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RBI Guidelines at odds with the Companies Act on appointment of Auditor

A comparative analysis between the Companies Act, SEBI Guidelines and SEBI Circular dated 18th Oct. 2019

– Ajay Kumar K V | Manager (corplaw@vinodkothari.com)

Introduction

The Reserve Bank of India has issued Guidelines[1] for Appointment of Statutory Central Auditors (SCAs)/Statutory Auditors (SAs) of Commercial Banks (excluding RRBs), UCBs and NBFCs (including HFCs) under Section 30(1A) of the Banking Regulation Act, 1949, Section 10(1) of the Banking Companies (Acquisition and Transfer of Undertakings) Act, 1970/1980 and Section 41(1) of SBI Act, 1955; and under provisions of Chapter IIIB of RBI Act, 1934 for NBFCs, on 27th April 2021.

The Guidelines provide for appointment of SCAs/SAs, the number of auditors, their eligibility criteria, tenure and rotation as well as norms for ensuring the independence of auditors.

However certain provisions of these Guidelines are either completely different or stringent as compared to the provisions of the Companies Act, 2013 (Act). Further, in case of listed entities the question would arise whether the SEBI circular CIR/CFD/CMD1/114/2019[2] dated 18th October 2019 shall be applicable, where the existing auditor is ineligible to continue as the auditor of the company and a new auditor is to be appointed.

In this write up, we have discussed the requirements under both RBI Guidelines as well as the Act.

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Various forms of Secured Lending

-Anita Baid, anita@vinodkothari.com

In this era of ever-increasing demand and continuous urge for developments, limitation of financial resources come as the biggest constraint in overall satisfaction of an individual or entity’s needs. Financial or funding options provided by various financial institutions such as banks and NBFCs come as a solution to such financial constraints. Loans from such financial institutions can be availed depending upon one’s immediate requirement and repayment capacity.

From the consumer’s perspective, funding is granted and resource constraint is sort out. However, there is always a fear of default in repayment of loans faced by the lenders. Thus, the position of the lender becomes ambiguous and unsafe in granting such loans. Here, comes the concept of secured financing. Secured financing is one in which the lender has security rights over certain collateral that the borrower makes available to support the loan. The borrower agrees that should he not repay the loan as agreed, the lender has a right to seize the collateral to satisfy the debt.

There are various instruments offered under secured financing depending upon the collateral the borrower is willing to provide. Some of the commonly used instruments have been discussed herein this article[1].

Loan Against Property (LAP)

A loan against property is a loan given or disbursed against the mortgage of a property. LAP belongs to the secured loan category where the credit evaluation of the borrower is done keeping his property as a security. The property can be commercial or residential.[2]

Immovable property being one of the most non-volatile security is mortgaged with the financial institution for obtaining required funds. Borrowers willing to purchase a residential/commercial property can obtain loan by keeping such desired property as the underlying security. The underlying security can be the property for which loan is being taken and/or a separate property as well. The loan is given as a certain percentage of the property’s market value, usually around 40% to 60%.

Here the loan is granted based on the quality of the collateral and less importance is given to the credit quality of the borrowers. Also, usually, these loans do not come with any end use restriction, that is to say, the borrowers get a free hand with respect to utilization of funds.

Loan Against Securities (LAS)

A loan against securities (LAS) is a loan given against the collateral of shares or securities. LAS enables one to borrow funds against listed securities such as shares, mutual funds, insurance and bonds to meet current financial needs. Borrowers can opt for this loan when they need instant liquidity for their personal/business needs and are sure to pay it back in few months.

There are however, specific regulations issued by RBI with respect to loan against shares of listed entities,

As per the [3]Master Directions applicable on NBFC-NSI-ND issued by RBI, NBFCs with asset size of Rs.100 crore and above who are lending against the collateral of listed shares shall, maintain a Loan to Value (LTV) ratio of 50% for loans granted against the collateral of shares. Additionally, for LAS in case where lending is being done for investment in capital markets, only Group 1 securities (specified in SMD/ Policy/ Cir – 9/ 2003 dated March 11, 2003 as amended from time to time, issued by SEBI) shall be accepted as collateral for loans of value more than Rs5 lakh, subject to review by the Bank. The lender shall also be required to report on-line to stock exchanges on a quarterly basis, information on the shares pledged in their favour, by borrowers for availing loans in the prescribed format.

