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Open in new tab RBI revises qualifying assets criteria for NBFC MFIs
/0 Comments/in Financial Services, NBFCs, RBI /by Vinod Kothari ConsultantsTeam, Vinod Kothari Consultants Pvt. Ltd.
The RBI on November 08, 2019[1] revised the limits relating to the qualifying assets criteria, giving a much needed boost to Micro-Finance Institutions. The change in limits comes pursuant to the Statement on Developmental and Regulatory Policies[2] issued as part of the Monetary Policy Statement dated 04 October, 2019.
A detailed regulatory framework for MFI’s was put into place in December, 2011 based on the recommendations of a Sub-Committee of the Central Board of the Reserve Bank. The regulatory framework prescribes that an NBFC MFI means a non-deposit taking NBFC that fulfils the following conditions:
- Minimum Net Owned Funds of Rs. 5 Crore.
- Not less than 85% of its net assets are in the nature of qualifying assets.
Thus meeting the qualifying assets criteria is crucial to be classified as an NBFC-MFI. The income and loan limits to classify an exposure as an eligible asset were last revised in 2015.
In light of the above and taking into consideration the important role played by MFIs in delivering credit to those in the bottom of the economic pyramid and to enable them to play their assigned role in a growing economy, it was decided to increase and review the limits.
Revised Qualifying assets criteria
The changes are highlighted in the table below:
| Qualifying Assets Criteria | |
| Erstwhile Criteria | Revised Criteria |
| Qualifying assets shall mean a loan which satisfies the following criteria: | |
| i. Loan disbursed by an NBFC-MFI to a borrower with a rural household annual income not exceeding ₹ 1,00,000 or urban and semi-urban household income not exceeding ₹ 1,60,000; | i. Loan disbursed by an NBFC-MFI to a borrower with a rural household annual income not exceeding ₹ 1,25,000 or urban and semi-urban household income not exceeding ₹ 2,00,000; |
| ii. Loan amount does not exceed ₹ 60,000 in the first cycle and ₹ 1,00,000 in subsequent cycles; | ii. Loan amount does not exceed ₹ 75,000 in the first cycle and ₹ 1,25,000 in subsequent cycles; |
| iii. Total indebtedness of the borrower does not exceed ₹ 1,00,000; | iii. Total indebtedness of the borrower does not exceed ₹ 1,25,000; |
| Note: All other terms and conditions specified under the master directions shall remain unchanged. | |
The Statement on Developmental and Regulatory Policies called for revisions in the household income and loan limits only. The notification of the RBI additionally, in light of the change in total indebtedness of the borrower, felt it necessary to also increase the limits on disbursal of loans.
The revised limits are effective from the date of the circular, i. e. November 08, 2019.
[1] https://www.rbi.org.in/Scripts/NotificationUser.aspx?Id=11727&Mode=0
[2] https://www.rbi.org.in/Scripts/BS_PressReleaseDisplay.aspx?prid=48318
Links of related articles:
Working Group proposal for stricter vigilance on CICs
/0 Comments/in NBFCs, RBI, UPDATES /by Vinod Kothari Consultants-By Anita Baid
anita@vinodkothari.com, finserv@vinodkothari.com
Regulators and stakeholders have been seeking a review of Core Investment Companies (CIC) guidelines ever since defaults by Infrastructure Leasing and Financial Services Ltd (IL&FS), a large systemically important CIC. In August 2019, there were 63 CICs registered with the Reserve Bank of India (RBI). As on 31 March, 2019, the total asset size of the CICs was ₹2.63 trillion and they had approximately ₹87,048 crore of borrowings. The top five CICs consist of around 60% of the asset size and 69% borrowings of all the CICs taken together. The borrowing mix consists of debentures (55%), commercial papers (CPs) (16%), financial institutions (FIs) other corporates (16%) and bank borrowings (13%).
Considering the need of the hour, RBI had constituted a Working Group (WG) to Review Regulatory and Supervisory Framework for CICs, on July 03, 2019. The WG has submitted its report on November 06, 2019 seeking comments of stakeholders and members of the public.
Below is an analysis of the key recommendations and measures suggested by the WG to mitigate the related risks for the CICs:
| Existing Provision & drawbacks | Recommendation | Our Analysis |
| Complex Group Structure | ||
| Section 186 (1) of Companies Act, 2013, which restricts the Group Structure to a maximum of two layers, is not applicable to NBFCs
|
The number of layers of CICs in a group should not exceed two, as in case of other companies under the Companies Act, which, inter alia, would facilitate simplification and transparency of group structures.
As such, any CIC within a group shall not make investment through more than a total of two layers of CICs, including itself. For complying with this recommendation, RBI may give adequate time of say, two years, to the existing groups having CICs at multiple levels. |
A single group may have further sub-division based on internal family arrangements- there is no restriction on horizontal expansion as such.
