Inter-lender balance transfer of loans: understanding the nuances

-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.

This concept of moving to a new lender is commonly called ‘Balance Transfer’. This, in common parlance, is a case wherein the borrower approaches a new lender and based on the request, the new lender evaluates the creditworthiness of the customer to sanction a new loan for repayment of the existing loan. The essence is that the transaction happens at the instance of the borrower. Further, as the name suggests, balance transfer implies the remaining loan exposure of the lender towards the borrower that is transferred to a new lender.

In 2020, balance transfers or loan refinance, as they are known in global parlance, gained tremendous traction. In the US, the volumes of mortgage loan refinancing were more than double the average mortgage loan refinancing volumes^[1]. Mortgage rates hitting all time lows was the primary reason behind increase in mortgage loan refinancing activity. Repeat refinance^[2] also became prevalent during this time.

RBI has in its Master Directions on Transfer of Loan Exposures^[3], specifically excluded transfer of loan accounts of borrowers by a lender to other lenders, at the request/instance of the borrower, from the purview of certain provisions of the said Master Directions. Hence, the discussion around ‘Balance Transfer’ becomes even more crucial.

This article discusses the concept of balance transfer, what constitutes and what does not constitute a balance transfer and how the same is regulated.

Understanding Balance Transfers in Global Parlance

Globally, the concept of balance transfer, or the facility wherein the exposure on the borrower is transferred to another lender, upon a request for such transfer being made by the borrower, is known as loan refinancing or refi. Loan refinancing may be done in various ways such as:

• Refinancing with existing lender: Borrowers tend to pre-pay existing loans and avail loans from other lenders, if the terms of other lenders are more favourable. In order to avoid such pre-payments, several lenders provide switchover facilities, wherein the borrowers can switch to loans with more favorable terms, with the same lender only. This is refinancing with the same lender.
• Refinancing with new lender (refinancer): Commonly, borrowers avail refinance facilities from other lenders (termed as refinancers), who offer better terms. This type of refinancing is known as refinancing with refinancer.
• Rate Refinancing: Where the refinance facility is provided at a lower interest rate compared to the existing facility.
• Term Refinancing: Where the terms of refinancing allow an extended tenure and reduced EMIs to the borrower.
• Rate and Term Refinancing: A combination of lower interest rates, lower EMI and extended tenure of the loan. This is the most common type of refinancing facility.
• Cash-Out Refinancing: Where the amount of refinance is higher than the outstanding amount of the existing loan. This type of refinancing is usually availed for dual purposes i.e. to repay the existing loan along with meeting some other liquidity needs.
• Cash-In Refinancing: Where the borrower repays a part of the outstanding loan before availing of the refinance, such that the amount of refinanced loan is lesser than the outstanding amount of the existing loan.

The concept of loan refinance is most common in mortgage finance (known as mortgage refinance or remortgage), however, with time, loan refinancing is an acceptable concept for all kinds of loans. Loan refinancing is also very popular in cases of student loans or education loans and personal loans.

Loan refinancing has also become very common in the case of student loans or education loans. The primary reason behind the same is that the student loan is extended based on the lower or NIL credit history, little or no income, or what is called in global parlance, a “thin file”. Loan refinancing is usually done once the borrower has a source of income and has built its credit score by paying a number of installments of the student loan itself or may be other credit dues such as credit cards. All these factors enable the borrower to have a better credit score and hence, a reduced rate of interest.

Similarly, personal loans are also refinanced after seasoning the loan with timely repayment for some time.

Motivations for Refinancing

As discussed above, the borrower usually has a motivation for availing of loan refinance. Usually, the decision to refinance is driven by pecuniary factors such as lower interest rates, lower EMIs, ability to have additional funding through refinance, shorter tenure-along with a lower interest rate, obtaining a term loan to refinance a bullet repayment or a balloon loan, etc.