Difference between LAP and LAS

The underlying security for LAP and Las is different which is prevalent from the respective names itself. Apart from this major difference there are other areas of difference between the two as well. The basic differences between the two are highlighted hereunder:

 

Features Loan against securities Loan against property
Nature of facility A loan against securities (LAS) is a loan given against the collateral of shares or securities. A loan against property (LAP) is a loan given or disbursed against the mortgage of a property.
Exposure In case of LAS the exposure is based on the value of securities In case of LAP it is based on the value of property.
Volatility The value of securities, in case it is listed shall fluctuate very frequently and hence the value of security is very volatile. The value of property is less volatile as compared to LAS.
Type of security The shares or securities can either be listed or unlisted. The property can either be movable or immovable.
End use Usually the end use of the facility extended is for investment in the securities. There is no end use restriction in case of LAP.
Regulations from RBI As per the Master Directions applicable on NBFC-NSI-ND issued by RBI, all Applicable NBFC with asset size of Rs.100 crore and above who are lending against the collateral of listed shares shall, maintain a Loan to Value (LTV) ratio of 50% for loans granted against the collateral of shares. No specific regulatory guideline has been prescribed regarding LTV ratio for granting loan against property by an NBFC.

 

 

LTV Ratio Further, as per the statutory provision, if the value of listed securities falls down thereby increasing the LTV ratio, additional security must be provided to maintain such LTV ratio. The Applicable NBFC must ensure that any shortfall in the maintenance of 50% LTV occurring on account of movement in the share prices is to be made good within 7 working days. In case of LAP, such reinstating is not statutory. However, the lender may revise the sanctioned limit in case the loan agreement provides for such discretionary right to the lender.

 

Statutory Requirement Additionally, for LAS in case where lending is being done for investment in capital markets, only Group 1 securities (specified in SMD/ Policy/ Cir – 9/ 2003 dated March 11, 2003 as amended from time to time, issued by SEBI) shall be accepted as collateral for loans of value more than Rs5 lakh, subject to review by the Bank. The lender shall also be required to report on-line to stock exchanges on a quarterly basis, information on the shares pledged in their favour, by borrowers for availing loans in the prescribed format. No such regulatory requirement.

 

IPO Funding

IPO or Initial Public Offer is a rewarding experience for individuals and companies as it offers substantial return to investors on the shares subscribed by them. However, it may so happen that an investor might not possess the requisite funds to subscribe to IPOs. In such a situation, inflow of funds from another source may become necessary. Here comes the concept of IPO funding which bridges the deficit between the resources at hand and the funds needed in aggregate. The lender creates a right of lien on the shares to be allotted to the investor/borrower in the IPO. This shall form the underlying security against the loan which can be liquidated in case of non-payment of principle and/or interest.[4]

Similar to LAS, IPO Financing is loan against acquiring shares and making a short-term profit that is expected at the time of initial price discovery of the shares once the shares are listed. However, unlike LAS, it is specifically for funding subscriptions to IPOs. In case of an IPO Financing, the exposure is based on the borrower and the securities/ shares, if allotted, are taken as collateral for securing the obligations under the loan. The transaction forces the applicant to sell the shares once listed, hence, the idea cannot be to finance an investment in shares.

The financial institution demands for an upfront payment of the margin amount based on the assessment of subscription levels. For example, if an investor applies for 100 shares and gets allotted only 10 shares due to oversubscription, the refund on 90 shares is divided between the borrower and lender proportionately. The shares allotted are held as lien by the lender.

Recently, the RBI had released a Discussion Paper on the Revised Regulatory Framework for NBFCs on 22nd January, 2021[5], wherein it has been proposed to fix a ceiling of Rs. 1 crore per individual in case of IPO financing by any NBFC.

Equipment Finance

Equipment financing is yet another type of secured financing wherein loan is given for purchase of commercial or office equipment. The underlying asset is the equipment for which loan is advanced and/or any other equipment. The loan is secured by way of a hypothecation over the equipment financed. For efficient and smooth functioning of various units of a commercial enterprise, existence of upgraded machinery is of utmost importance. Such acquisitions may require additional funds from external sources. Hence, equipment finance helps in improving the overall production levels.

Working Capital

Fulfilment of working capital requirements is perhaps the most integral responsibility of a company. Adequate working capital is needed to meet the day-to-day activities of an enterprise and enable it to function smoothly. Financing options for meeting working capital limits is also available. Loan is given for maintaining such working capital by placing a floating charge on the assets of the company. No fixed asset is kept aside as the underlying security. In case of any default, an asset of sufficient value shall be a seized and liquidated to meet the default.