Further, the definition of the group must be clarified for the purpose of determining the restriction- whether definition of Group as provided under Companies Act 1956 (referred in the RBI Act) or under the Master Directions for CICs would be applicable. To comply with the proposed recommendations, the timelines as well as suggested measures must also be recommended. |
| Multiple Gearing and Excessive Leveraging | ||
| Presently there is no restriction on the number of CICs that can exist in a group. Further, there is no requirement of capital knock off with respect to investments in other CICs. As a result, the step down CICs can use the capital for multiple leveraging. The effective leverage ratio can thus be higher than that allowed for regular NBFCs. |
For Adjusted Net Worth (ANW) calculation, any capital contribution of the CIC to another step-down CIC (directly or indirectly) shall be deducted over and above the 10% of owned funds as applicable to other NBFCs.
Furthe, step-down CICs may not be permitted to invest in any other CIC. Existing CICs may be given a glide path of 2 years to comply with this recommendation. |
Certain business groups developed an element of multiple gearing as funds could be raised by the CICs and as well as by the step down CICs and the other group companies independently. At the Group level, it therefore led to over-leveraging in certain cases.
A graded approach, based on the asset size of the CICs, must have been adopted in respect of leverage, instead of a uniform restriction for all. |
| Build-up of high leverage and other risks at group level | ||
| There is no requirement to have in place any group level committee to articulate the risk appetite and identify the risks (including excessive leverage) at the Group level | Every conglomerate having a CIC should have a Group Risk Management Committee (GRMC) which, inter alia, should be entrusted with the responsibilities of
(a) identifying, monitoring and mitigating risks at the group level (b) periodically reviewing the risk management frameworks within the group and (c) articulating the leverage of the Group and monitoring the same. Requirements with respect to constitution of the Committee (minimum number of independent directors, Chairperson to be independent director etc.), minimum number of meetings, quorum, etc. may be specified by the Reserve Bank through appropriate regulation. |
There is no particular asset size specified. Appropriately, the requirement should extend to larger conglomerates.
|
| Corporate Governance | ||
| Currently, Corporate Governance guidelines are not explicitly made applicable to CICs | i. At least one third of the Board should comprise of independent members if chairperson of the CIC is non-executive, otherwise at least half of the Board should comprise of independent members, in line with the stipulations in respect of listed entities. Further, to ensure independence of such directors, RBI may articulate appropriate requirements like fixing the tenure, non-beneficial relationship prior to appointment, during the period of engagement and after completion of tenure, making removal of independent directors subject to approval of RBI etc.
ii. There should be an Audit Committee of the Board (ACB) to be chaired by an Independent Director (ID). The ACB should meet at least once a quarter. The ACB should inter-alia be mandated to have an oversight of CIC’s financial reporting process, policies and the disclosure of its financial information including the annual financial statements, review of all related party transactions which are materially significant (5% or more of its total assets), evaluation of internal financial controls and risk management systems, all aspects relating to internal and statutory auditors, whistle-blower mechanism etc. In addition, the audit committee of the CIC may also be required to review (i) the financial statements of subsidiaries, in particular, the investments made by such subsidiaries and (ii) the utilization of loans and/ or advances from/investment by CIC in any group entity exceeding rupees 100 crore or 10% of the asset size of the group entity whichever is lower. iii. A Nomination and Remuneration Committee (NRC) at the Board level should be constituted which would be responsible for policies relating to nomination (including fit and proper criteria) and remuneration of all Directors and Key Management Personnel (KMP) including formulation of detailed criteria for independence of a director, appointment and removal of director etc. iv. All CICs should prepare consolidated financial statements (CFS) of all group companies (in which CICs have investment exposure). CIC may be provided with a glide path of two years for preparing CFS. In order to strengthen governance at group level, if the auditor of the CIC is not the same as that of its group entities, the statutory auditor of CIC may be required to undertake a limited review of the audit of all the entities/ companies whose accounts are to be consolidated with the listed entity. v. All CICs registered with RBI should be subjected to internal audit. vi. While there is a need for the CIC’s representative to be on the boards of its subsidiaries / associates etc., as necessary, there is also a scope of conflict of interest in such situations. It is therefore recommended that a nominee of the CIC who is not an employee / executive director of the CIC may be appointed in the Board of the downstream unlisted entities by the respective CIC, where required. |
The extent of applicability of NBFC-ND-SI regulations is not clear. The FAQs issued by RBI on CICs (Q12), state that CICs-ND-SI are not exempt from the Systemically Important Non-Banking Financial (Non-Deposit Accepting or Holding) Companies Prudential Norms (Reserve Bank) Directions, 2015 and are only exempt from norms regarding submission of Statutory Auditor Certificate regarding continuance of business as NBFC, capital adequacy and concentration of credit / investments norms.
Further, no asset size has been prescribed – can be prescribed on “group basis”. That is, if group CICs together exceed a certain threshold, all CICs in the group should follow corporate governance guidelines, including the requirement for CFS. Most of the CICs are private limited companies operating within a group, having an independent director on the board may not be favorable. Further, carrying out and internal audit and preparing consolidated financials would enable the RBI to monitor even unregulated entities in the Group. Currently, the requirement of However, if the recommendation
|
| Review of Exempt Category and Registration | ||
| Currently there is a threshold of ₹ 100 crore asset size and access to public funds for registration as CIC |
|
Since the category of ‘exempted CICs; were not monitored, there was no means to detect when a CIC has reached the threshold requiring registration.