Restructuring vs. Refinancing

One may contend that reduction in interest rates or amount of EMIs, availing additional funding, etc., is actually a manner of restructuring the loans. Does this indicate refinancing is a type of restructuring?

Loan restructuring is typically done to help the borrower in case of financial difficulty and avoid default by the borrowers. Further, loan restructuring essentially includes an agreement between the existing lender and the borrower to alter the terms of the existing loan. This means that the existing loan with the existing lender continues on revised terms.

On the other hand, loan refinancing, as discussed above, may or may not come from the existing lender; (it typically comes from a new lender). Additionally, the intention of loan refinancing is not to help the borrower in financial difficulty. In fact, in case a borrower is facing financial difficulty and the same is visible from his repayment behaviour, a new lender may not be willing to provide refinance or may not provide favorable terms.

Hence, while these two terms may prima facie seem similar, the intent and execution move to separate tangents, quite opposite to each other.

Is Loan Consolidation a type of Loan Refinancing?

In cases where a borrower has several loans, which the borrower intends to refinance, the borrower may avail a single loan of large size, typically amounting to an aggregate of all outstanding loan facilities.

Personal loans, credit card dues etc. may be consolidated in a personal loan with a lower interest rate. For example, it is a common practice in the US for students to consolidate several federal student loans into a Federal Direct Consolidation Loan^[4].

Consolidation of loans of different types is also possible, but the same will only make sense when the rate of interest of the consolidated loan is lower and provides certain benefits to the borrower. Further, the end use of the new loan may not necessarily be to take over an existing loan, instead it would usually be for personal needs, which may include repayment of existing liabilities.

Where the consolidation results in transferring several outstanding loans of the borrower into a single personal loan, the same should be considered as a fresh loan, and not a balance transfer.

Can New Loan Exposure be a type of Balance Transfer?

A balance transfer would ideally mean a situation where a borrower approaches a refinancer to shift its obligation from the existing lender to the refinancer. The loan amount is usually the same as the outstanding amount of the existing loan. Essentially, a case of rate/term/rate and term refinancing.

A borrower may also refinance its existing loan by availing a new loan from a lender. The new loan may, in addition to paying off the existing lender, provide additional funding to the borrower for other purposes. In such cases, there shall be more than one end-use of the loan. This would be similar to a cash-out refinancing discussed above.

In both cases, the exposure of a lender over a borrower gets transferred to another lender. The quantum of exposures may be different, but the net effect of the transfer remains the same. Hence, both balance transfer and availing a new loan to pay off an existing loan are types of loan refinancing only.

However, if the end-use of the new loan cannot be traced towards refinancing an existing loan or to repay an existing loan, or the nature of the new loan is entirely different and unrelated from the existing loan (say a personal loan refinanced by an MSME loan), the question of considering the same as balance transfer does not arise.

Features of Balance Transfer

From the above discussion, the following broad features of balance transfer or loan refinancing may be drawn:

• The transfer shall be at the behest of the borrower i.e. the borrower should itself identify and approach the refinancer;
• Appropriate reasons or motivation for the borrower to shift to another lender must be visible;
• The refinance agreement should ideally be a tripartite agreement, wherein the existing lender is informed about the refinancing. However, the absence of such a tripartite agreement should not indicate that the new loan is not a refinancing loan;
• The transfer is not intended to assist a borrower in financial difficulty i.e. the borrower does not have existing delays of defaults in repayments at the time of availing the refinance;
• The nature of the new loan matches with the existing loan i.e. for refinancing a mortgage loan, another mortgage loan is obtained. The same however is not a pre-requisite.