Here, it is important to understand the difference between LAS or LAP and a regular secured working capital loan. For instance, in case of LAS or LAP the exposure is based on the value of securities or the property, as the case may be, and not on the borrower. Whereas, in case of a secured loan the exposure is based on the borrower and the securities or property are taken as collateral for securing the obligations under the loan. Such a secured loan shall not be classified as LAS or LAP and hence maintaining the prescribed regulatory LTV ratio will also not be applicable in this case.

At a Glance

 

Features

LAP LAS IPO Funding Equipment Financing Working Capital Financing
Nature of facility Loan disbursed against the collateral of property Loan disbursed against the collateral of shares Loan extended for investing in IPO Loan advanced for purchase of equipment against the collateral of the same and/or any other equipment Loan advanced for meeting working capital requirements and accordingly a floating charge is created
Nature of security Property Shares Shares subscribed in IPO Equipment Floating charge on the assets.
Exposure Property Shares Investor Borrower Borrower
Volatility Very less Volatile Volatile Less volatile Less volatile
Regulatory Framework No specifications but additions can be made in the loan agreement as per discretion As per the Master Directions applicable on NBFC-NSI-ND issued by RBI, all Applicable NBFC with asset size of Rs.100 crore and above who are lending against the collateral of listed shares shall, maintain a Loan to Value (LTV) ratio of 50% for loans granted against the collateral of shares. No specifications but additions can be made in the loan agreement as per discretion No specifications but additions can be made in the loan agreement as per discretion No specifications but additions can be made in the loan agreement as per discretion

Conclusion

Secured financing comes as a relief to both borrowers and lenders. The borrower avails the required funds for meeting its financial or domestic purpose and the lender ensures security against the loan advanced by creating a mortgage or lien on the borrower’s property/shares.

[1] The discussion on the regulatory aspects have been restricted to the regulations applicable to NBFCs only.

[2] Read our article titled- Sitting comfy in the lap of LAP: NBFCs push loans against properties-  http://vinodkothari.com/wp-content/uploads/2017/03/sitting_comfy_in_the_lap_of_LAP.pdf

[3] https://rbidocs.rbi.org.in/rdocs/notification/PDFs/MD44NSIND2E910DD1FBBB471D8CB2E6F4F424F8FF.PDF

[4] http://www.thehindubusinessline.com/opinion/the-risky-game-of-ipo-financing/article9631176.ece

[5] https://rbidocs.rbi.org.in/rdocs/Publications/PDFs/DP220121630D1F9A2A51415B98D92B8CF4A54185.PDF

Restructuring of restructuring: Post 1st April NPAs may be upgraded as Standard under ResFra 2.0

– Anita Baid (anita@vinodktohari.com)

Source: FIDC’s letter to RBI dated June 3, 2021 seeking clarification on clause of Resolution framework – 2.0 relating to Individuals and Small Businesses and disclosures in the balance sheet read along with the RBI response via email dated June 7, 2021. Though called a clarification it actually makes a substantive positive change which is a silent realisation that there is substantial deterioration of performance of loans during the second wave of Covid-19.

The Reserve Bank of India (RBI) had proposed two restructuring frameworks on May 05, 2021- one for individuals and small businesses (‘Notification 31’) and the other one for MSMEs (‘Notification 32’). The intent of both frameworks is to allow restructuring of the loan account in distress due to the second wave of Covid-19.

Pursuant to the restructuring of the eligible loan account (under the respective framework) the standard classification of the assets can be retained. However, there are certain disparities between the two notifications in terms of eligibility criteria, process, etc.

One of the major distinctions is the fact that under Notification 31, there is no relaxation provided to borrowers who have slipped into NPA between the period from March 31, 2021 to the date of invocation. Hence, such loan accounts, which have become NPA from 1st April to the invocation date, irrespective of being restructured in compliance with the provisions of  Notification 31 will continue to be classified as NPA. However, whereby the loan account slipped into NPA classification between the date of invocation and implementation of resolution plan, such account can be upgraded to standard classification as on date of implementation of resolution plan. This position is different in case of MSMEs coming under Notification 32, wherein the borrowers who have slipped into NPA between the period from March 31, 2021, till the date of implementation shall be upgraded to standard.

The aforesaid interpretation was coming clear from the language of para 16 of Notification 31, which states as follows-

  1. If a resolution plan is implemented in adherence to the provisions of this circular, the asset classification of borrowers’ accounts classified as Standard may be retained as such upon implementation, whereas the borrowers’ accounts which may have slipped into NPA between invocation and implementation may be upgraded as Standard, as on the date of implementation of the resolution plan.

