Registration under Money-Lending Laws

finserv@vinodkothari.com

Our other articles on the topic can be accessed through below link:

  1. Registration under money-lending laws
  2. Inapplicability of money lending laws to regulated entities

 

List of Disclosures Requirements Applicable to NBFCs

 

Srl No Particular Clause Reference Remarks
List of Disclosure in Annual Report – As per RBI Direction
1 NBFCs shall disclose in their annual reports the details of the auctions conducted during the financial year including the number of loan accounts, outstanding amounts, value fetched and whether any of its sister concerns participated in the auction. Para 27(4) (d)-Loans against security of single product – gold jewellery Applicable for Gold loan business
2
Non-deposit taking NBFC with asset size of ₹ 500 crore and above issuing PDI, shall make suitable disclosures in their Annual Report about : Annex XVII
(i) Amount of funds raised through PDI during the year and outstanding at the close of the financial year;
(ii) Percentage of the amount of PDI of the amount of its Tier I Capital;
(iii) Mention the financial year in which interest on PDI has not been paid in accordance with clause 1(viii) above.
Terms and Conditions Applicable to Perpetual Debt Instruments (PDI) for Being Eligible for Inclusion in Tier I capital Applicable for NBFCs issuing PDIs
2A Details of all material transactions with related parties shall be disclosed in the annual report along with policy on dealing with Annual Report Para 4.3 – Annex IV, Master Directions
2B (i) Remunerarion of Directors (Para 4.5)
(ii) a Management Discussion and Analysis report
Para 4.3 – Annex IV, Master Directions
Disclosure in Financial Statements- as per RBI Direction
3
Disclosure in the balance sheet
The provision towards standard assets need not be netted from gross advances but shall be shown separately as ‘Contingent Provisions against Standard Assets’ in the balance sheet. Master Directions Para 14
Every applicable NBFCshall separately disclose in its balance sheet the provisions made as per these Directions without netting them from the income or against the value of assets.

The provisions shall be distinctly indicated under separate heads of account as under:-
(i) provisions for bad and doubtful debts; and
(ii) provisions for depreciation in investments.

Master Direction Para 17 (1) and (2)
In addition to the above every applicable NBFCshall disclose the following particulars in its Balance Sheet:
(i) Capital to Risk Assets Ratio (CRAR);
(ii) Exposure to real estate sector, both direct and indirect; and
(iii) Maturity pattern of assets and liabilities.
Master Direction Para 17 (5)
4 Indicative List of Balance Sheet Disclosure for non-deposit taking NBFCs with Asset Size ₹500 Crore and Above and Deposit Taking NBFCs (hereinafter called as Applicable NBFCs) Annex XIV Please refer Annex XIV
5
Disclosures to be made by the Originator in Notes to Annual Accounts Guidelines on Securitisation Transactions
The Notes to Annual Accounts of the originating NBFCs shall indicate the outstanding amount of securitised assets as per books of the SPVs sponsored by the NBFC and total amount of exposures retained by the NBFC as on the date of balance sheet to comply with the MRR. These figures shall be based on the information duly certified by the SPV’s auditors obtained by the originating NBFC from the SPV. These disclosures shall be made in the format given in Appendix 2.
6
LRM Framework
An NBFC shall publicly disclose information (Appendix I) on a quarterly basis on the official website of the company and in the annual financial statement as notes to account that enables market participants to make an informed judgment about the soundness of its liquidity risk management framework and liquidity position. Guidelines on Liquidity Risk Management Please refer Appendix I
7
LCR Disclosure Standards
NBFCs in their annual financial statements under Notes to Accounts, starting with the financial year ending March 31, 2021, shall disclose information on LCR for all the four quarters of the relevant financial year. The disclosure format is given in the Appendix I. Data must be presented as simple averages of monthly observations over the previous quarter (i.e., the average is calculated over a period of 90 days). However, with effect from the financial year ending March 31, 2022, the simple average shall be calculated on daily observations.
NBFCs should provide sufficient qualitative discussion (in their annual financial statements under Notes to Accounts) around the LCR to facilitate understanding of the results and data provided. Please refer Appendix I (Part B)
8
Schedule to the balance sheet Master Direction Clause 19
Every applicable NBFC shall append to its balance sheet prescribed under the Companies Act, 2013, the particulars in the schedule as set out in Annex IV.
9
Participation in Currency Options Master Direction Clause 83
Disclosures shall be made in the balance sheet regarding transactions undertaken, in accordance with the guidelines issued by SEBI.
10
Participation in Currency Futures Master Direction Clause 94
Disclosures shall be made in the balance sheet relating to transactions undertaken in the currency futures market, in accordance with the guidelines issued by SEBI.
11
Disclosure for Restructured Accounts Master Direction Annex VII
With effect from the financial year ending March 2014 NBFCs shall disclose in their published annual Balance Sheets, under “Notes on Accounts”, information relating to number and amount of advances restructured, and the amount of diminution in the fair value of the restructured advances as per the format given in Appendix – 4
12 Disclosures relating to fraud in terms of the notification issued by Reserve Bank of India
14
Moratorium Circular
The lending institutions shall suitably disclose the following in the ‘Notes to Accounts’ while preparing their financial statements for the half year ending September 30, 2020 as well as the financial years 2019-20 and 2020-2021:

(i) Respective amounts in SMA/overdue categories, where the moratorium/deferment was extended, in terms of paragraph 2 and 3;

(ii) Respective amount where asset classification benefits is extended.

(iii) Provisions made during the Q4FY2020 and Q1FY2021 in terms of paragraph 5;

(iv) Provisions adjusted during the respective accounting periods against slippages and the residual provisions in terms of paragraph 6.