Comparing Balance Transfers, New Loans and Transfer of Loan Exposures

Loan Refinancing in India

Para 2.4 of Master Circular- Loans and Advances – Statutory and Other Restrictions^[6] deals with the provisions of transfer of borrowal accounts at the instance of the borrower. The same requires the refinancer (being a bank) to obtain necessary information from the existing lender (also a bank) before transferring the borrowal account. It states-

1. a) Banks should put in place a Board approved policy with regard to take-over of accounts from another bank. The policy may include norms relating to the nature of the accounts that may be taken over, authority levels for sanction of takeover, reporting of takeover to higher authorities, monitoring mechanism of taken over accounts, credit audit of taken over accounts, examination of staff accountability especially in case of quick mortality of such cases after takeover, periodic review of taken over accounts at Board / Board Committee level, Top Management level, etc.
2. b) In addition, before taking over an account, the transferee bank should obtain necessary credit information from the transferor bank as per the format prescribed in Annex II of RBI circular DBOD.No.BP.BC.94/ 08.12.001/2008-09 dated December 8, 2008 on “Lending under Consortium Arrangement / Multiple Banking Arrangements”. This would enable the transferee bank to be fully aware of the irregularities, if any, existing in the borrower’s account(s) with the transferor bank. The transferor bank, on receipt of a request from the transferee bank, should share necessary credit information as per the prescribed format at the earliest.

The aforementioned format^[7] contains several details that are to be obtained by the refinancer, including qualitative and quantitative information on the existing loan account and the borrower.

For NBFCs, there are no such requirements for obtaining information from existing lender, however, they shall be guided by the above provisions, in pari materia, for transferring the loan accounts on request of the borrowers. While extending refinance facilities, NBFCs usually consider the credit score of the borrower. As a good practice, it is beneficial to obtain qualitative information on the borrower such as details of non-fund based facilities, details of loan applications under process, business activities of the borrower, details of litigations, if any, etc.

Compliances with respect to Balance Transfers

While undertaking a balance transfers, the following should be ensured:

• There should be a request from the borrower, which shall be kept on records: There is no specific format for such a request, however, it must indicate the basic details of the new loan and the fact that the same is requested by the borrower;
• The new lender shall approach the existing lender for obtaining basic details of the customer as per prescribed formats: This requirement is not applicable to NBFCs, however, should be ensured in pari materia;
• In case request is made to an NBFC, the decision must be conveyed to the borrower within 21 days from the receipt of the request: Banks should also ensure revert within a reasonable time;
• A tripartite agreement between the existing lender, new lender, and the borrower should be executed.

Applicability of TLE Directions

Chapter III of the TLE Directions excludes balance transfers at the instance of the borrower from its scope. Logically, the same should not be considered a transfer of loan by one lender to another for the purpose of TLE Directions, since a new loan is originated and the existing loan is paid off. It is not essentially a transfer by way of assignment or novation.

It may be argued that the refinance facility is still subjected to the provisions of Chapter II, as per the first proviso to para 29. The provisions of Chapter II though do not entail any specific compliance requirement on the transferor or the transferee, however, para 22 (under Chapter II) suggest that the MHP requirement is applicable. In our view, this does not seem to be the intent of the regulator to exclude the refinance transaction from the purview of TLE Directions but still require them to abide by the MHP requirements. Hence, a logical interpretation must be taken in this regard.

Conclusion

Balance transfer, also known as loan refinancing, is neither a type of restructuring of loans nor a debt consolidation. It may be done in several ways, suiting the specific needs of the borrower. It must be noted that the underlying motive behind such refinance should be that the other lender offers more favorable terms to the borrower.

^[1] Source: Freddie Mac Research, March 05, 2021- http://www.freddiemac.com/research/insight/20210305_refinance_trends.page

^[2] Repeat refinances include loans that were refinanced two or more times within a 12-month period

^[3] https://www.rbi.org.in/Scripts/NotificationUser.aspx?Id=12166&Mode=0

^[4] https://studentaid.gov/app/launchConsolidation.action

^[5] In case the new loan is for repayment of an existing loan- the same shall be treated as Balance Transfer

^[6] https://m.rbi.org.in/scripts/BS_ViewMasCirculardetails.aspx?id=9902#24

^[7] https://rbi.org.in/Scripts/NotificationUser.aspx?Id=4699&Mode=0#a2

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