the green deposits formally mark its presence in the Indian financial markets, one may be inquisitive on various aspects related to it. We have tried to analyze and put our views on the same in this write-up.

The Green Deposit Framework
Banks and deposit-taking NBFCs/HFCs may raise green deposits, in accordance with the Framework, from 1st June, 2023
Money raised by Green deposits to be deployed only for “green finance”; India’s taxonomy for the same to be developed. In the meantime, a list of eligible green activities/ projects has been announced, in line with SEBI’s definition of green bonds under NCS Regulations
Third party assessment/verification of use of proceeds mandatory
Impact assessment to be optional for FY 23-24, and mandatory from FY 24-25
Disclosure of green deposits and utilization in the annual financial statements
Read more

Private sector banks to continuously monitor major shareholders

RBI Directions, 2023 require banks to have a mechanism to detect violation w.r.t. RBI prior approval and ‘fit and proper’ status

– Vinita Nair, Senior Partner | corplaw@vinodkothari.com

Given their systemic significance, ensuring that ownership of banks neither gets concentrated, nor falls into wrong hands, has always been important. Therefore, acquisition of shares or voting rights (‘S/VR’) is strictly regulated by Section 12B of Banking Regulation Act, 1949 (‘BR Act’), supplemented by RBI Directions issued from time to time. In the case of public sector banks, there is a ceiling of 10% of the total voting rights for shareholders other than the Central Government.

Section 12B of BR Act prescribes the requirement of prior approval of RBI in case of a person intending to become a “major shareholder”, that is, a holder with 5% of the S/VR in a banking company. The requirement is applicable where a person acquires or agrees to acquire S/VR, which could be (a) either directly or indirectly, and (b) whether alone, or  by acting in concert with any other person. Hence, there is a need to do both horizontal aggregation [that is, relatives[1] and persons acting in concert (PAC)[2]], as well as vertical aggregation (that is, indirect acquisition through controlled entities or “associated enterprises[3].

This article discusses the possible pain points likely to be faced by the banks, other requirements under the new regime and actionable arising therefrom.

Read more

PML Act and Rules: Recent changes may have new compliance requirements

-Team Finserv | finserv@vinodkothari.com

Background

Financial sector entities have to follow PMLA and related rules, including by way of KYC Directions. The Finance Ministry came up with various amendments pertaining to the Prevention of Money-Laundering Act, 2002 (“PML Act”) and the Prevention of Money-Laundering (Maintenance of Records) Rules, 2005 (‘PML Rules’). The amendments pertain to revised thresholds for ascertainment of beneficial ownership (25% to 10%), implementation of group wide policies for compliance with provisions of Chapter IV, expanding the obligations under PMLA to service providers of virtual digital assets, etc.

Effective date and applicability:

The amendment shall be effective from the same date, i.e. March 07, 2023. It may be noted that the Master Direction – Know Your Customer (KYC) Direction, 2016  (‘KYC Directions’) are issued and updated by the regulator based on the amendment in PML Act and PML Rules. However, the Regulated Entities (RE) are required to ensure compliance with the provisions of PML Act and PML Rules, as amended from time to time. Hence, necessary steps must be taken based on the amendments.

Whether applicable to existing or new customers?

Customer Due Diligence (as required under the PML Act and Rules) is required to be undertaken at the time of commencement of a financial transaction or account-based relationship with the customer. Accordingly, necessary steps must be taken by the RE to ensure compliance with the Amendment Rules for all new customers or new financial transactions undertaken with existing customers after March 07, 2023. However, it is also pertinent to note rule 9(12) of the PML Rules which requires reporting entities to exercise continuous due diligence with respect to the business relationship with every clients.

Read more