Posts

Banking exposure to open the current account by the banks

-Siddarth Goel (finserv@vinodkothari.com)

Background

Declaration from current account customers

The RBI issued a circular dated August 06, 2020, whereby the regulator instructed all scheduled commercial banks and payments banks shall not open a current account for customers who have availed credit facilities in form of cash credit (CC)/overdraft (OD) from the banking system. The motive behind the circular being that all the transactions of borrowers should be routed through the CC/OD account.

The genesis of this circular was in RBI circular dated May 15, 2004, where banks were advised that at the time of opening of current accounts for their customers, they have to insist on a declaration form by the account-holder to the effect that he is not enjoying any credit facility with any other bank or obtain a declaration giving particulars of credit facilities enjoyed by such customer. The move was in essence to secure the overall credit discipline in banking so that there is no diversion of funds by the borrowers to the detriment of the banking system. Post-May 15, 2004, a clarification notification was issued by the regulator dated August 04, 2004, stipulating that in case there is no response obtained concerning NOC after waiting a minimum period of a fortnight, the banks may open current accounts of the customers.

Thus there was an obligation on banks to scrupulously ensure that their branches do not open current accounts of entities that enjoy credit facilities (fund based or non-fund based) from the banking system without specifically obtaining a No-Objection Certificate (NOC) from the lending bank(s). Further, the non-adherence by banks as per the circular is to be perceived as abetting the siphoning of funds and such violations which are either reported to RBI or noticed during the regulator inspection would make the concerned banks liable for penalty under Banking Regulation Act.

Establishment of CRILC

The RBI established a Central Repository of Information on Large Credits (CRILC). The CRILC was established in connection to the RBI framework “Early Recognition of Financial Distress, Prompt Steps for Resolution and Fair Recovery for Lenders: Framework for Revitalising Distressed Assets in the Economy“. As under the framework banks were required to furnish credit information to CRILC on all their borrowers having aggregate fund-based and non-fund based exposure of Rs. 5 Crores and above with them. Besides banks were required to furnish current accounts of their customers with outstanding balance (debit or credit) of Rs 1 Crore and above to the CRILC. The reporting under the extant framework was to determine SMA-0 classification, where the principal or interest payment is not overdue for more than 30 days but account showing signs of stress. An increase in the frequency of overdrafts in current accounts is one of the illustrative methods for determining stress.

Reposting of large credits

Post establishment of CRILC, a subsequent guideline on the opening of current accounts by banks was issued by the RBI via circular dated July 02, 2015, dealing with the same subject. To enhance credit discipline, especially for the reduction in NPA level in banks, banks were asked to use the information available in CRILC and not limit their due diligence to seeking NOC. Banks were to verify from the data available in the CRILC database whether the customer is availing of credit facility from another bank.

The chart below highlights the series and events and relevant circulars.

Credit Discipline- August 06, 2020 Circular

As per the circular dated August 06, 2020, issued by the regulator on Opening of Current Accounts by Banks – Need for Discipline (‘Revised Guidelines’), there are two aspects that need to be considered before opening a CC/OD facility or opening the current account of the customer. The Revised Guidelines provides a clear guiding flowchart for banks to follow when the customer approaches a bank for opening of the current account, the same has been categorised into two scenarios which could be considered by the banks to comply with the revised guideline.

Case 1: Customer wants to avail or is already having a credit facility in form of CC/OD

Case 2: Customer wants to open a current account or have an existing current account with the bank

 

Further, there is a requirement on banks to monitor all CC/OD accounts regularly at least quarterly, especially concerning the exposure of the banking system to the borrower. There has been an ambiguity surrounding what would amount to ‘exposure’ under the Revised Guidelines.

‘Exposure to the banking system’ under Revised Guidelines

The Revised Guidelines provides that exposure shall mean the sum of sanctioned ‘fund based and non-fund based credit facilities’. However, there is a regulatory ambiguity, since neither the term used by the RBI has been specifically defined in the Revised Guideline nor elsewhere under any other regulations. There is no straight jacket exclusive definition for determining as to what exposure banks should include determining funded and non-funded credit facilities. Therefore, based on back-tracing of regulatory regime an inclusive list can be of guidance for banks and borrowers especially large borrowers (like NBFCs and HFCs) and other financial institutions and corporates who rely on banking facilities (current account and CC/OD) extensively for their business.