As per the language, the asset classification can be retained as standard- this would mean the account which was standard as on the date of implementation has to be retained as standard. However, if the same has degraded to sub-standard category, the upgradation as standard is allowed only if it slipped into NPA between invocation and implementation. Hence, it could be inferred that the slippage before the invocation would not get the relief of upgradation upon restructuring.

This was a huge demotivation of the lenders who intend to restructure the loan accounts under Notification 31. Consequently, representation was made by the Finance Industry Development Council (FIDC) bringing to the notice of RBI that the restructuring notification for individuals and small businesses omits, though maybe unintentionally, to benefit the customers who may have slipped into NPA between April 1 and May 5 as it refers to invocation date and implementation date.

The eligible loan accounts of individuals and small businesses which were standard as on March 31, 2021 can be restructured under Notification 31 if the restructuring is invoked by September 30, 2021. Further, there is a likelihood that such an account may have slipped into NPA between April 1, 2021 till the date of invocation. Though Notification 32  for MSMEs clearly provides for an upgradation to account which might have slipped into NPA from March 1, 2021 till the implementation, however, similar relief was missing from Notification 31.

The RBI has, however, vide an email communication to the FIDC on June 7, 2021, clarified that the loan accounts that may have slipped into NPA between April 1, 2021 and the date of implementation, on the same lines as mentioned in Notification 32 for MSMEs, can be upgraded as standard assets on implementation of the resolution plan.

This would be a relief for not just the borrower but also the lenders who would not hesitate to restructure eligible and potential loan accounts, even if they have turned into NPA by the time the RBI notifications were issued.

Refer to our article on restructuring:

 

Rationalisation of KYC- Measures for relief or technical advancement?

-Kanakprabha Jethani and Anita Baid (finserv@vinodkothari.com)

Background

Considering the resurgence of the Covid-19 pandemic on the economy, the RBI Governor, on May 5, 2021, announced several measures with a view to infuse liquidity in the economy, avoid another wave of borrower defaults[1] as well as aid in ease of business during the lockdown.

Out of the several measures announced by the Governor, one was to simplify the KYC process, which is the initial step of any lending transaction. Some of the amendments seem to provide immediate relief from compliance requirements and some are intended to encourage carrying out KYC compliances electronically, given the social distancing norms.

In this regard, the RBI has issued the following notifications:

  1. Periodic Updation of KYC – Restrictions on Account Operations for Non-compliance dated May 5, 2021[2]
  2. Amendment to the Master Direction (MD) on KYC dated May 10, 2021[3]

In this article we intend to discuss the prima facie implications of the amendments introduced by the aforesaid notifications. Read more

FAQs: Appointment of Statutory Auditors

-Financial Services Divison (finserv@vinodkothari.com)

Last updated- June 11, 2021

The Reserve Bank of India has issued Guidelines for Appointment of Statutory Central Auditors (SCAs)/Statutory Auditors (SAs) of Commercial Banks (excluding RRBs), UCBs and NBFCs (including HFCs) under Section 30(1A) of the Banking Regulation Act, 1949, Section 10(1) of the Banking Companies (Acquisition and Transfer of Undertakings) Act, 1970/1980 and Section 41(1) of SBI Act, 1955; and under provisions of Chapter IIIB of RBI Act, 1934 for NBFCs, on 27th April 2021 (“Guidelines”).

The Guidelines intend to supersede the existing circulars/notification on appointment of statutory auditors by Banks and NBFC. The Guidelines provide necessary instructions for appointment of SCAs/SAs, the number of auditors, their eligibility criteria, tenure and rotation as well as norms for ensuring the independence of auditors.

We have tried to figure out the probable questions arising out of these Guidelines and respond to the same in the form of these FAQs.

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Factoring Law Amendments backed by Standing Committee

-Megha Mittal 

[finserv@vinodkothari.com]

In the backdrop of the expanding transaction volumes, and with a view to address the still prevalent delays in payments to sellers, especially MSMEs, the Factoring Regulation (Amendment) Bill, 2020 (‘Amendment Bill’) was introduced in September, 2020, so as to create a broader and deeper liquid market for trade receivables.

The proposed amendments have been reviewed and endorsed by the Standing Committee of Finance chaired by Shri. Jayant Sinha, along with some key recommendations and suggestions to meet the objectives as stated above.  In this article, we discuss the observations and recommendations of the Standing Committee Report  in light of the Amendment Bill.