Para 10 COVID19 Regulatory Package – Asset Classification and Provisioning
15
Disclosure under sector – Restructuring of Advances, Circular
NBFCs shall make appropriate disclosures in their financial statements, under ‘Notes on Accounts’, relating to the MSME accounts restructured under these instructions as per the following format:

No. of accounts restructured Amount (₹ in million)

Micro, Small and Medium Enterprises (MSME) sector – Restructuring of Advances
16
Lending institutions publishing quarterly statements shall, at the minimum, make disclosures as per the format prescribed in Format-A Para 52 of Resolution Framework for COVID-19-related Stress In the financial statements for the quarters ending March 31, 2021, June 30, 2021 and September 30, 2021
16A (i) registration/ licence/ authorisation, by whatever name called, obtained from other financial sector regulators;
(ii) ratings assigned by credit rating agencies and migration of ratings during the year;
(iii) penalties, if any, levied by any regulator;
(iv) information namely, area, country of operation and joint venture partners with regard to joint ventures and overseas subsidiaries and
(v) Asset-Liability profile, extent of financing of parent company products, NPAs and movement of NPAs, details of all off-balance sheet exposures, structured products issued by them as also securitization/ assignment transactions and other disclosures
Para 73 – Master Directions (Ref. Annexure XIV)
Other Disclosure
17 Report on-line to stock exchanges on a quarterly basis, information on the shares pledged against LAS, in their favour, by borrowers for availing loans 22 of Master Directions In format as given in Annex V for Master Direction.
18 Quarterly statement to RBI on change of directors, and a certificate from the Managing Director of the applicable NBFC that fit and proper criteria in selection of the directors has been followed 72 of Master Direction The statement must be sent 15 days of the close of the respective quarter. The statement for the quarter ending March 31, shall be certified by the auditors
19 On a quarterly basis, NBFCs shall report “total exposure” in all cases where they have assumed exposures against borrowers in excess of the normal single / group exposure limits due to the credit protections obtained by them through CDS, guarantees or any other permitted instruments of credit risk transfer Para 8 of Guidelines for Credit Default Swaps – NBFCs as users
Website Disclosure
20
Public disclosure
An NBFC shall publicly disclose information (Appendix I) on a quarterly basis on the official website of the company that enables market participants to make an informed judgment about the soundness of its liquidity risk management framework and liquidity position. Guidelines on Liquidity Risk Management Please refer Appendix I
21 NBFCs are required to disclose information on their LCR every quarter Para 6 LCR Framework To be made on website
Additional Disclosures w.r.t. COVID-19
22 Lending institutions publishing quarterly financial statements shall, at the minimum, shall make disclosures in their financial statements for the quarters ending September 30, 2021 and December 31, 2021. The resolution plans implemented in terms of Part A of this framework should also be included in the continuous disclosures required as per Format-B prescribed in the Resolution Framework – 1.0. As per format prescribed in Format-X
23 The number of borrower accounts where modifications were sanctioned and implemented in terms of Clause 22 above, and the aggregate exposure of the lending institution to such borrowers may also be disclosed on a quarterly basis,
24 The credit reporting by the lending institutions in respect of borrowers where the resolution plan is implemented under Part A of this window shall reflect the “restructured due to COVID-19” status of the account

FAQs on refund of interest on interest

-Financial Services Division (finserv@vinodkothari.com)

The Supreme Court of India (‘SC’ or ‘Court’) had given its judgment in the matter of Small Scale Industrial Manufacturers Association vs UOI & Ors. and other connected matters on March 23, 2021. The said order of SC put an end to an almost ten months-long legal scuffle that started with the plea for a complete waiver of interest but edged towards waiver of interest on interest, that is, compound interest, charged by lenders during Covid moratorium.  While there is no clear sense of direction as to who shall bear the burden of interest on interest for the period commencing from 01 March 2020 till 31 August 2020. The Indian Bank’s Association (IBA) has made representation to the government to take on the burden of additional interest, as directed under the Supreme Court judgment. While there is currently no official response from the Government’s side in this regard, at least in the public domain in respect to who shall bear the interest on interest as directed by SC. Nevertheless, while the decision/official response from the Government is awaited, the RBI issued a circular dated April 07, 2021, directing lending institutions to abide by SC judgment.[1] Meanwhile, the IBA in consultation with banks, NBFCs, FICCI, ICAI, and other stakeholders have adopted a guideline with a uniform methodology for a refund of interest on interest/compound interest/penal interest.

We have earlier covered the ex-gratia scheme in detail in our FAQs titled ‘Compound interest burden taken over by the Central Government: Lenders required to pass on benefit to borrowers’ – Vinod Kothari Consultants>

In this write-up, we have aimed to briefly cover some of the salient aspects of the RBI circular in light of SC judgment and advisory issued by IBA.

Read more

Presentation on scalar regulatory framework for the NBFC sector

The video of “Round table discussion on RBI’s proposed regulatory framework for NBFCs” can be viewed here 

Our write-up on the topic titled “Scalar regulatory framework for the NBFC sector” can be viewed here

 

About time to unfreeze NPA classification and reporting

-Siddarth Goel (finserv@vinodkothari.com)

Introduction

The COVID pandemic last year was surely one such rare occurrence that brought unimaginable suffering to all sections of the economy. Various relief measures granted or actions taken by the respective governments, across the globe, may not be adequate compensation against the actual misery suffered by the people. One of the earliest relief that was granted by the Indian government in the financial sector, sensing the urgency and nature of the pandemic, was the moratorium scheme, followed by Emergency Credit Line Guarantee Scheme (ECLGS). Another crucial move was the allowance of restructuring of stressed accounts due to covid related stress. However, every relief provided is not always considered as a blessing and is at times also cursed for its side effects.

