Summary of Scale Based Regulations

A brief highlights of the regulations along with charts summarising classification of NBFCs can be viewed here

List of Regulatory Provisions
NBFC-NSI NBFC-SI HFC
Without customer interface and public funds With customer interface or public funds Asset size between 500-1000 crores Asset size 1000 crores and above Top 10 or identified as such Not in Top 10 Top 10 or identified as such
Supervisory category BL BL BL ML UL ML UL
NOF No change, that is, Rs 2 crores Rs 5 crores by March 31, 2025
Rs 10 crores by March 31, 2027
No change, that is,
Rs 15 crores by March 31, 2022
Rs 20 crores by March 31, 2023
NPA Norms >150 days overdue By March 31, 2024
>120 days overdue By March 31, 2025
> 90 days By March 31, 2026
No change, that is, > 89 days
Appointment of Director Appoint at least one of the directors having relevant experience of having worked in a bank/ NBFC
IPO funding ceiling, if extending such loans Rs 1 crore per borrower [effective from 1st April, 2021]
Internal Capital Adequacy Assessment Process (ICAAP) NA NA NA Applicable Applicable Applicable Applicable
Maintain Common Equity Tier 1 capital of at least 9 per cent of Risk Weighted Assets NA NA NA NA Applicable NA Applicable
Leverage limits (in addition to CRAR) NA NA NA NA To be prescribed NA To be prescribed
Differential standard asset provisioning NA NA NA NA To be prescribed NA To be prescribed
Limits on Concentration of credit/investment NA NA Merged single exposure limit of 25% for single borrower/ party and 40% for single group of borrowers/ parties Merged single exposure limit of 25% for single borrower/ party and 40% for single group of borrowers/ parties To be followed till Large Exposure Framework is put in place Merged single exposure limit of 25% for single borrower/ party and 40% for single group of borrowers/ parties To be followed till Large Exposure Framework is put in place
Sensitive Sector Exposure (SSE), that is, exposure to commercial real estate and capital markets NA NA NA Fix board-approved internal limits Fix board-approved internal limits Same as existing
Regulatory Restrictions on
1. Loans to directors, senior officers, relatives of directors, entities where directors or their relatives have major shareholding
2. Need for ensuring appropriate permission while appraising real loan proposals
NA NA NA Applicable Applicable Applicable Applicable
Large Exposure Framework NA NA NA NA Applicable NA Applicable
Internal Exposure Limits to be set by the Board on certain specific sectors to which credit is extended NA NA NA NA Applicable; details awaited NA Applicable; details awaited
Risk Management Committee, at board or executive level To be constituted To be constituted To be constituted To be constituted To be constituted To be constituted To be constituted
Disclosures to include types of exposure, related party transactions, loans to Directors/ Senior Officers and customer complaints. Applicable Applicable Applicable Applicable Applicable Applicable Applicable
Board approved policy on grant of loans to directors, senior officers and relatives of directors and to entities where directors or their relatives have major shareholding Applicable Applicable Applicable Applicable Applicable Applicable Applicable
Except for directorship in a subsidiary, KMP shall not hold any office (including directorships) in any other NBFC-ML or NBFC-UL NA NA NA To ensure
compliance by October 1, 2024
To ensure
compliance by October 1, 2024
To ensure
compliance by October 1, 2024
To ensure
compliance by October 1, 2024
Independent director shall not be on the Board of more than three NBFCs (NBFC-ML or NBFC-UL) at the same time NA NA NA To ensure
compliance by October 1, 2024
To ensure
compliance by October 1, 2024
To ensure
compliance by October 1, 2024
To ensure
compliance by October 1, 2024
Additional Disclosures in annal financial statements NA NA NA Applicable with effect from March 31, 2023 Applicable with effect from March 31, 2023 Applicable with effect from March 31, 2023 Applicable with effect from March 31, 2023
Appointment of a Chief Compliance Officer (CCO) NA NA NA To be ensured by October 1, 2022 To be ensured by October 1, 2022 To be ensured by October 1, 2022 To be ensured by October 1, 2022
Composition of the Board should ensure mix of educational qualifications and experience within the Board NA NA NA To be ensured by October 1, 2022 To be ensured by October 1, 2022 To be ensured by October 1, 2022 To be ensured by October 1, 2022
Other Governance matters
i) The Board shall delineate the role of various committees (Audit Committee, Nomination and Remuneration Committee, Risk Management Committee or any other Committee) and lay down a calendar of reviews.
ii) Formulate a whistle blower mechanism for directors and employees to report genuine concerns.
iii) Board shall ensure good corporate governance practices in the subsidiaries of the NBFC.
NA NA NA To be ensured by October 1, 2022 To be ensured by October 1, 2022 To be ensured by October 1, 2022 To be ensured by October 1, 2022
Adoption of Core Banking Solution NA NA NA Applicable if having more than 10 branches Applicable if having more than 10 branches Applicable if having more than 10 branches Applicable if having more than 10 branches
Composition of the Board should ensure mix of educational qualification and experience within the Board NA NA NA NA Applicable NA Applicable
Mandatory listing of equity within 3 years of identification NA NA NA NA Applicable NA Applicable
Reporting removal of Independent Directors before tenure NA NA NA NA Applicable NA Applicable