This remains to be a concern. |
| Enhancing off-site surveillance and on-site supervision over CICs | ||
| There is no prescription for submission of off-site returns or Statutory Auditors Certificate (SAC) for CICs | Offsite returns may be designed by the RBI and prescribed for the CICs on the lines of other NBFCs. These returns may inter alia include periodic reporting (e.g. six monthly) of disclosures relating to leverage at the CIC and group level.
A CIC may also be required to disclose to RBI all events or information with respect to its subsidiaries which are material for the CIC. Annual submission of Statutory Auditors Certificates may also be mandated. Onsite inspection of the CICs may be conducted periodically. |
The reporting requirements may help in monitoring the activities of the CICs and developing a database on the structures of the conglomerates, of which, the CIC is a part. This may assist in identification of unregulated entities in the group.
|
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Our write-ups relating to NBFCs can be viewed here: http://vinodkothari.com/nbfcs/
Liquidity Risk Framework: A snapshot
/0 Comments/in Financial Services, NBFCs, RBI, UPDATES /by Vinod Kothari ConsultantsLiquidity Risk Management Framework- Snapshot
/0 Comments/in Financial Services, NBFCs, RBI, UPDATES /by Vinod Kothari ConsultantsApplicability
- Non-deposit taking NBFCs with asset size of Rs.100 crore and above
- Systemically important Core Investment Companies
- Deposit taking NBFCs irrespective of their asset size
All other NBFCs are also encouraged to adopt these guidelines on liquidity risk management on voluntary basis
Exclusion:
- Type 1 NBFC-NDs- NBFC-ND not accepting public funds/ not intending to accept public funds in the future andnot having customer interface/ not intending to have customer interface in the future
- Non-Operating Financial Holding Companies and Standalone Primary Dealers
Action to be taken:
The Board of Directors must revise the existing ALM policy or adopt a new LRM Framework to put in place internal monitoring mechanism for the following:
- Adopt liquidity risk monitoring tools/metrics to cover
- concentration of funding by significant counterparty/ instrument/ currency[1],
- availability of unencumbered assets that can be used as collateral for raising funds; and,
- certain early warning market-based indicators, such as, book-to-equity ratio, coupon on debts raised, breaches and regulatory penalties for breaches in regulatory liquidity requirement.
- The Board / committee set up for the purpose shall monitor on a monthly basis, the movements in their book-to-equity ratio for listed NBFCs and the coupon at which long-term and short-term debts are raised by them. This also includes information on breach/penalty in respect of regulatory liquidity requirements, if any.
- Monitor liquidity risk based on a “stock” approach to liquidity
- Board to set predefined internal limits for various critical ratios pertaining to liquidity risk.
- Indicative liquidity ratios are
- short-term liability to total assets;
- short-term liability to long-term assets;
- commercial papers to total assets;
- non-convertible debentures (NCDs) (original maturity less than one year) to total assets;
- short-term liabilities to total liabilities; long-term assets to total assets.
- Put in place process for identifying, measuring, monitoring and controlling liquidity risk.
- It should clearly articulate a liquidity risk tolerance that is appropriate for its business strategy and its role in the financial system
- Senior management should develop the strategy to manage liquidity risk in accordance with such risk tolerance and ensure that the NBFC maintains sufficient liquidity
- Develop a process to quantify liquidity costs and benefits so that the same may be incorporated in the internal product pricing, performance measurement and new product approval process for all material business lines, products and activities.
- Conduct stress tests on a regular basis for a variety of short-term and protracted NBFC-specific and market-wide stress scenarios (individually and in combination)
- Ensure that an independent party regularly reviews and evaluates the various components of the NBFC’s liquidity risk management process
Revision in the existing ALM framework to incorporate granular buckets
As per the existing norms, the mismatches (negative gap) during 1-30/31 days in normal course shall not exceed 15% of the cash outflows in this time bucket. Pursuant to the revised framework, the 1-30 day time bucket in the Statement of Structural Liquidity is segregated into granular buckets of 1-7 days, 8-14 days, and 15-30 days. The net cumulative negative mismatches in the maturity buckets of 1-7 days, 8-14 days, and 15-30 days shall not exceed 10%, 10% and 20% of the cumulative cash outflows in the respective time buckets.
Revision in interest rate sensitivity statement
Granularity in the time buckets would also be applicable to the interest rate sensitivity statement required to be submitted by NBFCs.
Composition of Risk Management Committee
The Risk Management Committee, which reports to the Board and consisting of Chief Executive Officer (CEO)/ Managing Director and heads of various risk verticals shall be responsible for evaluating the overall risks faced by the NBFC including liquidity risk.
Asset Liability Management (ALM) Support Group
The existing Management Committee of the Board or any other Specific Committee constituted by the Board to oversee the implementation of the system and review its functioning periodically shall be substituted with ALM Support Group. It shall consist of operating staff who shall be responsible for analysing, monitoring and reporting the liquidity risk profile to the ALCO. Such support groups will be constituted depending on the size and complexity of liquidity risk management in an NBFC.