Amid the various schemes, one of the controversial matter at the helm of the issue was charging of interest on interest on the accounts which have availed payment deferment under the moratorium scheme. The Supreme Court (SC) in the writ petition No 825/2020 (Gajendra Sharma Vs Union of India & Anr) took up this issue. In this regard, we have also earlier argued that government is in the best position to bear the burden of interest on interest on the accounts granted moratorium under the scheme owing to systemic risk implications.[1] The burden of the same was taken over by the government under its Ex-gratia payment on interest over interest scheme.[2]

However, there were several other issues about the adequacy of actions taken by the government and the RBI, filed through several writ petitions by different stakeholders. One of the most common concern was the reporting of the loan accounts as NPA, in case of non-payment post the moratorium period. The borrowers sought an extended relief in terms of relaxation in reporting the NPA status to the credit bureaus. Looking at the commonality, the SC took the issues collectively under various writ petitions with the petition of Gajendra Sharma Vs Union of India & Anr. While dealing with the writ petitions, the SC granted stay on NPA classification in its order dated September 03, 2020[3]. The said order stated that:

In view of the above, the accounts which were not declared NPA till 31.08.2020 shall not be declared NPA till further orders.”

The intent of granting such a stay was to provide interim relief to the borrowers who have been adversely affected by the pandemic, by not classifying and reporting their accounts as NA and thereby impacting their credit score.

The legal ambiguity

The aforesaid order dated September 03, 2020, has also led to the creation of certain ambiguities amongst banks and NBFCs. One of them being that whether post disposal of WP No. 825/2020 Gajendra Sharma (Supra), the order dated September 03, 2020, should also nullify. While another ambiguity being that whether the stay is only for those accounts that have availed the benefit under moratorium scheme or does it apply to all borrowers.

It is pertinent to note that the SC was dealing with the entire batch of writ petitions while it passed the common order dated September 03, 2020. Hence, the ‘stay on NPA classification’ by the SC was a common order in response to all the writ petitions jointly taken up by the court. Thus, the stay order on NPA classification has to be interpreted broadly and cannot be restricted to only accounts of the petitioners or the accounts that have availed the benefit under the moratorium scheme. As per the order, the SC held that accounts that have not been declared/classified NPA till August 31, 2020, shall not be downgraded further until further orders. This relaxation should not just be restricted to accounts that have availed moratorium benefit and must be applied across the entire borrower segment.

The WP No. 825/2020 Gajendra Sharma (Supra) was disposed of by the SC in its judgment dated November 27, 2020[4], whereby in the petition, the petitioner had prayed for direction like mandamus; to declare moratorium scheme notification dated 27.03.2020 issued by Respondent No.2 (RBI) as ultra vires to the extent it charges interest on the loan amount during the moratorium period and to direct the Respondents (UOI and RBI) to provide relief in repayment of the loan by not charging interest during the moratorium period.

The aforesaid contentions were resolved to the satisfaction of the petitioner vide the Ex-gratia Scheme dated October 23, 2020. However, there has been no express lifting of the stay on NPA classification by the SC in its judgment. Hence, there arose a concern relating to the nullity of the order dated September 03, 2020.

The other writ petitions were listed for hearing on December 02, 2020, by the SC via another order dated November 27, 2020[5]. Since then the case has been heard on dates 02, 03, 08, 09, 14, 16, and 17 of December 2020. The arguments were concluded and the judgment has been reserved by the SC (Order dated Dec 17, 2020[6]).

As per the live media coverage of the hearing by Bar and Bench on the subject matter, at the SC hearing dated December 16, 2020[7], the advocate on behalf of the Indian Bank Association had argued that:

It is undeniable that because of number of times Supreme Court has heard the matter things have progressed. But how far can we go?

I submit this matter must now be closed. Your directions have been followed. People who have no hope of restructuring are benefitting from your ‘ don’t declare NPA’ order.

Therefore, from the foregoing discussion, it could be understood that the final judgment of the SC is still awaited for lifting the stay on NPA classification order dated September 03, 2020.

Interim Dilemma

While the judgment of the SC is awaited, and various issues under the pending writ petitions are yet to be dealt with by the SC in its judgment, it must be reckoned that banking is a sensitive business since it is linked to the wider economic system. The delay in NPA classification of accounts intermittently owing to the SC order would mean less capital provisioning for banks. It may be argued that mere stopping of asset classification downgrade, neither helps a stressed borrower in any manner nor does it helps in presenting the true picture of a bank’s balance sheet. There is a risk of greater future NPA rebound on bank’s balance sheets if the NPA classification is deferred any further. It must be ensured that the cure to be granted by the court while dealing with the respective set of petitions cannot be worse than the disease itself.

The only benefit to the borrower whose account is not classified NPA is the temporary relief from its rating downgrade, while on the contrary, this creates opacity on the actual condition of banking assets. Therefore, it is expected that the SC would do away with the freeze on NPA classification through its pending judgment. Further, it is always open for the government to provide any benefits to the desired sector of the economy either through its upcoming budget or under a separate scheme or arrangement.

THE VERDICT

[Updated on March 24, 2021]

The SC puts the final nail to almost a ten months long legal tussle that started with the plea on waiver of interest on interest charged by the lenders from the borrowers, during the moratorium period under COVID 19 relief package.  From the misfortunes suffered by the people at the hands of the pandemic to economic strangulation of people- the battle with the pandemic is still ongoing and challenging. Nevertheless, the court realised the economic limitation of any Government, even in a welfare state. The apex court of the country acknowledged in the judgment dated March 23, 2020[8], that the economic and fiscal regulatory measures are fields where judges should encroach upon very warily as judges are not experts in these matters. What is best for the economy, and in what manner and to what extent the financial reliefs/packages be formulated, offered and implemented is ultimately to be decided by the Government and RBI on the aid and advice of the experts.

Thus, in concluding part of the judgment while dismissing all the petitions, the court lifted the interim relief granted earlier- not to declare the accounts of respective borrowers as NPA. The last slice of relief in the judgement came for the large borrowers that had loans outstanding/sanctioned as on 29.02.2020 greater than Rs.2 crores. The court did not find any rationale in the two crore limit imposed by the Government for eligibility of borrowers, while granting relief of interest-on-interest (under ex-gratia scheme) to the borrowers.[9] Thus, the court directed that there shall not be any charge of interest on interest/penal interest for the period during moratorium for any borrower, irrespective of the quantum of loan. Since the NPA stay has been uplifted by the SC, NBFCs/banks shall accordingly start classification and reporting of the defaulted loan accounts as NPA, as per the applicable asset classification norms and guidelines.

Henceforth, the CIC reporting of the defaulted loan accounts (NPA) must also be done. Surely, the said directions of the court would be applicable only to the loan accounts that were eligible and have availed moratorium under the COVID 19 package. [10]

The lenders should give credit/adjustment in the next instalment of the loan account or in case the account has been closed, return any amount already recovered, to the concerned borrowers.

Given that the timelines for filing claims under the ex-gratia scheme have expired, it is expected that the Government would be releasing extended/updated operational guidelines in this regard for adjustment/ refund of the interest in interest charged by the lenders from the borrowers.

 

 

[1] http://vinodkothari.com/2020/09/moratorium-scheme-conundrum-of-interest-on-interest/

[2] http://vinodkothari.com/2020/10/interest-on-interest-burden-taken-over-by-the-government/#:~:text=Blog%20%2D%20Latest%20News-,Compound%20interest%20burden%20taken%20over%20by%20the%20Central%20Government%3A%20Lenders,pass%20on%20benefit%20to%20borrowers&text=Of%20course%2C%20the%20scheme%2C%20called,2020%20to%2031.8.

[3] https://main.sci.gov.in/supremecourt/2020/11127/11127_2020_34_16_23763_Order_03-Sep-2020.pdf

[4] https://main.sci.gov.in/supremecourt/2020/11127/11127_2020_34_1_24859_Judgement_27-Nov-2020.pdf

[5] https://main.sci.gov.in/supremecourt/2020/11127/11127_2020_34_1_24859_Order_27-Nov-2020.pdf

[6] https://main.sci.gov.in/supremecourt/2020/11162/11162_2020_37_40_25111_Order_17-Dec-2020.pdf

[7] https://www.barandbench.com/news/litigation/rbi-loan-moratorium-hearings-live-from-supreme-court-december-16

[8] https://main.sci.gov.in/supremecourt/2020/11162/11162_2020_35_1501_27212_Judgement_23-Mar-2021.pdf

[9] Compound interest burden taken over by the Central Government: Lenders required to pass on benefit to borrowers – Vinod Kothari Consultants

[10] Moratorium on loans due to Covid-19 disruption – Vinod Kothari Consultants; also see Moratorium 2.0 on term loans and working capital – Vinod Kothari Consultants

 

 

Impact of restructuring on ECL computation

-Aanchal Kaur Nagpal (aanchal@vinodkothari.com)

Introduction

The disruption throughout the globe due to the COVID-19 pandemic has hit the Indian economy as well significantly. The financial sector has experienced a massive blow due to the impact of the pandemic on the credit worthiness and repayment capacity of the overall general public. RBI has responded through various measures including allowing moratorium period, providing resolution framework for stressed accounts due to COVID-19 and numerous other measures.

The retail borrower segment of several banks and NBFCs has also been adversely affected by the disruption and hence, the lenders are contemplating ways to extend certain benefits to such borrowers them under the various circulars issued by the RBI and government. In this regard, restructuring or modification in terms of a loan is being done for economic or legal reasons, relating to the borrower’s financial difficulty. However, such restructuring may also have implications on the books of accounts, especially for IndAS compliant entities.

The following note discusses the meaning of ‘restructuring’ and it impact on the credit risk of the borrower.

Meaning of Restructuring

As per RBI norms on Restructuring of Advances by NBFC, A restructured account is one where the NBFC, for economic or legal reasons relating to the borrower’s financial difficulty, grants to the borrower concessions that the NBFC would not otherwise consider.

As per the Basel guidelines on prudential treatment of problem assets –definitions of nonperforming exposures and forbearance, definition of forbearance is as follows:

4.1. Identification of forbearance

  1. Forbearance occurs when:
  • a counterparty is experiencing financial difficulty in meeting its financial commitments; and
  • a bank grants a concession that it would not otherwise consider, irrespective of whether the concession is at the discretion of the bank and/or the counterparty. A concession is at the discretion of the counterparty (debtor) when the initial contract allows the counterparty (debtor) to change the terms of the contract in their favour (embedded forbearance clauses) due to financial difficulty.

The meaning of restructuring is modification in terms of a loan, which is done for economic or legal reasons, relating to the borrower’s financial difficulty. Usually, restructuring may be of various types. A credit weakness related restructuring is one which is done to assist the borrower to continue to service the facility. If such restructuring was not done, potentially, the borrower may not have been able to service the facility. Therefore, this is done with a view to avert a default. Yet another type of restructuring is a preponement of payments or early clearance of a loan. A third example has been given in the definition itself – for example, passing on the benefit of any interest rate increase or decrease in case of floating rate loans.

Change in credit risk

Under Indian Accounting Standard (Ind AS) 109 Financial Instruments (‘IndAS 109’), Expected Credit Loss (ECL) provision is computed for the loan accounts and it is important to determine whether restructuring should be considered as a factor in determining change in the credit risk characteristic of the borrower.

Significant Increase in Credit Risk (SICR), in the context of IFRS 9, is a significant change in the estimated Default Risk (over the remaining expected life of the financial instrument). The term ‘significant’ is not defined in IFRS-9 and thus SICR is determined using various internal and external indicators. The provisions of para 5.5.12 of IndAS 109[1] are self-explanatory on the point that if there has been a modification of the contractual terms of a loan, then, in order to see whether there has been a SICR, the entity shall compare the credit risk before the modification, and the credit risk after the modification.

While SICR indicators usually suffice during normal circumstances, but adjusting to the ‘new normal’ would require ‘new’ ways to consider SICR. The most important question that arises is whether modification in the loan terms to avoid a credit default due to COVID-19 disruption would lead to SICR.

International Guidance

  • As per the International Monetary Fund Report on The Treatment of Restructured Loans for FSI Compilation,

The BCBS (2017) defines loan forbearance as a situation in which (1) a counterparty is experiencing financial difficulty in meeting its financial commitments, and (2) a bank grants a concession that it would not otherwise consider, whether or not the concession is at the discretion of the bank and/or the counterparty. The Guide defines restructured loans as loans arising from rescheduling and refinancing of the original loan. Therefore, all forbearance measures are loan restructuring, but not all loan restructurings are forbearance measures.

Recently, in response to COVID-19 shock, the BCBS (2020) has clarified that when borrowers accept the terms of a payment moratorium (public or granted by banks on a voluntary basis) or have access to other relief measures such as public guarantees, these developments may not automatically lead to the loan being categorized as forborne. At the same time, banks would still need to assess the likelihood of the borrower’s rescheduled payments after the moratorium period ends.

  • The Indian Accounting Standard Board also released a clarification under ‘IFRS 9 and Covid-19’[2] stating that,

Entities should not continue to apply their existing ECL methodology mechanically. For example, the extension of payment holidays to all borrowers in particular classes of financial instruments should not automatically result in all those instruments being considered to have suffered an SICR.

  • According to the European Banking Authority’s Final Report on ‘Guidelines on reporting and disclosure of exposures subject to measures applied in response to the COVID‐19 crisis’[3],

More precisely, moratoria on loan payments that are in accordance with the EBA Guidelines on legislative and non‐legislative moratoria on loan repayments applied in the light of the COVID‐ 19 crisis do not trigger forbearance classification and the assessment of distressed structuring of loans and advances benefiting from these moratoria and they do not automatically lead to default classification. For example, if a performing loan is subject to a moratorium compliant with the GL on moratoria, which brings contractual changes to the terms of the loan, in the existing supervisory reporting this loan will continue to be reported under the category of performing exposures with no specific indication of the measures applied. However, it is also emphasised that the credit institutions should continue the monitoring and where necessary the unlikeliness to pay assessment of loans and advances that fall under the scope of these moratoria.

  • The Prudential Regulatory Authority of the Bank of England sent letters[4] to CEOs of various Banks guiding the following –

Our expectation is that eligibility for, and use of, the UK Government’s policy on the extension of payment holidays should not automatically, other things being equal, result in the loans involved being moved into Stage 2 or Stage 3 for the purposes of calculating ECL or trigger a default under the EU Capital Requirements Regulation (CRR). This expectation extends to similar schemes to respond to the adverse economic impact of the virus.

We do not consider the use of a Covid-19 related payment holiday by a borrower to trigger the counting of days past due or generate arrears under CRR. We also do not consider the use of such a payment holiday to result automatically in the borrower being considered unlikely to pay under CRR.

Firms are reminded to apply sound risk management practices regarding the identification of defaults. Firms should continue to assess borrowers for other indicators of unlikeliness to pay, taking into consideration the underlying cause of any financial difficulty and whether it is likely to be temporary as a result of Covid-19 or longer term

Our expectation is that a covenant breach or waiver of a covenant relating to a modification of the audit report attached to audited financial statements because of the Covid-19 pandemic should not automatically, other things being equal, trigger a default under CRR or result in a move of the loans involved into Stage 2 or Stage 3 for the purposes of calculating ECL. This expectation extends to other covenant breaches and waivers of covenants with a direct link to the Covid-19 pandemic.

A breach of the covenants of a credit contract is a possible indication of unlikeliness to pay under the CRR definition of default. However, a covenant breach does not automatically trigger a default. Rather, firms have scope to assess covenant breaches on a case-by-case basis and determine whether they indicate unlikeliness to pay.

  • The Accounting Standards Board of Canada[5] also took note of the guidance provided by IASB on guidance on applying IFRS 9 Financial Instrument. Further, it also took note of the guidance[6] provided by the Office of the Superintendent of Financial Institutions (OFSI) in Canada and specified that the guidance is consistent with the requirements in IFRS 9 and should thus be considered along with the guidance provided by the IASB. The OFSI, through its guidance, provided the following in relation to applying IFRS in extraordinary circumstances –

IFRS 9 is principles-based and requires the use of experienced credit judgement. Consistent with OSFI’s IFRS 9 Financial Instruments and Disclosures guideline, OSFI is providing guidance on three specific aspects of the accounting for Expected Credit Losses (ECLs) due to the exceptional circumstances arising from COVID-19. Deposit taking Institutions (DTIs) should also consider any additional guidance provided by the International Accounting Standards Board on the application of IFRS 9 in relation to COVID-19.

Under the IFRS 9 ECL accounting framework, DTIs should consider both quantitative and qualitative information, including experienced credit judgment, in assessing for significant increase in credit risk. In OSFI’s view, the utilization of a payment deferral program should not result in an automatic trigger, all things being equal, for significant increase in credit risk.

  • The International Public Sector Accounting Standards Board (IPSASB) released QnA[7] to provide insight into the financial reporting issues associated with COVID-19 government responses, and the relevant International Public Sector Accounting Standards (IPSAS). According to the same,

Given the economic severity associated with COVID-19, entities will need to review their portfolio of financial assets and assess whether an impairment is necessary.

Considering the aforesaid guidelines, all restructuring should not automatically be implied as SICR and the same should be based on facts after analyzing the background of credit worthiness of the borrower.

In case the restructuring is done under the disruption scenario then the same is not indicative of any increase in the probability of default. Accordingly, the same should ideally not be considered as a factor for considering SICR. Thus, if the restructuring is done for accounts that are stressed as a direct result of COVID-19, then the same shall not be treated as SICR.

However, if the restructuring is granted as a generalized option to all customers without any attention paid to reasons for such credit weakness, then the same is done to merely avoid credit difficulty or default of such borrowers which may not necessarily be caused by COVID-19.

Further, something like moratorium, which is granted for a systemic disruption such as a crisis of payment and settlements, natural calamities, etc. is for non-economic reasons, and therefore, may not be likened with a credit-weakness-related restructuring. In the current scenario, the general assumption may be that the credit default is directly associated with the COVID-19 pandemic in most cases.

Restructuring to all borrowers at a class level

A financial institution may also intend to modify the terms of the loan for the entire class as against a particular individual. If the underlying reason for such modification is the financial difficulty faced by the entire class due to Covid disruption, such that the modification is to tide over such difficulty and continue to service the loan, in our view, this will amount to restructuring and lead to a downgrade of asset classification. The underlying rationale is that a loan is a credit decision which is made looking at the prevailing situation at the time of extension of the credit. If the payment schedule is adjusted to take into consideration any change in situations that has happened subsequent to the grant of the credit, the same should be a case of deterioration in the credit quality of the loan. While going by the language of the regulation it seems to refer to only individual cases of restructuring, however, the fact that the entire class of borrower is facing the financial difficulty cannot be overlooked. Merely because the restructuring has been done for a class of borrowers does not mean the restructuring is not to avert a potential default.

Usually, the need for restructuring is identified at the individual exposure level to which concessions are granted due to financial difficulties of the respective borrower. Taking a decision to provide relief to an entire class of borrower instead of considering individual restructuring of each borrower account is a matter of prudence, which must be taken without compromising the interest of the Company, that is the lender.

Impact on IND AS treatment

Based on the aforesaid discussion, it can be inferred that the restructuring under the disruption scenario is not indicative of any increase in the probability of default. Accordingly, the same should ideally not be considered as a factor for considering SICR and in turn, should not result in shifting of the financial instruments from one stage to another. However, in case the account showed signs of credit weakness even before the restructuring, then there should be a shift from one stage to another.

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[1] If the contractual cash flows on a financial asset have been renegotiated or modified and the financial asset was not derecognised, an entity shall assess whether there has been a significant increase in the credit risk of the financial instrument in accordance with paragraph 5.5.3 by comparing:

(a) the risk of a default occurring at the reporting date (based on the modified contractual terms); and

(b) the risk of a default occurring at initial recognition (based on the original, unmodified contractual terms).

[2] ifrs-9-ecl-and-coronavirus.pdf

[3] Microsoft Word – Guidelines on Covid -19 measures reporting and disclosure.docx (europa.eu)

[4] Dear CEO Letter on Covid-19 IFRS 9 Capital Requirements and Loan Covenants (bankofengland.co.uk)

[5] IFRS 9 Expected Credit Losses and COVID-19 (frascanada.ca)

[6] OSFI Actions to Address Operational Issues Stemming from COVID-19 (osfi-bsif.gc.ca)

[7] IPSASB-Staff-QA-COVID-19-Relevant-Accounting-Guidance_0.pdf (ifac.org)

RBI all set to regulate the HFCs

Introduction

The provisions of National Housing Bank Act, 1987 were amended w.e.f August 09, 2019 pursuant to the Finance Act, 2019 thereby shifting the power to govern Housing finance Companies (HFCs) from National Housing Bank (NHB) to the Reserve Bank of India (RBI). Consequently, the RBI on June 17, 2020, issued a draft for review of extant regulatory framework for HFCs[1] (‘Proposed Framework’), and had invited comments from the industry on the same. After considering the inputs received from the industry, the RBI, on October 22, 2020 issued the Regulatory Framework for HFCs[2] (‘Regulations’).

The Regulations intend to align the regulatory framework for HFCs with the one prevalent for NBFCs. In this write-up we bring out the significant features of the regulatory framework for HFCs.

Existing regulations to continue

The Regulations state that the existing guidelines issued by the NHB applicable to HFCs shall continue to be applicable unless the relevant provision has been provided for in the Regulations.

Though all major provisions have already been covered in the Regulations, however, certain aspects shall continue to be governed by NHB regulations such as provisions relating to transfer to reserve fund, maintenance of percentage of assets and concept of Tier I and Tier II capital. Better clarity in regards to the extant regulations that would continue to apply to HFCs would be apparent once the revised Master Directions for HFCs is issued.

Are exemptions from provisions of the RBI Act really exemptions?