A layered approach to NBFC Regulation:

A summary of the regulations can be viewed here

A layered approach to NBFC Regulation (1)

 

FAQs on Securitisation of Standard Assets

We invite you all to join us at the Indian Securitisation Summit, 2021. You are sure to meet the who’s-who of the Indian structured finance space – the originators, investors, rating agencies, legal counsels, accounting experts, global experts, and of course, regulators. The details can be accessed here

On September 24, 2021, the RBI released Master Direction – Reserve Bank of India Securitisation of Standard Assets) Directions, 2021. The same has been released after almost 15 months of the comment period on the draft framework issued on June 08, 2020. This culminates the process that started with Dr. Harsh Vardhan committee report in 2019.

It is said that capital markets are fast changing, and regulations aim to capture a dynamic market which quite often leads the regulation than follow it. However, the just-repealed Guidelines continued to shape and support the securitisation market in the country for a good 15 years, with the 2012 supplements mainly incorporating the response to the Global Financial Crisis.

We bring you this frequently asked questions on Securitisation to assist you better understand the Directions.

The file can downloaded at this link: https://mailchi.mp/607563e4f4d0/faq-on-sec-guidelines

Securitisation-FAQ-contents

 

Loan Participations: The Rising Star of Loan Markets?

Anita Baid | anita@vinodkothari.com

Introduction 

The Reserve Bank of India (RBI) has issued the new guidelines, viz. Master Directions- Reserve Bank of India (Transfer of Loan Exposures) Directions, 2021 and Master Directions- Reserve Bank of India (Securitisation of Standard Assets) Directions, 2021, on September 4, 2021, that replaces and supersedes the existing regulations on securitisation and direct assignment (DA) of loan exposures. The new directions have been made effective immediately which introduces several new concepts and compliance requirements.

The TLE Directionshave consolidated the guidelines with respect to the transfer of standard assets as well as stressed assets by regulated financial entities in one place. Further, the scope of TLE Directions covers any “transfer” of loan exposure by lenders either as transferer or as transferees/acquirers. In fact, the scope contains an outright bar on any sale or acquisition other than under the TLE Directions, and outside permitted transferors and transferees, apart from securitisation transactions.

Notably, the TLE Directions refer to all types of loan transfers, including sale, assignment, novation and loan participation. While the loan market in India is quite familiar[1] with assignments and novations, ‘loan participation’ to some, might appear to be an innovation by TLE Directions.  However, loan participation is not a new concept, and is quite popular in international loan markets, as we discuss below.

This article discusses the general concept of loan transfer and specifically delves into the ‘loan participation as a mode of such transfer. 

Loan Transfers: Assignment vs. Novation vs. Loan Participation

One of the important amendments under the TLE Directions has been the insertion of the definition of “transfer”, which is reproduced herein below- 

“transfer” means a transfer of economic interest in loan exposures by the transferor to the transferee(s), with or without the transfer of the underlying loan contract, in the manner permitted in these directions; 

Explanation: Consequently, the transferee(s) shall “acquire” the loan exposures following a loan transfer.  

This definition is customised to suit the objectives of the TLE Directions – that is, the TLE Directions would cover all forms of transfers where “economic interest” is transferred, but the legal ownership may or may not be transferred. This definition is specific to these Directions intended essentially to cover the transfer of economic interest, and is different from the common law definition of ‘transfer’. 

The provisions of TLE Directions are applicable to all forms of transfer of loans, irrespective of whether the loan exposures are in default or not. However, the TLE Directions limit the mode of transfer of stressed assets. Novation and assignment are the only ways of transferring stressed assets, whereas, in case of loans not in default, loan participation is also a mode of transfer. The said modes of loan transfers that have been permitted are not new and have existed even before. 

By inclusion of “loan participation” in the TLE Directions for the transfer of loans not in default means that the loans could be transferred by transferring an economic interest even without the transfer of legal title. However, in cases of loan transfers other than loan participation, legal ownership of the loan has to mandatorily be transferred. 

The graphic below summarises the various modes permissible mode of transfer of loans not in default, as per the TLE Directions:

In the case of assignments and novations, the assignee or transferee becomes the lender on record either by virtue of the assignment agreement (along with notice to the borrower) or by becoming a party to the underlying agreement itself. On the contrary, in the case of loan participation, the transfer is solely between the originator and the participant or transferee and thus creates no privity between the participant and the ultimate borrower. Under the participation arrangement, it is an understanding that the originator or lender on record passes to the participant whatever amount it receives from the borrower. Hence, by virtue of the transfer of the economic interest, there is a trust relationship created between the originator and the participant. 

The concept of Loan Participation

It is important to understand participation as a mode of transfer of economic interest under the TLE Directions. TLE Directions define loan participation as –

loan participation” means a transaction through which the transferor transfers all or part of its economic interest in a loan exposure to transferee(s) without the actual transfer of the loan contract, and the transferee(s) fund the transferor to the extent of the economic interest transferred which may be equal to the principal, interest, fees and other payments, if any, under the transfer agreement; 

Provided that the transfer of economic interest under a loan participation shall only be through a contractual transfer agreement between the transferor and transferee(s) with the transferor remaining as the lender on record

Provided further that in case of loan participation, the exposure of the transferee(s) shall be to the underlying borrower and not to the transferor. Accordingly, the transferor and transferee(s) shall maintain capital according to the exposure to the underlying borrower calculated based on the economic interest held by each post such transfer. The applicable prudential norms, including the provisioning requirements, post the transfer, shall be based on the above exposure treatment and the consequent outstanding.

Based on the aforesaid definition, it is essential to note the following-

  1. A loan exposure can be said to consist of two components- economic interest and legal title
  2. The economic interest in a loan exposure is not dependent on the legal title and can be transferred without a change in the lender on record
  3. In case of transfer of economic interest without legal title, the borrower interface shall be maintained entirely with the lender on record- hence, one of the benefits of loan participation would be that any amendments to the terms of the loan or restructuring could be done by the lender on record without involving the transferee
  4. The loan participation cannot be structured with priorities since the same may lead to credit enhancement- which is prohibited
  5. To the extent of loan participation based on the economic interest held post the transfer, income recognition, asset classification and provisioning must be done by the transferor and transferee, respectively

Note also, that para 12 of TLE Directions states that in loan participations, “by design”, the legal ownership remains with the originator (referred to as ‘grantor’ under TLE Directions), while whole or part of economic interest is passed on to the transferee (referred to as “participant” under TLE Directions). 

The following is therefore understood as regards loan participation –

  • Legal ownership is necessarily retained by the grantor, while it is only the ‘economic interest’ or a part of it, which is transferred to the participant.
  • As such, the originator remains the ‘face’ for the borrower, and is, therefore, called “lender on record”.
  • The TLE Directions do not prescribe any proportion (maximum/minimum) for which participation can happen. Though the Directions say that “all or part” of economic interest can be transferred. Also, the law seems flexible enough not to put any kind of restrictions on the categories or limits of economic interest which can be transferred. For instance, economic interest involves the right to receive repayments of principal as well as payments of interest (among others). The grantor can simply delineate these rights and grant participation for one but retain the other. 
  • The participant shall fund the grantor only to the extent of economic interest transferred in the former’s favour and nothing more. 
  • The participation has to be backed by a formal arrangement (agreement) between the parties

Post the “transfer”, the participant has no recourse on the grantor for the transferred interest. The recourse of both the grantor and the participant lies on the underlying borrower. Both these parties are required to maintain capital accordingly.

Essentially, the loan participation agreement, setting forth in detail the arrangement between the original lender and the participant, should specify the following- 

  1. that the transaction is a purchase of a specified percentage of a loan exposure by the participant, 
  2. the terms of the purchase of such participation, 
  3. the rights and duties of both parties, 
  4. the mechanism of holding and disbursing funds received from the borrower, 
  5. the extent of information to be shared with the participant, 
  6. the extent of right on collateral in the participated loan provided by the borrower, and
  7. procedures for exercising remedies and in the event of insolvency by any party, and clarification that the relationship is that of seller/purchaser as opposed to debtor/creditor

Is Loan Participation a True Sale?

The essential feature of loan participation is that the lender originating the loan remains in its role as the nominal lender and continues to manage the loan notwithstanding the fact that it may have sold off most or even all of its credit exposure. True Sale means that a sale truly achieves the objective of a sale, and being respected as such in bankruptcy or a similar situation. Securitisation and direct assignment transactions have inherently been driven by financing motives but they are structured as sale transactions. 

Essentially, the TLE Directions are entirely based on this crucial definition of ‘transfer’ which is stressing on the transfer of an economic interest in a loan exposure. Accordingly, even without transferring the legal title, the loan exposure could be transferred. Hence, the age-old concept of ensuring true sale in case of direct assignment transaction seems to have been done away with. 

However, the question that arises is whether in the case of secured loans, loan participation arrangements would transfer the right to collateral with the original lender or is it merely creating a contractual right against the originator towards proceeds of the collateral. This issue of the characterization of loan participation and when participations are true sales of loan interests has been discussed by the Iowa Supreme Courtin the case of Central  Bank and Real Estate Owned, L.L.C. v. Timothy C. Hogan, as Trustee of the Liberty and Liquidating Trust et. al., 891 N.W.2d 197 (Iowa 2017)

In this case, Liberty Bank extended loans between 2008 and 2009 to Iowa Great Lakes Holding, L.L.C. secured by the real estate and related personal property of a resort hotel and conference center. Liberty entered into participation agreements with five banks covering an aggregate of 41% (approximately) of its interest in these loans. The participation agreements were identical in terms; each provided that Liberty sold and the participant purchased a “participation interest” in the loans. It was held that Liberty had transferred an undivided interest in the underlying property, including the mortgage created on the property, pursuant to the participation agreements. The court ruled against Liberty Bank, reasoning that the participation agreements transferred “all legal and equitable title in Liberty’s share of the loan and collateral” to the participating banks. The participants were given undivided interests in the loan documents. In addition, the court noted that the default provisions emphasized that the participants shared in any of the collateral for the loan. 

Based on the discussion, the court suggested that participants should use the language of ownership, undivided fractional interest and trust, as well as avoid risk dilution devices to ensure that their interest is treated as an ownership and not a mere loan.

Loan Participation in US and UK

In the international financial market, loan participation has been a predominant component for a long time. The reason for favouring loan participation is that it allows participants to limit its exposure upto a particular credit and enable diversification of a portfolio without being involved in the servicing of loans.

The English law (prevalent in the UK) has widely adopted the Loan Market Association (LMA) recommendation that states- the lender of record (or grantor of the participation) must undertake to pay to the participant a percentage of amounts received from the borrower. This explicitly provides that the relationship between the grantor and the participant is that of debtor and creditor, provided the right of the participant to receive monies would be restricted to the extent of the assigned portion of any money received from any obligor. Hence, in case the grantor becomes insolvent, the participant would not enjoy any preferred status as a creditor of the grantor with respect to funds received from the borrower than any other unsecured creditor of the grantor. There are methods to structure transactions that enable participants to mitigate the risk of insolvency of the guarantor, as provided in the LMA’s paper ‘Funded Participations – Mitigation of Grantor Credit Risk’, however, these methods add complexity to what many regard as routine trades and are not generally adopted. 

In US banking parlance, these instruments are known simply as “participations”. The Loan Syndications and Trading Association (LSTA) had proposed that the relationship between grantor and participant shall be that of seller and buyer. Neither is a trustee or agent for the other, nor does either have any fiduciary obligations to the other. This Agreement shall not be construed to create a partnership or joint venture between the Parties. In no event shall the Participation be construed as a loan from participant to grantor. There have also been cases to draw a distinction between ‘true participation’ and ‘financing’. In a true participation, the participant acquires a beneficial ownership interest in the underlying loan. This means that the participant is entitled to its share of payments from the borrower notwithstanding the insolvency of the grantor (so the participant does not have to share those payments with the grantor’s other creditors) even though the beneficial ownership does not create privity between the participant and the borrower. On the other hand, a participation that is characterised as financing would have the same consequences as discussed above, which is to be considered at par with any other unsecured creditor of the grantor.

The following four factors typically indicate that a transaction is a financing rather than true participation: 

  1. the grantor guarantees repayment to the participant; failure by a participant to take the full risk of ownership of the underlying loan is a crucial indication of financing rather than a true participation
  2. the participation lasts for a shorter or longer-term than the underlying loan that is the subject of the participation; 
  3. there are different payment arrangements between the borrower and the grantor, on the one hand, and the grantor and the participant, on the other hand; and 
  4. there is a discrepancy between the interest rate due on the underlying loan and the interest rate specified in the participation. 

Apart from the similarity in the basic structure and business impetus for participation, the legal characterisation of these arrangements and some of their structural elements are different under UK and US law.

Conclusion

The recognition of this concept of loan participation would expand the scope for direct assignment arrangements and hence, there seems a likely increase in the numbers as well. However, it must be ensured that such arrangements are structured with care and keeping in mind the learnings from precedents in the markets outside India, to avoid any discrepancies and disputes in the future between the originator and the participant.

________________________________________________________________________________________________________________________________

[1] In India, during Q1 2020-21, DA transactions were around Rs.5250 crore, which was 70% of the total securitisation and DA volumes. With a growth of 2.3 times in the total volume of securitisation and DA transactions (due to the pandemic the number may be an outlier), in Q1 2021-22, the DA transactions aggregated to Rs.9116 crores, with a reduced share of 53% [Source: ICRA Research]

We invite you all to join us at the Indian Securitisation Summit, 2021. You are sure to meet the who’s-who of the Indian structured finance space – the originators, investors, rating agencies, legal counsels, accounting experts, global experts, and of course, regulators. The details can be accessed here

 

Workshop on RBI Master Directions on Securitisation and Transfer of loans

We invite you all to join us at the Indian Securitisation Summit, 2021. You are sure to meet the who’s-who of the Indian structured finance space – the originators, investors, rating agencies, legal counsels, accounting experts, global experts, and of course, regulators. The details can be accessed here

Our workshop on 28th and 29th September, went full and, hence we are coming up with this repeat workshop.

Please do register your interest here: https://forms.gle/vwM2G7boj4uvyiqM6

Details would be announced shorlty

Workshop-MasterDirection-8th

Our Write-ups on the topic:

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

-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.

Understanding the difference between authentication and verification

As per section 2(c) of the Aadhaar (Targeted Delivery of Financial and Other Subsidies, Benefits and Services) Act, 2016 (‘Aadhaar Act’)[2] “authentication” means the process by which the Aadhaar number along with demographic information or biometric information of an individual is submitted to the Central Identities Data Repository for its verification and such Repository verifies the correctness, or the lack thereof, on the basis of information available with it;

Further, Section 2(pa) defines offline verification as the process of verifying the identity of the Aadhaar number holder without authentication, through such offline modes as may be specified by regulations.

Authentication is a process of authenticity of aadhaar information using the authentication facility provided by the UIDAI. The same may be done in any of the following ways:

  • Use of demographic authentication: The Aadhaar number and demographic information of the customer is obtained and matched with the demographic information of the Aadhaar number holder in the CIDR[3].
  • Using one-time pin based authentication: Aadhaar number of customer is obtained. OTP is sent to the registered mobile number and/ or e-mail address. Aadhaar is authenticated when customer shares OTP and is shared with the same generated by UIDAI
  • Using biometric information: The Aadhaar number and biometric information submitted by the customer are matched with the biometric information stored in the CIDR.

Essentially, aadhaar authentication requires the Regulated Entity (RE) to obtain the aadhaar number of the customer. However, owing to the Supreme Court Verdict on Aadhaar, aadhaar number could be obtained only by banks or specific notified entities. Eventually, the concept of offline verification was introduced by virtue of which verification can be done using XML file or QR code which carries minimum details of the customer. RE is not required to obtain aadhaar number in this case.

Understanding the concept of AUA and KUA

The Aadhaar (Authentication) Regulations, 2016 provide the following definitions:

“Authentication User Agency” or “AUA” means a requesting entity that uses the Yes/ No authentication facility provided by the Authority;  

 “e-KYC User Agency” or “KUA” shall mean a requesting entity which, in addition to being an AUA, uses e-KYC authentication facility provided by the Authority;  

 “e-KYC authentication facility” means a type of authentication facility in which the biometric information and/or OTP and Aadhaar number securely submitted with the consent of the Aadhaar number holder through a requesting entity, is matched against the data available in the CIDR, and the Authority returns a digitally signed response containing e-KYC data along with other technical details related to the authentication transaction; 

 To Summarise:

  • AUA’s rights are limited and it gets only a yes or no as a response of aadhaar authentications, i.e. response to whether the aadhaar is authentic or not.
  • KUA’s rights are comparatively broader. It shall receive eKYC details of the customer upon utilising the authentication facility.

Further, there is a concept of sub-AUA and sub-KUA, which utilise the facility of licensed AUAs or KUAs for aadhaar authentication.

Application for AUA/KUA License

Process

The power of granting permission for use of aadhaar authentication facility by entities other than banks is derived from section 11A of the Prevention of Money Laundering Act, 2002[4] (‘PMLA’). It states-

(1) Every Reporting Entity shall verify the identity of its clients and the beneficial owner, by—

(a) authentication under the Aadhaar (Targeted Delivery of Financial and Other Subsidies, Benefits and Services) Act, 2016 (18 of 2016) if the reporting entity is a banking company; or

(b) offline verification under the Aadhaar (Targeted Delivery of Financial and Other Subsidies, Benefits and Services) Act, 2016 (18 of 2016); or

**

Provided that the Central Government may, if satisfied that a reporting entity other than banking company, complies with such the standards of privacy and security under the Aadhaar (Targeted Delivery of Financial and Other Subsidies, Benefits and Services) Act, 2016 (18 of 2016), and it is necessary and expedient to do so, by notification, permit such entity to perform authentication under clause (a):

**

In exercise of powers under the above mentioned provisions, the Ministry of Finance (MoF) issued a notification on May 9, 2019[5], providing the process for permitting entities other than banks for using authentication facilities of the UIDAI. The notification provides for the following process:

  • Step1: Application to be made to the concerned regulator
  • Step 2: Examination of the application by concerned regulator
    • To ensure conditions of section 11A of PMLA and other security and IT related requirements are met
  • Step 3: Examination by UIDAI of applications recommended by the regulator
    • To check standards of privacy and security set out by UIDAI are complied with
    • UIDAI to then send notification to the Department of Revenue, MoF
  • Step 4: Notification as AUA/KUA by MoF
  • Step 5: UIDAI to issue authorisation to use UIDAI’s authentication facility

The Reserve Bank of India, being the financial sector regulator, has issued the notification permitting all NBFCs, Payment System Providers and Payment System Participants to carry out authentication of client’s Aadhaar number using e-KYC facility. The Application form seeks various details about the applicant, including a confirmation that the entity is meeting the standards of complying with the Data Security Regulations 2016 of UIDAI and other related guidance / circular issued by UIDAI from time to time with regard to the privacy and security norms.

Eligibility

The most crucial aspect of eligibility for availing AUA/KUA license is the capability of meeting the standards of privacy and security set out by UIDAI. The requirement for meeting the said standards arises from section 4(4) of the Aadhaar Act[6], which states-

(4) An entity may be allowed to perform authentication, if the Authority is satisfied that the requesting entity is—

(a) compliant with such standards of privacy and security as may be specified by regulations; and

(b) (i) permitted to offer authentication services under the provisions of any other law made by Parliament; or

(ii) seeking authentication for such purpose, as the Central Government in consultation with the Authority, and in the interest of State, may prescribe.

 Additionally, the Aadhaar (Authentication) Regulations, 2016[7] provide for the eligibility criteria for appointment as AUA/KUA. As per the said regulations, the following requirements must be met by the applicant:

  • Backend infrastructure, such as servers, databases etc. of the entity, required specifically for the purpose of Aadhaar authentication, should be located within the territory of India.

  • Entity should have IT Infrastructure owned or outsourced capable of carrying out minimum 1 Lakh Authentication transactions per month.

  • Organisation should have a prescribed Data Privacy policy to protect beneficiary privacy.

  • Organisation should have adopted data security requirements as per the IT Act 2000.

Understanding standards of privacy and security

The regulations surrounding data protection and privacy issued by the UIDAI are:

  • Aadhaar (Data Security) Regulations, 2016
  • Aadhaar (Sharing of Information) Regulations, 2016
  • Miscellaneous circulars issued by the UIDAI from time to time

Major requirements under the said regulations are as follows:

  • Applicant to adopt an information security policy outlining information security framework of the applicant developed in line with applicable guidelines issued by UIDAI;
  • Applicant to designate an officer as Chief Information Security Officer (CISO) for ensuring compliance with information security policy and other security-related programmes and initiatives of UIDAI
  • Operations of applicant to be audited by information systems auditor
  • Applicant to ensure that biometric information is not stored, except for buffer during authentication;
  • Applicant to ensure identity information is not shared with anyone else except with prior approval

Conclusion

Pursuant to the said notification, the NBFCs or Payment System Providers or Payment System Participants shall be eligible to make application with the RBI, subject to compliance with the privacy and security norms issued by UIDAI. The notification is a much-awaited relaxation for the eligible non-banking entities to undertake Aadhaar authentication of their customers. However, the criteria for granting approval have not been laid down specifically and may be based on the evaluation conducted by the RBI along with UIDAI. For those who receive the approval, this would be an addition to the modes in which CDD of a customer can be conducted.

[1] https://www.rbi.org.in/Scripts/NotificationUser.aspx?Id=12161&Mode=0

[2] https://uidai.gov.in/images/targeted_delivery_of_financial_and_other_subsidies_benefits_and_services_13072016.pdf

[3] Central Identities Data Repository (CIDR) means a centralised database containing all Aadhaar numbers issued to Aadhaar number holders along with the corresponding demographic information and biometric information of such individuals and other information related thereto

[4] https://www.indiacode.nic.in/bitstream/123456789/2036/1/A2003-15.pdf

[5] https://dor.gov.in/sites/default/files/circular%20dated%2009.05.2019%20of%20PMLA.pdf

[6] https://uidai.gov.in/images/news/Amendment_Act_2019.pdf

[7] Refer Schedule A to Aadhaar (Authentication) Regulations, 2016 (Page 19)- https://uidai.gov.in//images/resource/CompendiumMay2020Updated.pdf

 

Related articles:

 

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

 

Workshop on Effective Regulatory interface: Preparing for and handling RBI’s NBFC inspections

Registeration for the workshop have been closed. You may register your interest for a repeat workshop here here: https://forms.gle/RmwXa13DjuLBqhMU9

brochure-Training-on-KYC-1-1

Registration under Money-Lending laws

Aanchal Kaur Nagpal and Parth Ved (corplaw@vinodkothari.com)

Introduction

More often than not, the term ‘lending activities’ instantaneously brings the ‘Reserve Bank of India’ (‘RBI’) to mind. However, lending business is not the domain of RBI alone. Amidst multiple RBI guidelines governing numerous financial institutions, the state legislations on money-lending have become long forgotten.

Money-lending laws were introduced with an intention to curb non-regulated indigenous lenders from charging exorbitant interest rates to borrowers. These laws typically require licensing of money lenders, impose a ceiling on rate of interest that money lenders can charge, and generally provide that a court shall not take cognizance of a matter filed by an unlicensed money lender.

While financial entities such as non-banking financial companies (‘NBFCs’), banks, insurance companies etc. have been exempted from obtaining money-lending licence as these are regulated by other laws, the question arises whether non-regulated entities undertaking the ‘business’ of lending would require to register under the money-lending laws.

Who are money lenders?

Although there is a strong network of financial institutions, recourse to such institutions, at most times, is not accessible to the rural parts of the country. Further, it is difficult for banks to extend loans to small farmers due to their rigid requirements for KYC and collateral. Money lenders perform a gap-filling function as they majorly cater to a class of borrowers whom other financial institutions, including banks, cannot reach.

Since they have been such an important link between the formal lending sector and the informal borrowing sector, there was a need for a strong framework to regulate their working. According to Entry 30 of List II (i.e. State List) of the Seventh Schedule to the Constitution of India, the State Legislature has exclusive power to make laws on activities relating to money-lending. To regulate the transactions of money-lending in the State of Maharashtra, the state legislature has enacted Maharashtra Money-Lending (Regulation) Act, 2014 (‘Money Lending Act’). However, other states too, have their respective money-lending laws. Our article deals with provisions under the Maharashtra Money Lending Law.

Applicability for registration and exemption

The Money Lending Act states that no money lender shall carry on the business of money-lending except in the area for which he has been granted a licence. The term used here is “business of money-lending”. Business of money-lending is defined as the business of advancing loans whether in cash or kind and whether or not in connection with, or in addition to any other business.

The above definition provides clarity on the following aspects –                                            

  • Money-lending transactions should constitute a business for the lender.
  • It may or may not be the primary business of the lender.
  • It may or may not be in cash.

This raises an important question as to what constitutes ‘business of money-lending’. Are there any lending transactions which are excluded from its purview? The money lending laws exclude certain kinds of loans and lenders. Accordingly, below we discuss various transactions which may not be classified as business of money-lending:

Exclusions from business of money-lending

1.     Secluded or isolated lending transactions

Including secluded or isolated lending transactions in the definition of money-lending business could result in classification of any loan of any amount given by anyone as a business of money-lending. Surely this could not have been the intention of the legislature. Recognising this, the Hon’ble Bombay High Court in Mandubai Vitthoba Pawar v. The State of Maharashtra & Ors. observed:

“11.             …for constituting a business of money lending there has to be a continuous and systematic activity by application of labour or skill with a view of earning income and then it could be called “business”. In order to do business of money lending, it would be necessary for the State to point out multiple activities of money lending done by the petitioner. Merely referring to one isolated transaction claimed to be a loan transaction or money lending would not be enough to attract the provisions of the Act and to brand the petitioner to be a person involved in business of money lending without having any license.”

This was again reiterated in Uttam Bhikaji Belkar vs The State of Maharashtra. This makes it clear that there has to be a continuous lending activity with profit motive to constitute a business of money-lending. If this condition is satisfied, the money lender has to obtain a valid license to carry on such business. Therefore, providing one-time loans with no intention to carry on the business of lending money, will not trigger the requirement of adhering to the money lending laws.

2.     Inter-corporate deposits

The intention of a company giving an Inter-corporate Deposit (ICD) is not to engage in a money-lending transaction but to earn a surplus on the idle funds available with them. In Pennwali India Ltd. and others vs Registrar of Companies it was observed that there exists a relationship of a debtor and a creditor in both cases – loans and deposits. But ICDs could also be for safe-keeping or as a security for the performance of an obligation undertaken by the depositor. Further, in the case of ICD, which is payable on demand, the deposit would become payable when a demand is made. In Housing and Urban Development Corporation Ltd. v. Joint Commissioner of Income Tax, the Hon’ble Income Tax Appellate Tribunal, Delhi Bench held:

“22. …the two expressions loans and deposits are to be taken different and the distinction can be summed up by stating that in the case of loan, the needy person approaches the lender for obtaining the loan therefrom. The loan is clearly lent at the terms stated by the lender. In the case of deposit, however, the depositor goes to the depositee for investing his money primarily with the intention of earning interest.”

Therefore, the money-lending transactions shall not include ICD and companies shall not be required to obtain a license for undertaking such transactions.

3.     Loans to group companies (subsidiary, associate etc.)

In lending transactions between companies within the same group, the intention is not to earn interest on such loan but to facilitate availability of funds to the group company for furtherance of business. Further, loans by companies are governed by Section 186 of the Companies Act, 2013. Section 2(13)(i) of the Money Lending Act states that “a loan does not include a loan to, or by, or deposit with any corporation (being a body not falling under any of the other provisions of this clause), established by or under any law for the time being in force which grants any loan or advance in pursuance of that Act”. Including such transactions under the scope of money-lending business would not be in line with the objects of the Money Lending Act which is to prevent the harassment to the farmers-debtors at the hands of the money lenders or to curb charging exorbitant interest rates.

4.     Parking of money

Parking of or investing idle funds in fixed deposits with Banks is in the nature of investments to earn a surplus on idle funds. Further, since regulation of banking and financial corporations is a matter of List I (i.e. Union List) of the Seventh Schedule to the Constitution of India, Section 2(13)(h) of the Money Lending Act explicitly states that “a loan shall not include a loan to, or by, a bank”, thereby excluding Banks from its purview.

5.     Loans by Non-banking Financial Companies

The term money lender, as defined in the Money Lending Act, includes individuals, HUF, companies, unincorporated bodies of individuals who carry on the business of money-lending or have a principal business place in Maharashtra.

However, it has excluded from its purview, non-banking financial companies (NBFC) since they are regulated by RBI under Chapter IIIB of the Reserve Bank of India Act, 1934.

Further, other regulated entities such as insurance companies, banks etc. from its purview.

Our write-up giving a detailed analysis of the definition of NBFC can be accessed here.

Accordingly, NBFCs shall not be required to obtain a license to carry out money-lending business in the State of Maharashtra.

Lending in multiple states

In case a company lends in multiple states,  it will have to adhere to provisions under the money lending laws of each such State.

Consequences of non-registration

Section 39 of the Money Lending Act states that whoever carries on the business of money-lending without obtaining a valid licence, shall be punished with –

  • imprisonment for a term which may extend to 5 years; or
  • with fine which may extend to Rs.50,000; or
  • with both.

Conclusion

Even though getting a valid license under the Money Lending Act helps money lenders to carry on business lawfully and have legal recourse against the defaulters, one of the major reasons for non-registration is the ceiling on interest rate. Many lenders are not even aware about the requirement of such registration. Considering the serious nature of punishment for lending money without a valid license, it’s imperative for entities to identify if they are undertaking business of money-lending and whether they have a valid license to do so.