Public Disclosure
To enable market participants to make an informed judgment about the soundness of its liquidity risk management framework and liquidity position-
- Disclose information in the format provided under Appendix I, on a quarterly basis on the official website of the company and
- In the annual financial statement as notes to account
Responsibility of Group CFO
The Group Chief Financial officer (CFO) shall develop and maintain liquidity management processes and funding programmes that are consistent with the complexity, risk profile, and scope of operations of the ‘companies in the Group’- as defined in the Master Directions.
MIS System
Put in place a reliable MIS designed to provide timely and forward-looking information on the liquidity position of the NBFC and the Group to the Board and ALCO, both under normal and stress situations.
Liquidity Coverage Ratio- Snapshot
Applicability:
- Non-deposit taking NBFCs with asset size of Rs.5,000 crore and above,
- Deposit taking NBFCs irrespective of their asset size
Exclusion:
- Core Investment Companies,
- Type 1 NBFC-NDs,
- Non-Operating Financial Holding Companies and Standalone Primary Dealer
Computation:
Liquidity Coverage Ratio (LCR) is represented by the following ratio:
Stock of High Quality Liquid Assets (HQLA)/ Total net cash outflows over the next 30 calendar days
Here, “High Quality Liquid Assets (HQLA)” means liquid assets that can be readily sold or immediately converted into cash at little or no loss of value or used as collateral to obtain funds in a range of stress scenarios.
Timeline:
Effective date of implementation of the LCR norm is December 01, 2020, as per the timeline mentioned herein below. The LCR shall continue to be minimum 100% (i.e., the stock of HQLA shall at least equal total net cash outflows) on an ongoing basis with effect from December 1, 2024, i.e., at the end of the phase-in period.
- For non-deposit taking systemically important NBFCs with asset size of Rs.10,000 crore and above and all deposit taking NBFCs irrespective of the asset size, LCR to be maintained as per the following timeline:
| From | December 01, 2020 | December 01, 2021 | December 01, 2022 | December 01, 2023 | December 01, 2024 |
| Minimum LCR | 50% | 60% | 70% | 85% | 100% |
- For non-deposit taking NBFCs with asset size of Rs. 5,000 crore and above but less than Rs. 10,000 crore, the required level of LCR to be maintained, as per the time-line given below:
| From | December 01, 2020 | December 01, 2021 | December 01, 2022 | December 01, 2023 | December 01, 2024 |
| Minimum LCR | 30% | 50% | 6
0% |
85% | 100% |
Disclosure Requirements:
NBFCs shall be required to disclose information on their LCR every quarter. Further, 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.
[1] A “Significant counterparty” is defined as a single counterparty or group of connected or affiliated counterparties accounting in aggregate for more than 1% of the NBFC-NDSI’s, NBFC-Ds total liabilities and 10% for other non-deposit taking NBFCs
A “significant instrument/product” is defined as a single instrument/product of group of similar instruments/products which in aggregate amount to more than 1% of the NBFC-NDSI’s, NBFC-Ds total liabilities and 10% for other non-deposit taking NBFCs.
Our other related write-ups:
FAQs on Commercial Paper
/0 Comments/in Capital Markets, Companies Act 2013, Corporate Laws, RBI, SEBI /by Vinod Kothari Consultants
STEERING COMMITTEE REPORT ON DIGITAL LENDING: ISSUES AND SOLUTIONS
/0 Comments/in Financial Services, Fintechs and Payment and Settlement Systems, NBFCs, RBI /by Vinod Kothari Consultants– Richa Saraf (legal@vinodkothari.com)
The Department of Economic Affairs has recently shared the report of the Steering Committee[1] which discusses the various issues faced by fintech companies. This write up tries to focus on the issues in relation to online lending, and the recommendations given by the Steering Committee on the same.
Verifying the Authenticity of User:
RBI already provides for guidelines pertaining to Know Your Customer (KYC), specifying Originally Seen and Verified (OSV) norms, laying down conditions for non-face to face KYC, and in fact the e- KYC process was simplified with the advent of Aadhaar. However, the Aadhaar verdict by the Apex Court has adversely affected the fintech industry, and the Steering Committee has observed that there is need to explore alternatives for physical KYC. The following are the key recommendations in this regard:
- Offline Authentication Process: These days smartphones are equipped with biometric enabled multi-factor authentication, therefore, technology may be put to use for the purpose of KYC and authentication of the user. Some fintech companies have already come up with various unconventional mode of KYC, such as video based KYC, obtaining validated electronic versions of KYC related documents through DigiLocker, etc., as an additional layer of protection, authentication of the user can also be done by sending an OTP at the registered mobile number of the user, or by using geo location, which indicates the IP address of the user. The Committee has also recognised some of these options in its Discussion Paper, provided the same is subject to prior customer consent.
- Central Data Registry: In the light of representations made by various stakeholders, the Committee has expressed that e-KYC has the potential to reduce customer on-boarding and servicing costs significantly, and has, therefore, recommended that all financial sector regulators fix deadlines for on boarding existing KYC data to the Central KYC registry, making KYC a complete digital and paperless process.
- Other non- traditional way of data exchange: The Discussion Paper also mentions about the usage of the Application Programme Interface (API), for facilitating real time information sharing; India Stack[2] being one such API, where digital records move with an individual’s digital identity, eliminating the need for massive amount of paper collection and storage.
Determination of Borrower’s creditworthiness:
The Steering Committee has noted how the poor and the unbanked are often unable to access credit due to the lack of formal credit history and/ or non-availability of significant information/ document. The following are the key recommendations in this regard:
- Data sharing in the finance industry: The Committee believes that APIs must be used for cloud storing of data, and the same should be open, to ensure equal access to all those who wish to build on or rely on this data. For instance, an India Agri Stack can be built, such that lenders can evaluate the creditworthiness of agricultural borrowers. This stack can include a farmer’s borrowing history, land ownership data, income data, among other information. Additional APIs to facilitate research and the creation of applications may include: Government departments and local government bodies unified stack; land registry and state land records; ownership/fitness/loan/mortgage/enforcement records to provide transparency to transactions; and so on. Further, India MSME Stack may be built for MSME financing related data.
- Digitisation of land records: The Digital India- Land Records Modernisation Program[3] is aimed at national integration of all land related data across the country in order to provide conclusive titles, including details such as characteristics of the land, mortgages, encumbrances, ownership and other rights, etc., enabling financial services companies to make informed decisions about lending.
- Reliance on Informal Modes: Fintech companies are using a variety of sources for collecting customer information and advanced data analytics to access customer credibility, for instance obtaining data from social media usage, web browser history, financial transaction behaviour, product purchase behaviour, etc. from the mobile phones of prospective borrowers. Some companies are also resorting to psychometric tests to build the customer’s profile.
For agri- loans specifically, to access the credit score of a borrower, it is suggested that companies use permutation and combination of the alternate data which may be available, such as weather forecasts and records, agronomic surveys, accessing the demographic, geographic, financial and social information of the customer, farmer progressiveness and such like. Referring to a Chinese agricultural fintech company Nongfenqi, which generates credit scores on the basis of interaction with customers’ business partners, fellow customers and villagers, the Committee has observed that the default rate in such model is merely 0.1%. In order to increase access to credit and to stabilise the growth of such practices, the Committee has recommended that Ministry of Economics and Information Technology (MEITY) and TRAI to formulate a policy to enable such practices through a formal, consent-based mechanism.
- Usage of Artificial Intelligence (AI): AIs afford an opportunity to gain insight into customer behaviour pattern, thereby aiding in determination of their creditworthiness. Equifax[4] is one credit information agency, which gives potential lenders an overall insight on the borrower’s credit health through Neuro Decision Technology. It claims to predict the likelihood of a business incurring severe delinquency, charge-off or bankruptcy on financial accounts within the next 12 months. Vantage Score Solution[5], which claims to predict the likelihood of the borrower repaying the borrowed money, also used AI to develop a model for people with thinner credit profiles.
The Steering Committee has also recognised AI for modernising the credit scoring methodology and approach.
Execution of agreements online:
Fintech entities have been vigorously using e- mode for entering into transactions; for instance, providing app- based loan, on a click. While one may contend that click- wrap agreements are prone to fraud, since the user is not known, and thus, cannot be relied upon, such may the case in any mode of execution. Most of the time in litigations, it is not uncommon for parties to challenge the authenticity of agreement, claiming that the acceptance by mail was not sent by him, that the signature is forged, etc. While physical signatures may be examined by way of forensic, it is difficult to verify whether a click- wrap agreement was actually entered into by the parties or was a mere mistake on the part of either of the parties.
While e-agreements are generally held as valid and enforceable in the courts, for high stake transactions, parties have apprehensions on the enforceability in case of default of loan or non- compliance of any of the terms, and therefore, they still insist on wet signatures on physical agreements. The Steering Committee has discussed about re-engineering of legal processes for the digital world. The Committee suggests that insistence on wet signatures on physical loan agreements be replaced by paperless legal alternatives, as these can enable cutting costs and time in access to finance, repayment, recovery, etc., for businesses and financial service companies. To achieve the goal of paperless economy also the requirement of physical loan agreements are unwanted. The Committee has, therefore, recommended that the Department of Legal Affairs should review all such legal processes that have a bearing on financial services and consider amendments permitting digital alternatives in cases such as power-of-attorney, trust deeds, wills, negotiable instrument, other than a cheque, any other testamentary disposition, any contract for the sale or conveyance of immovable property or any interest in such property, etc., (where IT Act is not applicable), compatible with electronic service delivery by financial service providers.
Other recommendations w.r.t. lending industry:
(a) Enhancing competition by way of referral pool:
The Committee recommends that all financial sector regulators may study the potential of open data access among their respective regulated entities, for enabling competition in the provision of financial services; RBI may encourage banks to make available databases of rejected credit applications available on a consent-basis to a neutral marketplace of alternate lenders. In line with the Open Data Regulations in the UK banking sector, the Committee further recommends that RBI may consider making available bank data (such as transaction and account history data) to fintech firms through APIs.
(b) Data privacy risks:
The Committee notes that the data sharing between entities is also subject to privacy laws, and while the Ministry of Science and Technology has already formulated the National Data Sharing and Accessibility Policy[6], and MEITY is the nodal Ministry to implement the policy, the same needs wider acceptance and implementation. The Committee has further recommended that a taskforce in the Ministry of Finance may be set up with the participation of the regulators and suitable recommendations may be made to safeguard the interests of consumers.
The Committee has expressed that the provisions of the Data Protection Bill, 2018[7] may have far-reaching implications on the growth of fintech sector, and has therefore, recommended that regulators should urgently review the existing regulatory framework with respect to data protection and privacy concerns, in keeping with emerging data privacy legislation in India.
[1]https://dea.gov.in/sites/default/files/Report%20of%20the%20Steering%20Committee%20on%20Fintech_2.pdf
[4] https://www.equifax.co.in/
[5] https://www.vantagescore.com/
[6] https://dst.gov.in/sites/default/files/nsdi_gazette_0.pdf
[7] https://meity.gov.in/writereaddata/files/Personal_Data_Protection_Bill,2018.pdf
Our related write-ups can be viewed here:
Please find below the link for other write-ups relating to Fintechs.
http://vinodkothari.com/category/financial-services/fintech/
Personal revolving lines of credit by NBFCs: nuances and issues
/1 Comment/in Financial Services, Fintechs and Payment and Settlement Systems, NBFCs, RBI /by Vinod Kothari ConsultantsBy Kanakprabha Jethani | Executive
Vinod Kothari Consultants P. Ltd.
Personal loans by NBFCs are mostly extended as revolving lines of credit. Most of these facilities are originated by use of online apps. The lender will be quite keen, if there were no regulatory obstacles, to provide this line of credit by way of a credit card, or virtual credit card. However, there are regulatory barriers to NBFCs issuing credit cards. Therefore, NBFCs end up giving revolving lines of credit. However, the lurking issue is – if a credit card is also an instance of a revolving line of credit, is revolving line of credit an alternative to a card or virtual card, and if so, are there regulatory issues in NBFCs giving personal revolving lines of credit?
The issue is not whether the credit is personal, or for business purposes, for instance, a working capital line of credit. There is a general notion that NBFCs cannot extend working capital lines of credit, while they may give working capital loans.
It is important to examine this issue at length – as is done in this article.
Revolving line of credit: explained
A revolving line of credit is a mode of lending wherein the lender agrees to lend an amount equal to or less than a pre-determined credit limit, as approved for the borrower. The parameters for fixing the limit may be the credit appraisal of the borrower, or, as in case of working capital, the asset liability gap. The borrower may continue to use the line of credit – he may keep repaying, in which case the drawn amount comes down, and then he may re-draw, when the drawn amount goes up. The credit limit gets restored on repayment being made by the borrower. Such line of credit maybe secured or unsecured, depending on the agreement between lender and the borrower. The line of credit is essentially governed by the agreement between the parties. The term “revolving” does not imply that the line of credit is not subject to a review, or repayment. Each line of credit has a review period. If the lender decides not to revolve the line of credit, then the line of credit becomes a term loan, and has to be paid down as per the terms of agreement between the lender and the borrower.
For certain types of facilities, a revolving line of credit is aptly suitable. While, in case of businesses, working capital is best financed by a line of credit, in case of personal finance also, the ability to draw based on a line of credit extends the finances of the borrower, and allows him the flexibility to tap into the funding when needed, and pay it off when not needed. There is, of course, a standing commitment on the part of the lender to provide the facility amount the amount of the limit, for which lenders may charge a continuing commitment charge.
A line of credit implies a commitment to disburse. To the extent of the amount already disbursed, there is a funded facility. To the extent of the limit sanctioned but not yet availed, there is an unfunded commitment to disburse. Undisbursed or partly disbursed loans are common in case of term loans as well – for example, a home loan may take a substantial time to get disbursed.
Similarities between a credit card and revolving line of credit
A credit card is a payment card which the borrower may use for making payments at point of sale. The lender makes payment on behalf of the borrower and then recovers the same from the borrower. A detailed explanation of features of credit cards maybe referred to in one of our write-ups[1].
A revolving line of credit shares some of its features with a credit card, due to which they are seen as equivalents. The similarities between both the modes are as follows:
- Borrowers can take the disbursement as and when needed.
- The lender, in both cases, always reserves the right to reduce the credit limit.
- The lender has to maintain optimum amount of working capital to meet the disbursement demands of the borrowers.
- The credit limit is restored on repayment being made.
Disparity between credit card and revolving line of credit
Based on usual practice of the market, the following are the key points:
- Security: A revolving line of credit maybe secured or unsecured, whereas, a credit card is always unsecured.
- End-use restrictions: There are no restrictions on end use of funds in case of a credit card. However, in a line of credit, the end use is restricted by mentioning the purpose for availing the loan in the loan agreement. Of course, the purpose may be generic – for example, personal use or general business use.
- Restriction w.r.t. withdrawal of fund: A revolving line of credit does not require a purchase to be made in order to get the funds disbursed. It allows money to be transferred into bank account for any reason without requiring an actual transaction. Whereas, in case of a credit card, payments can be made at Point of Sale (PoS) only and thus, it requires an actual transaction for the disbursement to be made..
- Interest Period: In case of credit card, if repayment is made within a specified term, no interest is usually charged. However, after the specified period, a high rate of interest is charged. While on the other hand, in case of a revolving line of credit, the interest is calculated from the day of disbursement being made at a comparatively lower rate.
- Credit Limit: As a market practice, revolving line of credit maybe availed for business purposes or personal purposes and thus, has higher credit limits as compared to a credit card which is generally used for personal purposes only.
- Manner of Repayment: In case of credit card, funds once availed have to be repaid within a specified period of time, in lump sum. On the other hand, when credit is availed from a revolving line of credit, the same is repaid by the borrower in instalments.
- Risks: Credit cards come with the risk of theft, misuse etc. However, the same maybe done away with, in case of virtual credit cards.
The fundamental difference
The abovementioned differences are, in essence, surficial. They are based on practices of the market, which may easily be reshaped suiting the needs of the parties. What is the key difference between a card, virtual card and a revolving line of credit?
A logical difference that one finds is that while in case of a credit card, the borrower uses it to make payments to third parties, in case of a revolving line of credit, the disbursements are made to the account of the borrower from where the borrower may use it for the required purpose. A credit card is an instrument: it can be used to settle payments, and therefore, becomes a part of the payment and settlement system. A straight line of credit may be tapped by the borrower. After tapping the line, the borrower may use it for making payments and settlements. But the line of credit itself is not an instrument of settling payments.
Therefore, fundamentally, while a revolving line of credit is a promise by lender to the borrower, a credit card is a promise by the lender to the world at large. A lender in case of a line of credit is obliged to make disbursement to the borrower, and only the borrower has a recourse against the lender. However, in case of issue of credit cards, the issuer or the lender is obliged to make payments to any authorized merchant who supplies goods and services against the card.
Understanding Promise to the World at Large
A credit card is a mode of payment. It is a part of the payments and settlement system. Usually, when a customer swipes the credit card at merchant point of sales (POS), the issuer’s liability to make payment to the customer comes into existence. The cardholder is absolved from the liability to the merchant and becomes liable to the issuer.
Settlements in case of a credit card may be understood as follows:
Settlement 1: Merchant and issuer
Settlement 2: Issuer and cardholder
In settlement 1, the time of settlement depends on the specifics of the card network, that is to say, the issuer shall make payment for the goods after a few days, based on the settlement cycle. In effect, at the time of sale, the merchant has not received any payment but has given the goods to the customer based on the strength of credit given by the credit card issuer.
What if the revolving line of credit gives an option to the customer at the merchant POS? Would that amount to a promise to the world at large?
The answer to this question lies in the nitty-gritty of the structure. How would the payment be made to the merchant? Would it result in creation of a relationship between the lender and the merchant?
Lets us assume a revolving line of credit with an option to use the disbursement at merchant POS. Note here that it is the option to use the ‘disbursement’- hence, the settlement takes place as follows:
Settlement 1: Lender disburses loan to the customer’s account/wallet
Settlement 2: Customer makes payment to the merchant
There is no creation of a relationship between the card issuer and the merchant. Post-disbursement, the customer will be liable to repay to the lender.
The thin line of difference between the two concepts lies in the manner of creation of relationships between the parties. The same is highlighted from the above discussion.
The burning question- Can NBFCs extend a revolving line of credit?
Logical answer
The distinction between a revolving line of credit and credit card has already been highlighted above. Further, it is also quite evident from the above discussion that a credit card has wider risks than that of a revolving line of credit. In case of a revolving line of credit, the failure on the part of the lender to disburse the sanctioned amount impacts the borrower. However, if a card issuer defaults, it may affect all those merchants who might have used the card to supply goods and services. There may be a contagion impact, and therefore, the failure of a card issuer has systemic implications. Thus, capital adequacy, solvency and liquidity are far greater issues for a card issuer, than in case of a plain lender against revolving line of credit.
The above discussion leads one to conclude that there are no specific concerns in case of granting of a revolving line of credit. The only concern may be the exposure on account of the sanctioned but undisbursed amount, for which off-balance sheet credit conversion factors exist.
Regulatory support
The above logic may further be supported by the provisions of the Prudential Framework for Resolution of Stressed Assets[2], wherein the Reserve Bank of India (RBI) has recognized the practice of extending revolving line of credit by NBFCs. Following is the relevant extract from the said framework which is applicable on Scheduled Commercial Banks (excluding RRBs), All India Term Financial Institutions, Small Finance Banks, Deposit taking NBFCs and Systemically Important NBFCs (‘NBFC-SI’):
In the case of revolving credit facilities like cash credit, the SMA sub-categories will be as follows:
| SMA Sub-categories | Basis for classification – Outstanding balance remains continuously in excess of the sanctioned limit or drawing power, whichever is lower, for a period of: |
| SMA-1 | 31-60 days |
| SMA-2 | 61-90 days |
So, firstly there are no express restrictions on extending revolving line of credit and secondly, the RBI recognizes such credit in its frameworks. Therefore, it is safe to take this recognition as a provenance to allowability of extending revolving line of credit by NBFCs.
Further, the provisions relating to restructuring of accounts of borrowers by NBFCs as per the Master Directions also recognize extension of revolving cash credit. It recognizes that roll-over of short-term loans based on actual requirement of borrower and not as a concession considering the credit weakness of the borrower, shall not be considered as restructuring of accounts. For-this purpose, short-term loans shall not include properly assessed regular Working Capital Loans like revolving Cash Credit or Working Capital Demand Loans. The relevant extract is as follows:
“In the cases of roll-over of short-term loans, where proper pre-sanction assessment has been made, and the roll-over is allowed based on the actual requirement of the borrower and no concession has been provided due to credit weakness of the borrower, then these shall not be considered as restructured accounts.
**
Further, Short Term Loans for the purpose of this provision do not include properly assessed regular Working Capital Loans like revolving Cash Credit or Working Capital Demand Loans.”
Concerns on maintenance of capital
In case of line of credit, the disbursements are to be made as and when the borrower requires, therefore, the NBFC should maintain adequate capital and liquidity to meet such abrupt demands. The RBI Master Directions take care of the solvency concerns of the NBFCs extending revolving line of credit. Liquidity standards, internally set by the NBFC under the ALM process, also contain safeguards by taking the undisbursed amount of committed facilities as “required funding”.
The Master Directions for NBFC-SI[3] requires the NBFC-SIs to maintain a Capital to Risk Assets Ratio (CRAR) of 15%. It provides the detailed methodology of how the risk-weighting of assets is to be done to meet the CRAR requirement.
Following is the extract from the said methodology:
| Instrument | Credit Conversion Factor |
| Other commitments (e.g., formal standby facilities and credit lines) with an original maturity of:
up to one year over one year |
20 50 |
| Similar commitments that are unconditionally cancellable at any time by the applicable NBFC without prior notice or that effectively provide for automatic cancellation due to deterioration in a borrower’s credit worthiness |
0 |
Thus, depending on the terms of the revolving line of credit, a credit conversion factor will be multiplied to the total amount of obligation and the capital will be maintained accordingly.
Further, the Master Directions for Non-Systemically Important NBFCs (NBFC-NSIs)[4] require the NBFC-NSIs to maintain a leverage ratio of 7. Leverage Ratio shall mean Total outside Liabilities/ Owned Funds.
The definition of Total Outside Liabilities can be derived from Master Directions for Core Investments Companies (CICs)[5] which is as follows:
“outside liabilities” means total liabilities as appearing on the liabilities side of the balance sheet excluding ‘paid up capital’ and ‘reserves and surplus’, instruments compulsorily convertible into equity shares within a period not exceeding 10 years from the date of issue but including all forms of debt and obligations having the characteristics of debt, whether created by issue of hybrid instruments or otherwise, and value of guarantees issued, whether appearing on the balance sheet or not.”
Due to the leverage restriction, NBFC-NSIs shall also automatically be restricted from lending more than its capacity.
Nuts and bolts to the structure of revolving line of credit
From the above discussion, it is clear that NBFCs may extend revolving line of credit. However, from the prudence perspective, following are certain essentials that must be kept in mind by the NBFCs while extending a revolving line of credit:
- It is advisable for the lender to retain the right to unconditionally cancel the commitment of revolving line of credit. In such case, the credit conversion factor for such exposure shall be “0”.
- The terms of the line of credit must provide for review and reset as the lender may deem fit.
- The lender must ensure that it maintains liquidity to meet abrupt calls for disbursement by the borrower.
- In case the tenure of revolving line of credit is pre-determined, the credit conversion factor shall accordingly be taken as 20 or 50.
Conclusion
Though there are similarities between features of a credit card and a revolving line of credit, but the differences are not skin-deep. Further, it may also be argued that the RBI Master Directions recognize NBFCs extending line of credit, by providing expressly for prudential framework for SMA classification for revolving line of credit.
[1] http://vinodkothari.com/2018/07/credit-cards-and-emi-cards-from-an-nbfc-viewpoint/
[2] https://www.rbi.org.in/Scripts/NotificationUser.aspx?Id=11580&Mode=0
[3]https://rbidocs.rbi.org.in/rdocs/notification/PDFs/45MD01092016B52D6E12D49F411DB63F67F2344A4E09.PDF
[4] https://rbidocs.rbi.org.in/rdocs/notification/PDFs/MD44NSIND2E910DD1FBBB471D8CB2E6F4F424F8FF.PDF
[5] https://rbidocs.rbi.org.in/rdocs/notification/PDFs/39MD440D125D51C2451295A5CA7D45EF09B9.PDF