The Regulations exempt HFCs from complying with the provisions of Chapter III B of the Reserve Bank of India Act, 1934 (RBI Act), except for the registration and Net Owned Funds (NOF) requirements. Further, specific exemption has been granted from the provisions of section 45-IB and 45-IC of the RBI Act, in place of which section 29B and 29C of the National Housing Bank Act, 1987 (NHB Act) shall continue to remain applicable.

Sections 29B and 29C of the NHB Act contain the same provisions as that of sections 45-IB and 45-IC of the RBI Act respectively. Hence, in essence there is no separate requirement for HFCs and the same is in line with the corresponding provisions applicable on NBFCs.

Accordingly, both NBFCs and HFCs will be on the same page since the provisions of section 45-IB and 45-IC of RBI Act are corresponding to that of section 29B and 29C of NHB Act.

Harmonisation in phased manner

Para 3 of the Proposed Framework stated that harmonisation of certain provisions such as capital adequacy requirements, Income Recognition, Asset Classification and Provisioning (IRACP) norms, concentration norms, limits on exposure to Commercial Real Estate (CRE) & Capital Market (CME) etc. shall be done in a phased manner. The Regulations, with respect to para 3, have remained silent for the time being and have stated that the same shall be issued in the upcoming two years.

Principal Business Criteria (PBC)

 

As per the Regulations, in order to be classified as an HFC, following criteria shall be required to be satisfied:

  • A company incorporated under the Companies Act, 2013;
  • Must be an NBFC i.e. financial assets are more than 50% of total assets and financial income is 50% or more of total income;
  • Housing Finance Assets should be 60% or more;
  • At least 50% of total assets should be towards housing finance for individuals;

Prior to the amendment in the Finance Act, the term ‘principal business’ was not referred to in the NHB Act. For the purposes of registration, NHB was recognizing companies as HFCs if such a company had, as one of its principal objects, transacting the business of providing finance for housing (directly or indirectly).  Now, the identification and registration of an HFC shall be based on meeting the PBC rather than just mentioning the same as one of the principal objects in its charter documents. Further, the requirement of minimum concentration towards ‘individuals’ is a new concept and possibly to protect the HFCs from systemic exposures.

The PBC prescribed in the Proposed Framework stated that at least 50% of ‘net assets’ shall be in the nature of qualifying assets. However, the income criteria was based on total income. Net assets means total assets reduced by cash and bank balances and money market instruments. However, gross income would include interest and other income earned from bank balances and money market instruments as well, that have been excluded from the computation of net assets. Hence, there was no parity between both the comparative bases. Vinod Kothari Consultants (VKC) had sent recommendation to the RBI suggesting to bring both the bases at parity. The RBI has considered the same and has accordingly revised the bases to total asset and total income. A company will be treated as an NBFC if its financial assets are more than 50 per cent of its total assets (netted off by intangible assets) and income from financial assets should be more than 50 per cent of the gross income. Further, for an HFC, it must have 60% of the total asset towards providing finance for housing and 50% of the total assets towards individual housing finance.

Timeline for achieving the PBC

The proposed framework provides the following timelines for achieving the aforesaid PBC

Timeline Minimum percentage of total assets towards housing finance Minimum percentage of total assets towards housing finance for individuals
March 31, 2022 50 40
March 31, 2023 55 45
March 31, 2024 60 50

Existing HFCs, which currently do not fulfill the said criteria shall meet the same within the above mentioned timelines. For this purpose, the HFCs shall be required to submit a Board approved roadmap (as discussed in the ‘Actionables Box’). In case of failure to do so/achieve the PBC specific to housing loans as per the timelines, the HFC shall be treated as NBFC – Investment and Credit Companies (NBFC-ICC) and shall be required to approach the RBI for conversion to NBFC-ICC.

Definition of Housing Finance

The definition of Housing Finance provided in the Regulations is the same as that provided in the Proposed Framework for ‘qualifying asset’. Further, there is a clarification provided in the Regulations stating- “Integrated housing project comprising some commercial spaces (e.g. shopping complex, school, etc.) can be treated as residential housing, provided that the commercial area in the residential housing project does not exceed 10 percent of the total Floor Space Index (FSI) of the project.”

The aforesaid concept of integrated housing project has been drawn from the NHB Directions.

The detailed analysis of the definition of qualifying asset as compared to the erstwhile definition of Housing Finance may be referred here- http://vinodkothari.com/2020/06/comparison-between-the-proposed-and-existing-regulatory-framework-for-hfcs/

NOF requirement

The Proposed Framework stated that HFCs shall maintain a minimum NOF of Rs. 20 crores of more. The same has been retained in the Regulations. The existing NOF requirements for HFCs is Rs. 10 crores and hence, existing HFCs having a lower NOF shall be required to increase their NOF to Rs. 15 crores by March 31, 2022 and Rs. 20 crores by March 31 2023. Further, they are required to submit a statutory auditor’s certificate (as discussed in the ‘Actionables Box’). In case of failure to do so, the registration of the HFC shall be cancelled/ converted into NBFC-ICC upon request of the HFC for the same.

Definition of Tier I and Tier II Capital

The Proposed Framework provided for inclusion of PDIs in the definition of TIer I and Tier II Capital. The Regulations are silent on the same, hence, the existing definition as per the NHB Directions shall continue to be applicable

Liquidity Risk Framework (LRM) and Liquidity Coverage Ratio (LCR)

The Proposed Framework extended the applicability of the provisions of LRM and LCR to HFCs. VKC had recommended that the same should be made applicable in a phased manner. Considering the said recommendation, the RBI has clarified that the provisions of LCR are required to be met in a phased manner as per the following timelines:

 

It is noteworthy here that while the milestones for NBFC start from December 1, 2020, the milestones for HFCs shall commence from December 1, 2021. The LRM and LCR framework for NBFCs was introduced on November 4, 2020 and NBFCs were given a time period of more than a year to implement the LCR. Similarly, HFCs have also been given time to implement the same.

Exposure to group companies

The Proposed Framework provided for restriction on dual financing i.e. HFCs may choose to lend only at one level. That is, the HFC can either undertake an exposure on the group company in real estate business or lend to retail individual home buyers in the projects of group entities, but not do both.

The Proposed Regulations lacked clarity as to whether it extends to all kinds of group entities or only such entities which are engaged in real estate. VKC had made a recommendation to clarify the same since the Proposed Regulations used the phrase “HFC decides to take any exposure in its group entities”. It now seems clear that the intention is to cover in general all companies in a group engaged in real estate business and not just the group of the respective HFC.

Further, the language of the Regulations refers to group companies, however, the same shall also include any company engaged in real estate business. Hence, the HFC may either have an exposure towards a company engaged in real estate business or lend to retail individual home buyers in the projects of such company.

Considering the requirement for HFCs to do lend a major part of their portfolio to individuals and this restriction on dual financing, it seems that builder lending will be discouraged. In the present state of housing industry in the country, this should not be the intention of the regulator.

Further, the maximum exposure an HFC may have on a single entity in a group of companies shall be 15% of its owned funds and for the group shall be 25% of owned funds. These provisions are similar to the concentration norms applicable to NBFCs. However, these refer to exposure to a group engaged in real estate business. Further, the RBI shall release concentration norms for all exposures of HFCs in due course of time.

Loan To Value Ratio (LTV) requirements

The following LTV requirements have been laid down in the Regulations:

  • For loan against shares (LAS) – 50%
  • Loans against security of gold jewellery – 75%

The LTV requirement for LAS is in line with the guidelines for NBFCs and the Proposed Framework, however, the LTV requirement for gold loans was not specified in the Proposed Framework and is a new insertion.

Levy of Foreclosure Charges

The Regulations bar HFCs from charging foreclosure charges on floating rate term loans sanctioned for purposes other than business to individual borrowers. Below figure explains how foreclosure charges may/may not be charges by HFCs:

Immediate Actionables for HFCs

 

S.no. Actionable
1. All HFCs shall submit RBI a Board approved plan within three months including a roadmap to fulfil the Principal Business Criteria and timeline for such transition
2 HFCs whose NOF is currently below Rs 20 crore, will be required to submit a statutory auditor’s certificate to RBI within a month evidencing compliance with the prescribed levels as at the end of the period mentioned by RBI for complying the same. That is in the month of April, 2022 and April, 2023.

 

3. The HFCs to whom LRM framework would be applicable (more than 100 cr asset size) shall make public disclosures on quarterly basis on their website in the format given in Appendix-1 of the guidelines

HFC Vs NBFC’

A quick comparative of the provisions applicable for HFCs and NBFCs can be seen below:

Provisions/Guidelines NBFCs HFCs Similarity/

Difference

PBC 50-50 criteria In addition to 50-50 criteria, 60-50 criteria also applicable Different- Additional criteria to be fulfilled
NOF Requirement 2 crores 20 crores Different
Applicable guidelines for fraud control Master Direction – Monitoring of Frauds in NBFCs (Reserve Bank) Directions, 2016 Master Direction – Monitoring of Frauds in NBFCs (Reserve Bank) Directions, 2016 Same
Applicability of guidelines on Information Technology Master Direction – Information Technology Framework for the NBFC Sector dated June 08, 2017. Master Direction – Information Technology Framework for the NBFC Sector dated June 08, 2017. Same
Definition of public deposits As per Master Directions on Acceptance of Public Deposits Similar to that for NBFCs along with an additional point- any amount received from NHB or any public housing agency shall also be exempted from the definition of public deposit. Similar- except for an additional insertion
Implementation of Indian Accounting Standards Circular on Implementation of Indian Accounting Standards dated March 13, 2020[3] Circular on Implementation of Indian Accounting Standards dated March 13, 2020 Same
LTV Requirements for Loan Against Shares 50% 50% Same
LTV Requirements for Gold Loans 75% 75% Same
Levy of foreclosure charges NBFCs shall not impose foreclosure charges/ pre-payment penalties on any floating rate term loan sanctioned for purposes other than business to individual borrowers HFCs shall not impose foreclosure charges/ pre-payment penalties on any floating rate term loan sanctioned for purposes other than business to individual borrowers Same
Guidelines on Securitization Transactions and reset of Credit Enhancement As per Master Directions for NBFCs and other applicable circulars As applicable to NBFCs Same
Managing Risks and Code of Conduct in Outsourcing of Financial Services As per Master Directions for NBFCs As applicable to NBFCs Same
Guidelines on Liquidity Coverage Ratio As per Master Directions for NBFCs As applicable to NBFCs, as per timelines mentioned above Same
Guidelines on Liquidity Risk Management Framework: As per Master Directions for NBFCs As applicable to NBFCs Same
Exposure of HFCs to group companies engaged in real estate business: 15% of Owned Funds to single entity 25% to a group There are similar concentration norms for lending and investment Similar

 

[1] https://www.rbi.org.in/Scripts/PublicationReportDetails.aspx?UrlPage=&ID=959

[2] https://rbidocs.rbi.org.in/rdocs/notification/PDFs/NT605BE165AA9E8043EFA087339829CCF469.PDF

[3] https://www.rbi.org.in/Scripts/NotificationUser.aspx?Id=11818&Mode=0

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