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ECLGS 2.0- Another push for businesses

-Kanakprabha Jethani (kanak@vinodkothari.com)

Background

The Government of India had, in response to the crisis caused by the COVID-19 pandemic, announced an Emergency Credit Line Guarantee Scheme (ECLGS). Under the scheme, the Government undertook to guarantee additional facilities provided by Lending Institutions (LIs) to their existing borrowers[1]. These facilities were limited to business loans only.

On November 12, 2020, the Finance Minister (FM), in a press conference, extended the last date granting loans under ECLGS 1.0 from November 30, 2020 to June 30, 2020. Further, the FM also announced introduction of ECLGS 2.0. On November 26, 2020, ECLGS 2.0 was introduced and the existing operational guidelines[2] and FAQs on the scheme[3] were revised. The below write-up discusses the major features of ECLGS 2.0 and changes in the existing ECLGS (referred to as ECLGS 1.0).

Opt-in Vs. Opt-out

While ECLGS 1.0 is essentially an opt-out facility, i.e. the lenders are required to offer a pre-approved additional facility to all the existing eligible borrowers and provide them an option to opt-out (not avail the funding). Under ECLGS 1.0, it is the responsibility of the LIs to determine the eligibility of the borrowers and offer loans.

On the contrary, the ECLGS 2.0 is an opt-in facility i.e. only those eligible borrowers, who intend to avail the funding and make an application for the same, will receive the additional facility. Here, the LIs would check the eligibility of the borrower upon receipt of application from the borrower for such funding. Hence, the responsibility of the lender to offer has now been changed to the responsibility of the borrower to apply.

Difference between ECLGS 1.0 and ECLGS 2.0

Particulars ECLGS 1.0 ECLGS 2.0
Eligibility of the borrower ·         Credit outstanding (fund based only) across all lending institutions- up to Rs.50 crore

·         Days Past

·         Due (DPD) as on February 29, 2020 – up to 60 days or the borrower’s account should not have been classified as SMA 2 or NPA by any of the lender as on 29th February, 2020

·         Borrower should be engaged in any of the 26 sectors identified by the Kamath Committee on Resolution Framework vide its report[4] and the Healthcare sector

·         Total credit outstanding (fund based only) across all lending institutions- above Rs.50 crores and not exceeding Rs.500 crore

·         DPD as on February 29, 2020 -up to 30 days respectively or the borrower’s account should not have not been classified as SMA 1, SMA 2 or NPA by any of the lender as on 29th February 2020

Nature of Facility Pre- approved additional funding with 100% guarantee coverage from the NCGTC Non-fund based (in case of banks and FIs-other than NBFCs)/fund-based/mix of fund-based and non-fund based additional facility- with 100% guarantee coverage
Amount 20% of the total credit outstanding of the borrower up to Rs. 50 crores 20% of the total credit outstanding of the borrower up to Rs. 500 crores
Tenure 4 years from the date of disbursement 5 years from the date of first disbursement of fund based facility or first date of utilization of non-fund based facility, whichever is earlier

Other changes

Along with introduction of ECLGS 2.0, a few changes have been introduced in ECLGS 1.0 as well. The major changes are as follows:

  • Extension of last date of disbursing loans from November 30, 2020 to June 30, 2021;
  • Extension of the last date for sanctioning loans to March 31, 2021;
  • The limit on turnover, under the eligibility criteria has been removed;
  • The requirement of creating a second charge on the existing security has been waived-off in case of loans up to Rs. 25 lakhs.

Conclusion

With intent to provide relief and to give a push to the real sector, the government has been introducing various benefits and facilities; ECLGS being one of them. The date of the scheme has been extended to further provide benefit to the business. In this line, ECLGS 2.0 has also been introduced, with stricter eligibility criteria (to ensure lower risk) and higher loan sizes.

[1] Refer our detailed FAQs on the scheme here- http://vinodkothari.com/2020/05/guaranteed-emergency-line-of-credit-understanding-and-faqs/

[2] https://www.eclgs.com/documents/ECLGS%20-Operational%20Guidelines%20-%20Updated%20as%20on%2026.11.2020.pdf

[3] https://www.eclgs.com/documents/FAQs-ECLGS%20-Updated%20as%20on%2026.11.2020.pdf

[4] https://www.rbi.org.in/Scripts/PublicationReportDetails.aspx?UrlPage=&ID=1157

 

Our related write-ups:

 

 

Modes of Restructuring of Stressed Accounts

Our detailed write-ups on these frameworks may be referred here: