Banking regulation is slated to get into a group-wide regulatory framework, embroiling group entities of banks. According to a draft of the proposed regulation circulated on 4th October, 2024,[1] (“Draft Proposal”) NBFCs in the bank group, engaged in lending or housing finance shall be treated as Upper Layer entities, and additionally, shall be subject to the restrictions on lending as applicable to banks. The proposed regulations also provide that there shall be no overlap between the business carried by the bank[2], and that by bank group entities, which, literally, would mean that lending and asset finance business cannot be done by banking group companies, and if the bank has a housing finance subsidiary, housing finance can be done only by the housing finance entity.
Once the draft circular, expected to force banks to do a major group rejig, is finalised, banks will have 2 years time to comply with it. The restrictions are proposed to be put by way of amendments to the 2016 Master Direction- Reserve Bank of India (Financial Services provided by Banks) Directions, 2016[3] (‘Master Directions’).
The following are some of the major proposals:
Certain activities can be carried only by subsidiaries, and not by banks departmentally
These include activities listed under paragraphs 13, 14(a), 14(b), 15, 16, 17 and 22 in Chapter – III of the Master Directions viz. mutual fund business, insurance business, pension fund management, investment advisory services, portfolio management services and broking services or other such risk-sharing activities that require ring-fencing. While out of the list aforesaid, mutual fund business and Insurance business with risk participation, pension fund management investment advisory services, portfolio management service, broking services for commodity derivatives segment were there in the 2016 Directions as well, the new inclusion seems to be “risk sharing activities that require ring-fencing”. This expression will obviously require explanation. Formation of a limited liability entity is sometimes recommended for the reason of ring-fencing, that is, ensuring that the business liabilities do not go beyond the investment made by the shareholder. Hence, if the activity carried by the bank is something that is in the nature of risk absorption or risk participation, the same can be done only through separate entities.
No overlap in permitted businesses
The most challenging requirement would be to ensure that in case of multiple regulated entities in the same banking group, only one entity within the group shall be allowed to engage in a specific type of permissible business. There should not be any overlap between loan products extended by the bank and its group entities. Hence, in case the group has an HFC extending housing loans, the same shall not be extended by the banking entity.
Bank lending restrictions apply to group entities as well
There are numerous restrictions on lending by banks[4], including lending to connected entities, directors’ interested entities, senior officers, etc. To the extent these are not currently applicable to NBFCs and HFCs, these restrictions will now apply to such entities in the banking group.
Further, the Draft Proposal also provides that group entities shall not be deployed for regulatory arbitrage – they cannot do what is not permitted for the bank.
Bar on investment in Category III AIFs
Banks shall not invest in Cat III AIFs. In case of a bank’s group entities, if the entity is a sponsor of an AIF, it can only hold the minimum investment required as a sponsor [Rs. 1 crore]. Note that earlier in December 2023, the RBI has given a shocker, to curb round tripping of money, prohibiting banks and NBFCs to make investment in such AIFs, which in turn have an investment in borrowers of banks/NBFCs[5]. Further, prior approval from RBI’s Department of Regulations shall be required before investing 20% or more in the equity capital of any financial services company/ Category I or II AIF either individually or collectively by the bank group
The statutory cap of 30% of investee’s capital to include investments by group companies
It is an important provision of the Banking Regulation Act [Section 19(2)] that restricts a bank from holding more than 30% of the equity capital of an investee. This cap shall now include shares held by group companies as well. In existing practice, NBFCs/lending entities in the group are deployed for holding shares or pledges of more than 30%. In fact, one of the proposed changes speaks about shares held indirectly through “trustee companies” as well, raising a question whether shares held by mutual funds and AIFs will also be aggregated. The answer should be negative, as MF and AIF investments cannot be said to be investments held indirectly by the bank, unless the AIF is majority controlled by the bank.
Capital management to be group-wide
The banking group shall have a group-wide capital management policy, enumerating risks and providing economic capital. Understandably, ICAAP will also have to be monitored on a group-wide basis.
Our comments
Veteran bankers are not surprised by the RBI’s move, though, with expected losses, changes in LCR requirements and lot more in the offing, this seems too much over too short a time. In fact, when the non-operating financial holding company (NOFHC) model was recommended in 2013 by the Parliamentary Standing Committee on Finance, it was laid there that “(T)he general principle is that no financial services entity held by the NOFHC would be allowed to engage in any activity that a bank is permitted to undertake departmentally”. The idea of ring fencing of diverse activities was inspired by the need for controlling contagion, alleviation of regulatory arbitrage, etc. The RBI’s Internal Committee named P K Mohanty Working Group also made similar recommendations.
The proposed changes are clearly aimed at curbing any possibility of regulatory arbitrage. Currently, most foreign banks in India have non-banking finance companies; several Indian banks also have NBFCs which are quite large in size and do things which the bank does. In some cases, such as lending against shares, given the NBFC lending norms being more liberal, NBFCs are used for loans against shares, particularly for funding equity investments by group holding companies. Further, NBFCs are not subject to the statutory limit of 30% of the investee company’s capital, by way of ownership, pledge or mortgage. This liberty will no longer be available.
As regards housing finance entities forming part of banking groups, unless the RBI provides a carve out, there will be need to do major corporate restructuring. There are large home loan portfolios both within banks, as also in bank group HFCs. The bank will either need to spin off the housing finance business, or to consider stake sale in HFCs to bring them out of the “group company” definition.
In short, once the proposed changes are finally coded, the banking sector in the country is headed for some very far reaching restructuring changes.
[2] There is a list of permissible activities that can be undertaken by the bank, laid down in Master Direction- Reserve Bank of India (Financial Services provided by Banks) Directions, 2016 (Updated as on August 10, 2021)
https://vinodkothari.com/wp-content/uploads/2023/06/vinod-kothari-logo.png00Vinod Kotharihttps://vinodkothari.com/wp-content/uploads/2023/06/vinod-kothari-logo.pngVinod Kothari2024-10-07 23:02:582024-10-08 10:55:29RBI proposes major regulatory restrictions on bank NBFCs and HFCs
The Reserve Bank of India (‘RBI’) issued a notification dated September 30, 2024[1] raising concerns on the irregular practices observed in the grant of loans against pledge of gold ornaments and jewellery.
The RBI’s comprehensive review has unveiled notable deficiencies, including lapses in due diligence process, credit appraisals, ineffective monitoring of loan-to-value (LTV) ratios, a lack of transparency in the auctioning of jewellery upon default and so on. This notification compels all commercial banks, primary co-operative banks, and non-banking financial companies to undertake a meticulous evaluation of their existing gold lending processes and rectify identified gaps or shortcomings.
The trust and fairness in a lender-borrower relationship is one of the most fundamental drivers of financial regulation, and ensuring this trust and fairness in lender-borrower relationships is crucial for the growth and stability of the financial sector. NBFCs doing lending business are likely very conversant with the obligations captured in the RBI regulation on fair lending practices that details the general principles on adequate disclosure of the terms and conditions of a loan, and the adoption of non-coercive recovery methods. However, they may be unaware of the rights and obligations under the Consumer Protection Act, 2019 (‘CP Act’) which inter alia deals with “Unfair Contracts”. Interestingly, the CP Act defines a contract to be unfair if such contract significantly undermines consumer rights including clauses that restrict prepayment or contains clauses towards unilateral termination of agreements etc. These terms, which are also covered under the RBI’s Fair Practice Code, highlight a convergence in regulatory and statutory protections for borrowers.
In this article, we explore the rights of a borrower and the obligations of a lender under the CP Act and highlights the extant obligations under the Fair Practices Code, and other RBI regulations, and in doing so also explore the emerging convergence in these regulations concerning consumer protection norms.
Meaning of Unfair Contract and its impact
Section 2(46) of the CP Act, defines an “unfair contract” as follows-
(46) “unfair contract” means a contract between a manufacturer or trader or service provider on one hand, and a consumer on the other, having such terms which cause significant change in the rights of such consumer, including the following, namely:
(i) requiring manifestly excessive security deposits to be given by a consumer for the performance of contractual obligations; or
(ii) imposing any penalty on the consumer, for the breach of contract thereof which is wholly disproportionate to the loss occurred due to such breach to the other party to the contract; or
(iii) refusing to accept early repayment of debts on payment of applicable penalty; or
(iv) entitling a party to the contract to terminate such contract unilaterally, without reasonable cause; or
(v) permitting or has the effect of permitting one party to assign the contract to the detriment of the other party who is a consumer, without his consent; or
(vi) imposing on the consumer any unreasonable charge, obligation or condition which puts such consumer to disadvantage;
Based on the aforesaid definition, from the perspective of lenders, unfair contracts would include any agreement that significantly undermines consumer rights. Examples of unfair terms include:
Preventing early prepayment of debt, even with payment of applicable penalties;
Allowing the lender to unilaterally terminate the agreement without reasonable cause;
Assigning the contract to another party in a manner detrimental to the consumer, without their consent;
Imposing unreasonable charges, obligations, or conditions that disadvantage the consumer.
It is important to note that the aforesaid list is not exhaustive. Beyond these provisions, the RBI Fair Practice Code also identifies practices that can render contracts unfair, including:
Charging excessive interest rates.
Imposing interest during undisbursed loan periods.
Enforcing unreasonable lock-in periods in loan agreements or sanction letters, etc.
The CP Act permits the classification of any contract that results in an unreasonable bargain as unfair, and subject to review by consumer courts such as the State Commission (Section 47(iii)) and the National Commission (Section 58(ii)). Additionally, Sections 49(2) and 59(2) state that if a contract term is deemed unfair by these commissions, it can be declared null and void.
Further, via the principle of the doctrine of restitution, as outlined in Section 65 of the Indian Contract Act, 1872 if any part of a contract is declared void, the benefits received by any party must be returned or compensated to the party from whom they were obtained.
Under the CP Act, an unfair contract exists where there is a manufacturer, trader, or service provider on one side, and a consumer on the other. Therefore, to assess the “unfair contract” aspect in loan contracts, a key consideration will be whether the borrower is a “consumer” as denoted thereunder.
Determination of ‘Consumer’ under the CP Act
Section 2(7)(ii) of the CP Act in respect of loans defines consumer as any person who has availed services for a consideration which has been paid or promised or partly paid by such person and partly promised, however, does not include any person who has availed of such service for any commercial purposes. Hence, in the context of loans, borrowers who have availed of loans for “commercial purposes” would not qualify as consumers under CP Act. As the law currently stands, any person who obtains loans for his personal use would still fall under the definition of the term “consumer”. However, there might be debates on whether a person availing business loans would fall under the ambit of the CP Act. The term “commercial purposes” per se has not been defined under the CP Act and thus, has been subject to judicial interpretation.
We now proceed to analyse the current standing of the law in relation to business loans as well as retail loans and understand what qualifies as a service being taken for “commercial purpose”.
Are retail and commercial borrowers recognized as ‘consumers’
The definition of a “consumer” under S.2(7) of the CP Act includes any person who buys a good or hires a service for consideration paid or under any system of deferred payment.
This would also cover in its ambit borrowers because in the context of Banks, the Supreme Court has held that persons who avail of any banking services is a consumer under the Consumer Protection Act1.
Additionally, as the National Consumer Disputes Redressal Forum, and the State Consumer Disputes Redressal Forum pass reasoned orders on the interests of borrowers obtaining facilities from NBFC, persons obtaining non-banking financial services shall also fall under the definition of “consumer”.
Hence, borrowers of retail loans would be recognized as consumers. However, the definition of a “consumer” under S.2(7) of the CP Act does not cover persons who have obtained goods, or availed services for a commercial purpose.
A commercial purpose includes business-to-business transactions between entities where there is a direct nexus with profit-generating activities. “Commercial” denotes activities pertaining to commerce, and connected with/engaged in commerce having profit as a main aim. Where there is ambiguity, it may be seen whether the dominant intent/purpose of the transaction was to facilitate some kind of profit generation for the purchaser / their beneficiary2. Such activities or contracts would be out of the scope of the Consumer Protection Act3.
As regards loans, where a loan is obtained for a commercial purpose, the person who obtained such a loan does not come under the category of “consumer”4.
A. Overdraft facility
In Shrikant G. Mantri vs Punjab National Bank5, the appellant took an overdraft facility to expand his business profits, and subsequently from time to time the overdraft facility was enhanced so as to further expand his business and increase his profits. The Supreme Court held that the relationship between the appellant and the respondent is purely a “business to business” relationship. As such, the transactions would clearly come within the ambit of ‘commercial purpose’ and accordingly the appellant is not a consumer under the Act.
B. Working Capital Loans
In the case of Standard Chartered Bank & Anr. v Mankumar Kundliya6, one Mankumar Kundliya was the sole proprietor of the proprietorship firm M/s Sahil Distributors, who had obtained working capital facility from the bank. The issue before the National Commission was on deciding whether the respondent was a “consumer” under the Act. The court negating the contention held that the working capital loan facility obtained by the respondent “cannot be said to be for earning livelihood of the Respondent, and the same are inherently commercial in nature and the relationship between the parties is purely “Business to Business” in nature. Further, the Appellant also has independent commercial interests. Therefore, the transactions are essentially for ‘Commercial Purpose’ and the case does not fall under the exceptions to the term ‘Commercial Purpose’ carved out in the definition of the term ‘Consumer’ under the statute.”
C. Self Employment
Loans obtained for the purpose of self-employment may be considered business loans from the perspective of the lender, but the CP Act views such borrowers as “consumers”7.
Would retail and commercial borrowers come under the ambit of “unfair contract” as per CP Act
As mentioned above, an unfair contract refers to a contract with a manufacturer, or trader, or service provider on one hand, and a consumer on the other having such terms as which would cause significant change in the rights of the consumer.
Loan contracts are contracts that may be tested against this definition, and the definition of an unfair contract in the CP Act is an “inclusive definition”, i.e. it is not exhaustive. It can cover emerging industry practices not specifically captured in any legislation. The CP Act is to be construed in favour of the “Consumer” as it is a “social benefit oriented legislation”8, and lending entities would be well advised to review their restrictive covenants and terms against this definition, specifically in case of retail borrowers.
Since an unfair contract requires one of the parties of the contract to be a “consumer”, it would not include commercial loan contracts where the parties would not be “consumers” under the Act, save and except in circumstances where such loans have been obtained by the borrower for purposes of self-employment. Consequently, remedies through the State Consumer Commission or the National Consumer Commission under Sections 47 and 58 of the Act respectively are not available. Therefore, recourse to these commissions is not an option for addressing issues related to unfair contracts in this context.
However, if terms of the contract are unfair, businesses can seek remedies through the Commercial Courts Act, 2015. According to Section 2(c)(i) of the Commercial Courts Act, such unfair contracts may form subject matter of a “commercial dispute”. As a result, businesses can still address these issues through the commercial courts, subject to the dispute meeting the quantum of “specified value” as provided under 2(c)(i) of the Commercial Courts Act. Alternatively, the business which has availed business loans will also have other common law remedies, and may file a suit before a court of appropriate jurisdiction to declare the terms of the Contract as unfair and void.
Common/ prevalent terms and covenants that qualify as ‘unfair’
The following terms have specifically been held to be an “unfair contract” or unfair trade practice by the Consumer Disputes Redressal Commissions with regards to lenders regulated by RBI:
Excessive Penal Interest/Charge: Charging of excessive penalty/penal interest (in 2021), holding that incorporating such excessive terms into the loan agreement amounted to an unfair trade practice9.
Ceiling on interest rate: Even where RBI does not prescribe an upper limit for NBFC on rate of interest to be charged, the same can still be considered an unfair contract/unfair trade practice by the consumer courts10.
Enhancement of interest without borrower consent: Enhancing of interest rate without obtaining written consent of the borrower. Additionally, where clauses of the loan agreement are not in conformity with RBI guidelines, the agreement itself becomes voidable being against the law of the land11.
Repossession Clause: Forcible seizure of a vehicle particularly where no prior notice is given before seizing the vehicle, nor any opportunity given to pay dues constitutes an unfair trade practice, and a deficiency in service. The Supreme Court has in this context also held that any action for recovery in these cases may be struck down12.
In addition, the covenants demanding instant repayment of loan facilities by the Lender without the occurrence of any default may also be construed as an unfair contract and draw the remedies/penalties as has been provided below.
Though remedies under the CPA may not be available in case of business loans, however, clauses as has been discussed under consumer loans may also form an unfair contract even in cases of business loans in case the same are present in the terms of the loan agreement with the business entity.
Remedies/ Penalties under the CP Act
The terms of the contract may be declared null and void (by the National Commission and State Commission (S.59 and S.49 of the Act), and the District/State/National Commissions may issue orders to the opposite party directing them to discontinue the unfair practices.
However, penal measures are not present towards business loans considering that persons availing business loans are not included within the ambit of the CP Act.
However, while the ambit of “Unfair Contract” under the CP Act is broader in its coverage, the Fair Practice Code of the RBI generally applies to retail loans as well as business loans, save and except to the circumstances where certain paras in the Fair Practice Code are explicitly made applicable on loans provided to individuals. Accordingly, the persons who have availed retail loans as well as persons who have availed business loans can raise their grievances with the RBI ombudsman in circumstances where the grievances have not been addressed by the lender to the satisfaction of the borrower.
Key Takeaways
Lenders
Borrowers
Consumer Definition: Retail Loans: Borrowers are recognized as consumers under the CP Act.
Business Loans: Borrowers are not considered consumers if the loans are for commercial purposes.
Consumer Protection: Retail Loans: As a consumer, borrowers are protected under the CP Act, which includes rights against unfair contract terms and practices.
Business Loans: Loans obtained for commercial purposes do not fall under the CP Act.
Unfair Contracts: Retail Loans: Lenders must ensure that contract terms do not qualify as unfair under the CP Act to avoid legal challenges.
Business Loans: While the provisions relating to “unfair contract” as provided under the CP Act may not apply, lenders should be aware that such contracts could still be challenged under other legal frameworks.
Unfair Contract Terms: Retail Loans: Borrower can challenge unfair contract terms such as restrictions on prepayment, unreasonable lock-in periods, and excessive interest rates under the CP Act.
Business Loans: Although remedies under the CP Act might not apply, the borrower can seek redress through other legal means if unfair practices are present.
Common Unfair Terms:Lenders should avoid terms that restrict prepayment, impose unreasonable lock-in periods, charge foreclosure fees, or apply excessive interest rates. Even though the CP Act might not apply to business loans, similar terms can affect borrower satisfaction and lead to disputes.
Grievance Redressal: Retail Loans: Utilise the mechanisms for redressal, including filing complaints with the National or State Consumer Disputes Redressal Forums.
Business Loans: Address grievances through the Commercial Courts Act, 2015, or common law remedies if contract terms are deemed unfair.
Remedies and Compliance: Retail loans: Lenders should be prepared to modify or eliminate unfair terms to comply with the requirements of the CP Act and avoid regulatory as well as statutory action.
Business loans: Lenders should understand that while remedies under the CP Act might not be available, there are still other legal avenues for addressing unfair practices.
Fair Practice Code:Both retail and business loan borrowers can escalate unresolved grievances to the RBI ombudsman under the Fair Practice Code.
Fair Practice Code:Ensure compliance with the RBI’s Fair Practice Code for both retail and business loans. Complaints can be escalated to the RBI ombudsman if unresolved satisfactorily.
Conclusion
In navigating the complex landscape of borrower rights and lender obligations under a financial transaction, the CP Act, and the RBI’s Fair Practices Code play pivotal roles. The CP Act safeguards borrowers by addressing “unfair contracts,” including terms that restrict prepayment or impose excessive penalties. While these robust protections are available for retail loans, they do not extend to business loans intended for commercial purposes. However, borrowers of business loans are still covered under the Fair Practices Code, which ensures fair treatment and provides a grievance redressal mechanism through the RBI ombudsman.
We recommend that Lenders be vigilant in crafting fair contract terms to avoid legal disputes, and ensure compliance with both regulatory and statutory frameworks. For retail loan borrowers, avenues for challenging unfair practices are clear and accessible. For business loan borrowers, while direct remedies under the CP Act may not apply, alternative legal channels are available. Ultimately, understanding and adhering to these regulations is crucial for maintaining trust and fairness in lender-borrower relationships which constitutes the bedrock of the financial services sector.
Citicorp.Maruti Finance Ltd vs S.Vijayalaxmi on 14 November, 2011 AIR 2012 Supreme Court 509 ↩︎
https://vinodkothari.com/wp-content/uploads/2023/06/vinod-kothari-logo.png00Staffhttps://vinodkothari.com/wp-content/uploads/2023/06/vinod-kothari-logo.pngStaff2024-09-18 10:39:572024-09-18 10:58:27Navigating Unfair Contracts: Understanding Borrower Rights and Lender Obligations under the Consumer Protection Act
The concept of a marketplace, i.e a platform where buyers and sellers meet, appears to have existed since antiquity and is one of the defining features of evolved commerce in any particular civilization (e.g the Middle Eastern and Persian ‘Bazaar’, the Ancient Greek ‘Agora’, the Silk Road, ‘Mandis’ in India, etc.). Marketplaces have evolved from being platforms of meetings where the confluence of trade occurs (such as a venue), to persons or entities actively providing a platform for such exchange and obtaining consideration for the intermediation provided. As they are rooted in the fabric of our culture, it is natural that these models will continue to appear and replicate themselves across different mediums (i.e. Physical, Online), and different sectors (such as platforms for financial services and lending, sales of second-hand goods, fashion and cosmetics, legal services, and even tuition).
The ambit of regulation here is usually to the extent of intermediation and facilitation provided, however drawing this line can become challenging for regulators when under the garb of intermediation entities begin to operate as agents, or as sellers without discharging the commensurate compliance burden. This piece addresses such a regulatory concern in digital lending marketplaces, where there is an emergence of entities using the marketplace model to offer services/features that mimic the role of an agent, or a vendor.
Online Marketplaces and Agency
Under S.3(g) of the E-Commerce Rules 2020, a “Marketplace e-commerce entity” is an entity that provides an information technology platform on a digital or an electronic network to facilitate transactions between buyers and sellers. The DIPP Press note 2/2018 differentiates between a marketplace mode of e-commerce and an inventory model of e-commerce, where a marketplace model is characterized by its providing of a platform to facilitate the transactions, as opposed to an “inventory model” where there is ownership exercised over the goods and services. At the risk of oversimplifying, it can also be stated that Marketplaces under the IT Act are also “intermediaries”, and a “pure marketplace” would be one that is limited to the function of facilitation and intermediation. The precise scope of facilitation and intermediation are covered in sectoral regulations, where the regulator considers what degree of facilitation will cross this threshold (for example under the DIPP Press Note, and the Digital Lending Guidelines)
Marketplace entities, to the extent that they are facilitating a transaction between the two parties, are not vendors/sellers. Marketplace entities are not agents either. In law, an agent is a person employed to do any act for another, or to represent another in dealings with a third person. For one to be considered the agent of another, the terms of agency don’t need to be expressly stated in a contract, so long as the general terms constituting the agency relationship are consented to, i.e. the parties have agreed to what amounts in law to such a relationship. The key features of a principal-agent relationship viz. the liability of a principal for acts of the agent in the course of the contract, the power to bind the principal to contracts, make representations on behalf of the principal, etc. are not found in a marketplace model. A marketplace cannot represent, negotiate, or make dealings on behalf of the seller. Similarly, the seller cannot be held liable for the actions of a marketplace in the course of its representation.
Because determining agency is a question of substance over form, Lending Service Providers are categorized as Agents (insofar as their dealings with third parties on behalf of the Regulated Entity are concerned) because the scope of their activities would include customer acquisition, acquisition support, underwriting support and servicing. Undertaking such functions on behalf of a lender/seller and actively promoting them in their dealings with a third party constitutes an agency, and this “triangular relationship” is one of the principal features of an agency contract. Therefore, LSPs are regulated to the extent of their agency, and the compliance burden is placed on the REs contracting with them.
But, there is an emerging class of marketplace lending entities, facilitating lending by offering a platform and algorithms matching the needs of the Borrower with the Lender/Regulated Entity, that purport to offer services not requiring them to register or comply with the RBI Regulation. Insofar as these services, are within the domain of facilitation and intermediation, and do not include promoting or representing a particular lender to borrowers, taking variable returns, offering any kind of credit risk mitigation/guarantees, or assurances for minimum returns/recovery of monies they would stay within the ambit of the marketplace model. Such services in relation to the marketplace entity’s dealing with the customer will be an extension of the principal-agent relationship with the regulated entity, and insofar as they concern dealings with the principal/regulated entity themselves (such as offering guarantees) is akin to the role played by a del credere agent. Intermediaries do not take a “skin in the game” with respect to the sellers, it is very uncharacteristic of their function which is fundamentally premised on neutrality.
Conclusion
In the digital lending space, entities that wish to operate using a marketplace business model would necessarily need to operate like a marketplace by limiting the extent of their services to providing intermediation, and facilitation, which can be matching the needs of the borrowers and the lenders through an algorithmic service, and offering a platform for the transaction. However, they cannot offer any kind of credit risk mitigation/guarantees or assurance for minimum returns/recovery of monies because those services take them outside the scope of a marketplace. Consider financial services on ONDC, which operating in the marketplace model is not an LSP, because the scope of its function is limited to providing a “technology that facilitates discoverability and interaction of the lender apps registered on the network with those of the LSP (Buyer App)” (more on this here). These entities may not actively promote the products of an entity either, and in the traditional lending marketplace, entities such as Business Correspondents that provide this function are considered agents. Where such services are offered, continuing to call oneself a marketplace is not the panacea to compliance.
Department of Industrial Policy & Promotion, Press Note No. 2 (2018 Series).
Information Technology Act, 2000, S.2(1)(w)
Kunal Bahl and Ors. vs. State of Karnataka (07.01.2021 – KARHC) : MANU/KA/0010/2021.
The Indian Contract Act, 1872, S.182.
Life Insurance Corporation and Ors. vs. Rajiv Kumar Bhasker (28.07.2005 – SC) : MANU/SC/0441/2005
Guidelines on Digital Lending
Bharti Cellular Limited vs. Assistant Commissioner of Income Tax, Circle 57, Kolkata and Ors. (28.02.2024 – SC) : MANU/SC/0144/2024.
https://vinodkothari.com/wp-content/uploads/2023/06/vinod-kothari-logo.png00Team Finservhttps://vinodkothari.com/wp-content/uploads/2023/06/vinod-kothari-logo.pngTeam Finserv2024-09-13 18:03:062024-09-13 18:03:57Identifying the Contours of a Lending Marketplace
Following the success of our recent workshop in Mumbai and Bengaluru, we are delighted to announce our upcoming 2-day refresher course on RBI regulations for NBFCs in Delhi!
https://vinodkothari.com/wp-content/uploads/2023/06/vinod-kothari-logo.png00Team Finservhttps://vinodkothari.com/wp-content/uploads/2023/06/vinod-kothari-logo.pngTeam Finserv2024-08-17 17:01:592024-09-10 16:52:37Two day refresher course on NBFC Regulations – Delhi
Vide notification dated August 12, 2024, RBI has amended certain regulations applicable to Housing Finance Companies, and NBFCs to enure harmonization between HFC Master Directions and SBR Master Directions. These amendments shall be effective from January 01, 2025. The following table contains a snapshot of the changes from all HFCs and NBFCs1:
Sr.
Particulars
Erstwhile provision
Amended / Harmonised provision
Changes in HFC Master Directions for all HFCs
1
Participation in exchange-traded currency derivatives
HFCs were allowed to participate in currency futures and options however no regulatory guidelines were prescribed for the same.
All HFCs can now participate in currency futures exchanges and Non-deposit HFCs with asset size of ₹1000 crore and above can participate in currency option exchanges, subject to the guidelines issued in the matter by the Foreign Exchange Department of the Reserve Bank and necessary disclosures in the balance sheet in accordance with guidelines issued by SEBI.
3
Participation in Interest Rate Futures
HFCs were allowed to participate in interest rate futures however no regulatory guidelines were prescribed for the same.
All HFCs can now participate in interest rate futures exchanges as clients and Non-deposit HFCs with asset size of ₹1000 crore and above are permitted to participate in interest rate futures market as trading members, subject to adherence to instructions contained in Rupee Interest Rate Derivatives (Reserve Bank) Directions, 2019 dated June 26, 2019, as amended from time to time.
4
Credit Default Swaps (CDS)
HFCs were allowed to participate in the CDS market however no regulatory guidelines were prescribed for the same.
HFCs will now be permitted to participate in the CDS market as users only and they may buy credit protection only to hedge their credit risk on corporate bonds they hold.
HFCs cannot enter into short positions in CDS contracts.
HFCs shall be required to comply with Annex XIV of SBR Directions while participating in CDS market as users.
5
Issue of co-branded credit cards
HFCs were not allowed to issue co-branded cards under the erstwhile directions.
HFCs are now allowed to issue co-branded credit cards, subject to the instructions prescribed in Master Direction – Credit Card and Debit Card – Issuance and Conduct Directions, 2022, as amended from time to time.
6
Accounting Year
Every HFC shall prepare its financial statements for the year ending on the 31st day of March.
HFCs must finalize their balance sheets within 3 months from the relevant date. If an HFC wishes to extend this period under the Companies Act, it must first obtain approval from NHB before seeking an extension from the RoC. In cases where NHB and RoC grants extension of time, the HFC shall furnish to NHB a proforma balance sheet(unaudited) as on March 31 of the year and the returns due on the said date.
7
Periodicity of IS Audit
The Audit Committee must ensure that an Information System Audit of the critical and significant internal systems and processes is conducted at least once in two years to assess operational risks faced by the HFC.
HFCs can now decide the periodicity of IS Audit as per its policy in accordance with IT Governance Directions. However, a continuous auditing approach for critical systems shall be undertaken.
8
Investment through Alternative Investment Funds for calculation of NOF
No regulatory guidelines were prescribed
To determine the Net Owned Funds (NOF) of a Housing Finance Company (HFC), investments or loans to subsidiaries, group companies, and other HFCs exceeding 10% of owned funds are deducted from the owned funds. Investments made by an HFC in group entities, either directly or indirectly through an AIF (if 50% or more of the AIF’s funds come from the HFC) or an AIF trust (if the HFC is the beneficial owner and 50% of the trust’s funds come from the HFC), shall be treated similarly.
9
Technical Specifications for all participants of Account Aggregator ecosystem
Regulatory provisions did not exist
HFCs acting either as ‘Financial Information Provider’ or ‘Financial Information User’ are expected to adopt the technical specifications published by ReBIT, as updated from time to time.
Changes in SBR Directions for all NBFCs
7
Periodicity of IS Audit
The Audit Committee must ensure that an Information System Audit of the critical and significant internal systems and processes is conducted at least once in two years to assess operational risks faced by the NBFCs.
NBFCs can now decide the periodicity of IS Audit as per its policy in accordance with IT Governance Directions. Further, a continuous auditing approach for critical systems shall be undertaken.
The changes specifically for deposit taking HFCs and NBFCs have note been covered↩︎
https://vinodkothari.com/wp-content/uploads/2023/06/vinod-kothari-logo.png00Staffhttps://vinodkothari.com/wp-content/uploads/2023/06/vinod-kothari-logo.pngStaff2024-08-14 15:08:512024-08-16 10:59:27Aligning Regulations: Harmonizing the Frameworks for HFCs and NBFCs
What is the notification on change in Risk Weights (RWs) issued by RBI?
RBI has issued notification dated August 12, 2024 on Review of Risk Weights for Housing Finance Companies (HFCs). Accordingly, with immediate effect, the RWsfor computation of risk weighted assets (RWAs), for capital adequacy purposes, for for undisbursed portion of housing loans/other loans shall be capped at the RWA computed on a notional basis for an equivalent amount of disbursed loan. In other words, the applicable RW shall be lower of (a) RW, applying the credit conversion factor (CCF) on the undisbursed loan, with a 100% RW; and (b) the RW that will be applicable, based on the size and the LTV of the loan, if the undisbursed part were to be disbursed.
The RBI’s bi-monthly Monetary Policy review was accompanied by the Governor’s customary statement, dated 8th August, 2024, highlighting 4 areas of potential risks to financial stability. Two of these relate to uncollateralised or personal lending.
The 4 red flags raised by the Governor are as follows.
First, with alternative financial instruments being available and attractive, lesser money is flowing into the banking system by way of deposits, thereby the credit-deposit ratio indicates deposit growth trailing the growth in credit. This would force banks to look for alternative short term sources of funding, to fund the credit growth, potentially creating what is known as structural liquidity risk. Structural liquidity risk is said to exist when there is greater dependence on short-term sources of funding, as compared to short-term assets.
It is notable that recently, the RBI proposed to increase the run-off rate for retail deposits which are backed by internet banking facility. Most retail deposits these days are. A higher run-off rate implies a faster ability of the depositor to withdraw his deposit, thereby increasing the assumption for outflows, which is used for computing the liquidity coverage ratio (LCR). Higher LCR requirement means higher funds blocked in so-called high-quality liquid assets, and thereby lesser funds available for lending. Thus, the Governor’s reference to slower deposit growth relative to lending will get be even stronger, once the proposed changes in LCR are implemented.
https://vinodkothari.com/wp-content/uploads/2023/06/vinod-kothari-logo.png00Staffhttps://vinodkothari.com/wp-content/uploads/2023/06/vinod-kothari-logo.pngStaff2024-08-08 18:14:402024-08-19 15:48:26RBI Governor red-flags personal loans, top-up lending, once again
https://vinodkothari.com/wp-content/uploads/2023/06/vinod-kothari-logo.png00Staffhttps://vinodkothari.com/wp-content/uploads/2023/06/vinod-kothari-logo.pngStaff2024-07-31 12:41:132024-07-31 13:51:38Defaulters at will, and defaulters of size: RBI issues new Directions
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