The CRILC may not be the only source for banks while the collection of borrower’s credit information. Other modes could be information by Credit Information Companies (CICs), National E-Governance Services Ltd. (NeSL), etc., and even by obtaining customers’ declaration, if required. However, since the revised guideline stresses on borrowers having exposure more than 5 crores, therefore, information disseminated by the banks to CRILC is a good point to start with and to comply with under the revised guidelines. The circular dated July 02, 2015, draws reference to the Central Repository of Information on Large Credits (CRILC) to collect, store, and disseminate data on all borrowers’ credit exposures. The guideline further provided banks to verify the data available in the CRILC database whether the customer is availing credit facility from another bank. Further even under the Guidelines on “Early Recognition of Financial Distress, Prompt Steps for Resolution and Fair Recovery for Lenders” dated January 30, 2014, provided that credit information shall include all types of exposures as defined under RBI Circular on Exposure Norms.

The RBI Exposure Norms dated July 01, 2015, defines exposure as;

“Exposure shall include credit exposure (funded and non-funded credit limits) and investment exposure (including underwriting and similar commitments). The sanctioned limits or outstandings, whichever are higher, shall be reckoned for arriving at the exposure limit. However, in the case of fully drawn term loans, where there is no scope for re-drawal of any portion of the sanctioned limit, banks may reckon the outstanding as the exposure.”

The banking exposure norms provide for two exposures; namely credit and investment exposures. Further RBI Exposure Norms defines ‘credit exposure’ and ‘Investment Exposure’ as follows;

“2.1.3.3. Credit Exposure

Credit exposure comprises the following elements:

(a) all types of funded and non-funded credit limits.

(b) facilities extended by way of equipment leasing, hire purchase finance and factoring services.

2.1.3.4 Investment Exposure

  1. a) Investment exposure comprises the following elements:

(i) investments in shares and debentures of companies.

(ii) investment in PSU bonds

(iii) investments in Commercial Papers (CPs).

  1. b) Banks’ / FIs’ investments in debentures/ bonds / security receipts / pass-through certificates (PTCs) issued by an SC / RC as compensation consequent upon sale of financial assets will constitute exposure on the SC / RC. In view of the extraordinary nature of the event, banks / FIs will be allowed, in the initial years, to exceed the prudential exposure ceiling on a case-to-case basis.
  2. c) The investment made by the banks in bonds and debentures of corporates which are guaranteed by a PFI1(as per list given in Annex 1) will be treated as an exposure by the bank on the PFI and not on the corporate.
  3. d) Guarantees issued by the PFI to the bonds of corporates will be treated as an exposure by the PFI to the corporates to the extent of 50 per cent, being a non-fund facility, whereas the exposure of the bank on the PFI guaranteeing the corporate bond will be 100 per cent. The PFI before guaranteeing the bonds/debentures should, however, take into account the overall exposure of the guaranteed unit to the financial system.”

The Revised Guidelines, specifically define exposure in a footnote to the revised guideline stipulating that to arrive at aggregate exposures in the footnote as follows;

“‘Exposure’ for the purpose of these instructions shall mean sum of sanctioned fund based and non-fund based credit facilities”.

Further the RBI in its subsequent FAQs on revised guidelines dated December 14, 2020, guided on what could be included in aggregate exposure.

4. Whether aggregate exposure shall include Day Light Over Draft (DLOD)/ intra-day facilities and irrevocable payment commitments, limits set up for transacting in FX and interest rate derivatives, CPs, etc.

All fund based and non-fund based credit facilities sanctioned by the banks and carried in their Indian books shall be included for the purpose of aggregate exposure.”

Further in FAQ No. 3 in the circular dated December 14, 2020, the RBI clarified that

3. For the purpose of this circular, whether exposure of non-banking financial companies (NBFCs) and other financial institutions like National Housing Bank (NHB) shall be included in computing aggregate exposure of the banking system.

The instructions are applicable to Scheduled Commercial Banks and Payments Banks. Accordingly, the aggregate exposure for the purpose shall include exposures of these banks only”

While the regulator evaded assigning express meaning as to what could be included while determining banking exposure and took an inclusive view. However, from the foregoing, it is amply clear that the credit facilities should include credit exposures (funded and not funded) that have been sanctioned by banks. Therefore, only exposures to banks and payments banks are to be included while calculating exposures, any or all the exposure of a borrower to the other financial institutions like NHB, LIC Housing, SIDBI, NABARD, Mutual funds & other development Banks are neither commercial banks nor payments banks hence are to be excluded. [The list of licensed payments banks by the RBI can be viewed here. ]

CIRLC captures credit information of borrowers having aggregate fund-based and non-fund based exposures of Rs. 5 Crores and above including investment exposures. The banks are required to submit a quarterly return to CIRLC. It is pertinent to note that total investment exposure is to be indicated separately under the head total investment exposure. While there is a need for a detailed breakup on fund-based and non-fund based credit facilities in the CIRLC return. The table below is an indicative list of (funded and non-funded) loans to be submitted from the CIRLC return.

 

Non-Funded credit exposure  Funded credit exposure
Letter of Credit Cash Credit/ Overdraft
Guarantees Working Capital Demand Loan (including CPs)*
Acceptances Inland Bills
Foreign Exchange Contracts Packing Credit
Interest Rate Derivatives (incl FX Interest Rate Derivatives) Export Bills
Term Loan
Credit equivalent of OBS/derivative exposure

*CP to be included in WCDL only if part of working capital sanctioned limit. All other CPs are to be considered as investment exposure.

Therefore, all the investment exposures of banks to the borrower such as investments in corporate bonds, shares, PTCs issued by asset reconstruction companies and securitisation companies, and others are to be excluded while arriving at aggregate fund-based and non-fund based credit facilities as under the Revised Guidelines. Nevertheless, the PTCs issued by NBFCs or HFCs are investment exposure of banks on the underlying loan pools and not on the originator entity. Similarly, exposure of a bank in a co-lending transaction is exposure on the ultimate obligor and not the co-originating partner NBFC.

 

 

Our Other Related Articles

Banking Regulation (Amendment) Ordinance By Vallari Dubey – Vinod Kothari Consultants

RBI guidelines on governance in commercial banks – Vinod Kothari Consultants

RBI proposes to strengthen governance in Banks – Vinod Kothari Consultants

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:

 

 

RBI aligns list of compoundable contraventions under FEMA with NDI Rules

‘Technical’ contravention subject to minimum compoundable amount, format for public disclosure of compounding orders revised.

– CS Burhanuddin Dohadwala | corplaw@vindkothari.com

Introduction

Compounding refers to the process of voluntarily admitting the contravention, pleading guilty and seeking redressal. It provides comfort to any person who contravenes any provisions of FEMA, 1999 [except section 3(a) of the Act] by minimizing transaction costs. Reserve Bank of India (‘RBI’) is empowered to compound any contraventions as defined under section 13 of FEMA, 1999 (‘the Act’) except the contravention under section 3(a) of the Act in the manner provided under Foreign Exchange (Compounding Proceedings) Rules, 2000. Provisions relating to compounding is updated in the RBI Master Direction-Compounding of Contraventions under FEMA, 1999[1].

Following are few advantages of compounding of offences:

  1. Short cut method to avoid litigation;
  2. No further proceeding will be initiated;
  3. Minimize litigation and reduces the burden of judiciary;

Present Circular

Pursuant to the supersession of FEM (Transfer or Issue of Security by a Person Resident Outside India) Regulations, 2017[2] (‘TISPRO”)and issuance of FEM (Non-Debt Instrument) Rules, 2019[3] [‘NDI Rules] and FEM (Mode of Payment and Reporting of Non-Debt Instruments) Regulations, 2019[4] [‘MPR Regulations’], RBI has updated the reference of the erstwhile regulations in line with the NDI Rules and MPR Regulations vide RBI Circular No.06 dated November 17, 2020[5] (‘Nov 2020 Circular’).

Additionally, the Nov 2020 Circular does away with the classification of a contravention as ‘technical’, as discussed later in the article.

Lastly, the Nov 2020 Circular modifies the format in which the compounding orders will be published on RBI’s website.

Compounding of contraventions relating to foreign investment

The power to compound contraventions under TISPRO delegated to the Regional Offices/ Sub Offices of the RBI has been aligned with corresponding provisions under NDI Rules and MPR Regulation as under:

Compounding of contraventions under NDI Rules
Rule No. Deals with Corresponding regulation under TISPRO Brief Description of Contravention
Rule 2(k) read with Rule 5 Permission for making investment by a person resident outside India; Regulation 5 Issue of ineligible instruments
Rule 21 Pricing guidelines; Paragraph 5 of Schedule I Violation of pricing guidelines for issue of shares.
Paragraph 3 (b) of Schedule I Sectoral Caps; Paragraph 2 or 3 of Schedule I Issue of shares without approval of RBI or Government respectively, wherever required.
Rule 4 Restriction on receiving investment; Regulation 4 Receiving investment in India from non-resident or taking on record transfer of shares by investee company.
Rule 9(4) Transfer by way of gift to PROI by PRII of equity instruments or units of an Indian company on a non- repatriation basis with the prior approval of the Reserve Bank. Regulation 10(5) Gift of capital instruments by a person resident in India to a person resident outside India without seeking prior approval of the Reserve Bank of India.
Rule 13(3) Transfer by way of gift to PROI by NRI or OCI of equity instruments or units of an Indian company on a non- repatriation basis with the prior approval of the Reserve Bank.

 

Compounding of contraventions under MPR Regulations
Regulation No. Deals With Corresponding regulation under TISPRO Brief Description of Contravention
Regulation 3.1(I)(A) Inward remittance from abroad through banking channels; Regulation 13.1(1) Delay in reporting inward remittance received for issue of shares.
Regulation 4(1) Form Foreign Currency-Gross Provisional Return (FC-GPR); Regulation 13.1(2) Delay in filing form FC (GPR) after issue of shares.
Regulation 4(2) Annual Return on Foreign Liabilities and Assets (FLA); Regulation 13.1(3) Delay in filing the Annual Return on Foreign Liabilities and Assets (FLA).
Regulation 4(3) Form Foreign Currency-Transfer of Shares (FC-TRS); Regulation 13.1(4) Delay in submission of form FC-TRS on transfer of shares from Resident to Non-Resident or from Non-resident to Resident.
Regulation 4(6) Form LLP (I); Regulations 13.1(7) and 13.1(8) Delay in reporting receipt of amount of consideration for capital contribution and acquisition of profit shares by Limited Liability Partnerships (LLPs)/ delay in reporting disinvestment / transfer of capital contribution or profit share between a resident and a non-resident (or vice-versa) in case of LLPs.
Regulation 4(7) Form LLP (II);
Regulation 4(11) Downstream Investment Regulation 13.1(11) Delay in reporting the downstream investment made by an Indian entity or an investment vehicle in another Indian entity (which is considered as indirect foreign investment for the investee Indian entity in terms of these regulations), to Secretariat for Industrial Assistance, DIPP.

Technical contraventions to be compounded with minimal compounding amount

As per RBI’s FAQs[1] whenever a contravention is identified by RBI or brought to its notice by the entity involved in contravention by way of a reference other than through the prescribed application for compounding, the Bank will continue to decide (i) whether a contravention is technical and/or minor in nature and, as such, can be dealt with by way of an administrative/ cautionary advice; (ii) whether it is material and, hence, is required to be compounded for which the necessary compounding procedure has to be followed or (iii) whether the issues involved are sensitive / serious in nature and, therefore, need to be referred to the Directorate of Enforcement (DOE). However, once a compounding application is filed by the concerned entity suo moto, admitting the contravention, the same will not be considered as ‘technical’ or ‘minor’ in nature and the compounding process shall be initiated in terms of section 15 (1) of Foreign Exchange Management Act, 1999 read with Rule 9 of Foreign Exchange (Compounding Proceedings) Rules, 2000.

Nov 2020 Circular provides for regularizing such ‘technical’ contraventions by imposing minimal compounding amount as per the compounding matrix[1] and discontinuing the practice of giving administrative/ cautionary advice.

Public disclosure of compounding order

Compounding order by RBI can be accessed at the RBI website-FEMA tab-compounding orders[1]. In partial modification of earlier instructions issued dated May 26, 2016[2] it has been decided that in respect of the Compounding Orders passed on or after March 01, 2020 a summary information, instead of the compounding orders, shall be published on the Bank’s website in the following format:

Sr. No. Name of the Applicant Details of contraventions (provisions of the Act/Regulation/Rules compounded)

(Newly inserted)

Date of compounding order

(Newly inserted)

Amount imposed for compounding of contraventions Download order

(Deleted)

It seems that the compounding order will not be available for download.

Conclusion:

The delegation of power is done for enhanced customer service and operational convenience. Revised format of disclosure of compounding orders will be more reader friendly. Delay in filing of forms under MPR Regulations on FIRMS portal is subject to payment of Late Submission Fees (LSF) as per Regulation 5. The payment of LSF is an additional option for regularising reporting delays without undergoing the compounding procedure.

Abbreviations used above:

  • PROI: Person Resident Outside India;
  • PRII: Person Resident In India;
  • NRI: Non-Resident Indian;
  • OCI: Overseas citizen of India;

FIRMS: Foreign Investment Reporting & Management System.

Our other articles/channel can be accessed below:

1. Compounding of Contraventions under FEMA, 1999- RBI delegates further power to Regional Offices:

http://vinodkothari.com/wp-content/uploads/2017/03/Compounding_of_Contraventions_under_FEMA_1999_-_RBI_delegates_further_power_to_Regional_Offices.pdf

 

2. Other articles on FEMA, ODI & ECB may be access below:

http://vinodkothari.com/category/corporate-laws/

 

3. You Tube Channel:

https://www.youtube.com/channel/UCgzB-ZviIMcuA_1uv6jATbg

[1] https://www.rbi.org.in/scripts/Compoundingorders.aspx

[2] https://www.rbi.org.in/Scripts/NotificationUser.aspx?Id=10424&Mode=0

[1] https://www.rbi.org.in/Scripts/NotificationUser.aspx?Id=10424&Mode=0

[1] https://m.rbi.org.in/Scripts/FAQView.aspx?Id=80 (Q. 12)

[1] https://www.rbi.org.in/Scripts/BS_ViewMasDirections.aspx?id=10190

[2] https://www.rbi.org.in/Scripts/NotificationUser.aspx?Id=11253&Mode=0

[3] http://egazette.nic.in/WriteReadData/2019/213332.pdf

[4] https://www.rbi.org.in/Scripts/BS_FemaNotifications.aspx?Id=11723

[5]https://rbidocs.rbi.org.in/rdocs/notification/PDFs/APDIRS62545AA7432734B31BD5B59601E49AA6C.PDF

Compound interest burden taken over by the Central Government: Lenders required to pass on benefit to borrowers

-Team Vinod Kothari Consultants P. Ltd. (finserv@vinodkothari.com)

While compound interest is the unquestionable reality of the world of banking and finance, somehow, courts have always been disapproving of the idea of “interest on interest”. After some months of litigation in the Apex Court and a lot of confusion surrounding interest on interest being charged by the lenders on loan accounts whose payments were deferred under the Covid-induced moratoriums, the Central Government (CG) has come up with a scheme whereby the CG will take over the differential interest, that is, difference between compound interest and simple interest during the 6 month period starting 01.03.2020. The lending institutions will have to pass on this benefit to the borrowers. Of course, the scheme, called Scheme for grant of ex-gratia payment of difference between compound interest and simple interest for six months to borrowers in specified loan accounts (1.3.2020 to 31.8.2020) [Ex-Gratia Scheme or EGS]  is limited only to smaller borrowers, that is, borrowers falling under the specified category loan accounts, classified as standard and having an aggregate exposure of not exceeding Rupees 2 (two) crores as on 01.03.2020.

We have earlier submitted that the government is best placed to provide any relief to borrowers on issues concerning interest on interest.[1] The issue has finally been addressed via Notification dated 23.10.2020 providing the “Scheme for grant of ex-gratia payment of difference between compound interest and simple interest for six months to borrowers in specified loan accounts (1.3.2020 to 31.8.2020)”.[2]

This ex-gratia payment scheme is another COVID-19 related relief and incentive by the Government to bear additional interest on certain small specified loan accounts. The total estimated burden on the exchequer by virtue of the Scheme may be about Rs 7500 crores.

The Ministry of Finance (MoF), GOI has also issued four clarifications to date on EGS via FAQs dated 26.10.2020, 29.10.2020, 03.11.2020, and 04.11.2020 respectively.[3]

In this write-up, we have highlighted some of the important aspects of the scheme in form of FAQs below:

Objective/Nature and Scope of the Scheme

  1. What is the objective of this Ex-gratia Scheme?

This Ex-gratia Scheme seems to be the CG’s answer to the resentment that was quite obvious in the Supreme Court proceedings in the matter of Gajendra Sharma Vs Union of India.[4] The Scheme says it clearly that the payment under EGS is not a contractual, legal or equitable liability of the CG and is only an only an ex-gratia payment to the following designated class of borrowers in view of the COVID-19 pandemic.

The essential idea of the EGS is to provide the benefit of having to pay simple interest by the borrowers covered under the Scheme. The period covered by the two moratoriums is to be taken into consideration under this Ex-gratia Scheme, that is the period from 01.03. 2020 to 31.05.2020[5] and 01.06.2020 to 31.08.2020[6]. The underlying philosophy of the EGS seems that the central purpose of the moratorium was to grant relief to smaller borrowers whose business/earnings were disrupted by the Pandemic. However, the grant of moratorium did not provide any relief from payment of interest. Thus, interest continued to be compound even while the borrower availed of the moratorium. In many cases, thus, the moratorium hardly helped, as it resulted in mounting of interest burden, which may have even worsened the situation of the  borrower.

The Scheme now transforms compound interest into simple interest during the Moratorium Period, that is, the period commencing from 01.03.2020 to 31.08.2020 (‘Moratorium Period’).

As our workings (See in next question) have demonstrated the impact of the EGS on the borrower depends on two factors – (a) the rate of interest on the facility; and (b) the size of the funded facility.

  1. How will the Ex-gratia payment be impacted with varying interest rates and outstanding amounts?

Please refer to the table at the end of this write-up.

  1. Is the payment of the ex gratia amount under the scheme, optional for lending institutions or the same has to be complied mandatorily by the lending Institutions?

The payment to the specified loan accounts of eligible borrowers is mandatory under the Scheme. The language of Ex-gratia Scheme clearly provides that the lending institutions shall credit the difference between simple interest and compound interest for a period between 1,03,2020 to 31.08.2020 in specified loan accounts of eligible borrowers.

Further the RBI notification dated 26.10.2020 clearly advises the lending institutions to be guided by the provisions of the scheme and take necessary action within stipulated timeline.

  1. Can a Lending Institution be selective in terms of granting the benefit or denying it to certain Borrowers?

The applicability of the scheme is not optional. As per the RBI notification, all lending institutions are advised to be guided by the provisions of the Scheme and take necessary action within the stipulated timeline. Hence, the lending institution is obligated to extend the benefit of the EGS to all the eligible borrowers. See below for the meaning of “eligible borrowers.”

Scope of “Lending Institutions”

  1. Which Lending Institutions have to pass the benefits to borrowers under this Scheme?

The following is the list of the lenders have to comply with the operational guidelines of the scheme (“Lending Institutions”) :

  • Banking Companies
  • Public Sector Banks (PSB)
  • Co-operative Banks – Urban Co-operative Banks,or a State Co-operative Bank, or a District Co-operative Bank
  • Regional Rural Banks (RRB)
  • All India Financial Institutions
  • Non-Banking Financial Companies registered with the RBI
  • Non-Banking Finance Company being a Micro Finance Institution, also a member of Self Regulatory Organisation (SRO) registered with RBI
  • Housing Finance Companies registered with RBI, or National Housing Bank
  1. Are all types of NBFCs covered under the Scheme irrespective of the asset size?

The Government intends to pass on the benefit of the Scheme through the Lending Institutions including all NBFCs involved in lending to the specified category of borrowers irrespective of the asset size of the NBFCs.

  1. Is this scheme applicable on co-lending?

The EGS scheme does not exclude loans originated by two or more Lending Institutions. The objective of the scheme is to pass the benefit of the EGS to eligible borrowers. Therefore,  in case the borrower is eligible, the benefit under the EGS shall be extended taking blended rate of interest as the reference rate for differential computation of CI and SI during the moratorium period. The rates of interest charged by the respective lenders may be different inter-se; however, the benefit of interest differential will be given to the borrower based on the blended interest rate.

  1. In case of co-lending, what if there is one eligible Lending Institution, and one who is not eligible?

Current guidelines of the RBI on co-lending do not seem to be extending to co-lending arrangements between one lender who is in the list of Lending Institutions above, and one who is not. It will be difficult to think of one of co-lenders passing on the benefit, while the other does not.

  1. Does this Scheme cover the loans which have been securitised?

The fact that a specified loan account has been securitized does not deny the borrower from availing the benefit under this Scheme. Therefore, the servicer/originator should pass the benefit of ex-gratia payment to the eligible borrower even in case of securitised loans. The interest rate differential is essentially credited to the account of the Eligible Borrower – therefore, it is treated as if it is a cash inflow from the borrower, and should accordingly become a part of the waterfall, as and when the same is received from SBI.

9A. In case of securitisation, the original lender is simply a servicer. Is it envisaged that the servicer will still be empowered/required to pass on the benefit of the Scheme to the borrower, and claim the same from the Govt, even though technically the loan is not on the books of the lender?

Given the benevolent and borrower-centric intent of the Scheme, we are of the view that the benefit of the Scheme cannot be denied to a borrower whose loans have been assigned. Technically, whether the originator is still holding the loan or has sold it away to an SPV or other assignee should not matter. The benefit can easily be passed on as a payment from the customer.

  1. Does this scheme include specified loan accounts which have been subject to direct assignment?

The same treatment as in case of securitisation should apply in case of direct assignments as well. The benefit of interest differential should be given to the borrower. The amount received from the CG through SBI should be treated as a payment received from the borrower, and should be shared between the assignor/assignee in their ratio of sharing the inflows.

A subsequent clarification in MoF FAQs dated 03.11.2020 in FAQ No. 2, specifies the eligibility of loans under EGS which have been bought as part of pool buyouts by one lending institution from another. [Updated on 04.11.2020]

  1. The amount received from the CG by way of interest differential may be treated as payment made by the borrower. Should it be treated as payment of principal, payment of interest, or payment of any other dues from the borrower?

In our view, the contractual appropriation rules should be applicable to the amount received from the CG. The amount received from the CG is essentially the amount received from the borrower. Hence, appropriation rules as contained in the loan agreement should apply to this amount as well.

  1. Does this Scheme cover Core Investment Companies?

Question does not arise as CICs are intended to provide financial support to “group companies only.

Scope of “Eligible Borrowers”

  1. Which all borrowers are eligible to be benefitted under the Scheme?

The borrowers falling under any or more of the “Facilities” (see below) are eligible under Ex-gratia Scheme “Eligible Borrower”. However, such facilities need to satisfy the following conditions:

  • Such borrower should not have sanctioned limit and the outstanding amount exceeding Rs. 2 (two) crores in aggregate with all the lending institutions as on 29.02.2020. That is, the sum of borrowings of such a borrower from specified loan accounts and borrowings other than that under specified loan account shall also be taken into account while arriving at aggregate exposure of Rs. 2 Crores.

For computation of the borrowing cap, see further questions below.

  • Such an eligible category loan account should be standard (less than 90 DPD) as on 29.02.2020.
  • Whether such borrower availed complete moratorium, partial moratorium, or did not avail any moratorium benefit in respect of such eligible category loan account is irrelevant for the purpose of extending benefit under the Ex-gratia Scheme.
  1. Will the Non Fund Based Limits as on 29.02.2020 be included for arriving at the borrower eligibility of amount upto Rs. 2 crore?

No, the fund based limits shall not be included for arriving at the eligibility criteria for the purpose under EGS. The same has also been clarified by the MoF in its FAQs.

  1. Whether the Rs. 2 crore limit applies for borrowings across all lending institutions?

Yes, the 2 crore limit shall be considered across all the lending institutions.

  1. In case of working capital facility, for the purpose of limit of Rs 2 crores, the lending institution shall consider the actual amount availed or the sanctioned limit?

The language and intent of the EGS is very clear that the aggregate of sanctioned and outstanding amount of loan in respect of a particular eligible borrower is to be considered. Hence, the sanction limit shall be considered.

  1. As on 29.02. 2020, a borrower is standard with one lender, but is not standard with another. What will be the eligibility of the borrower in such a case?

In our view, the condition for eligibility for the benefit is that the borrower is standard as on the reference date. Additionally, we need to aggregate the facilities enjoyed by the borrower with other lending institutions. We do not have to read any further conditions. That is, if the borrower is not standard with a particular lending institution, then such lending institution shall not grant the benefit to the borrower. However, the lending institution with which the borrower is standard should not be precluded from granting the benefit of the Scheme.

The same has also been subsequently clarified in MoF FAQs dated 03.11.2020 in FAQ No. 1. [Updated on 04.11.2020]

  1. How does a lending institution get to know how much facilities a borrower is availing from other lending institutions, in order to arrive at the borrowing cap?

Lending institutions are to assess this on the basis of information available with them as well as information accessible from credit bureaus. This has also been clarified by the MoF in its FAQs.

  1. A borrower has availed a loan of Rs 1 crore from an NBFC. Additionally, the borrower has taken a home loan of Rs 1.50 crores from the company where he is currently working. Is he eligible?

We need to aggregate the borrowings from Lending Institutions. Employee loan taken from the company where the borrower is working does not fall under the list of facilities for the purpose of the Scheme. Hence, no question of aggregating the same.

  1. A borrower satisfies all other conditions but is classified as NPA as on 29.02.2020 and subsequently becomes standard. Will the borrower be eligible under the Scheme?

The subsequent movement of the NPA to standard will not make the account eligible under the scheme. As per the eligibility conditions, the loan account must be classified as standard as on 29.02.2020.

  1. A borrower account was standard as on 29.02.2020 and also satisfies all the other eligibility conditions under the scheme, but as on date is an NPA. Can the benefit still be availed?

Yes, the benefit shall still be given to the borrower based on the fact that the loan account was eligible as on 29.02.2020.

  1. A borrower under a specified loan account is having a sanctioned limit of Rs. 2.5 Crores as on 29.02.2020, however its aggregate outstanding borrowing with respect to such loan account as on 29.02.2020 is less than 2 crore, will such borrower be eligible under the Ex-gratia Scheme?

The Ex-gratia Scheme clearly specifies that the ‘sanctioned limit’ and ‘outstanding amount’ with respect to loan accounts should not exceed Rs. 2 Crore. The aggregate of the borrower’s sanctioned limit and outstanding loan amount from all lending institutions to such a borrower should be less than Rs. 2 Crores. Hence, in our view, the borrower shall not be eligible.

  1. A borrower under specified loan account has an aggregate outstanding loan facility as on 29.02.2020 less than Rs. 2 Crores with a lending institution. Additionally it also has a Bank Guarantee in its favour with the same or any other lending institution. Will such a borrower be eligible under the Ex-gratia Scheme? 

The FAQs issued by the Department of Financial Services clearly states that non fund based limits will not be included for arriving at the eligibility. Accordingly, the borrower shall be eligible under the EGS.  

23A. A borrower availed a sanctioned loan facility of Rs. 2.5 Crore and as of 29.02.2020, the principal outstanding is Rs. 1.80 Crore, will such a borrower be eligible under the Scheme?

Yes. As per the FAQs issued by the Department of Financial Services (FAQ 10), the sanctioned and outstanding amounts have to be seen as on 29.02.2020. In the question above if the sanctioned loan facility has been completely availed, i.e. borrower cannot make further drawdowns from such sanctioned facility of 2.5 crore, then such borrower account should be eligible under the Scheme.

  1. Is there any requirement for eligible borrowers under specified loan accounts which needs to be fulfilled for the purpose of availing ex-gratia payment benefit?

No, as per the ex-gratia scheme guidelines all lending institutions under the scheme have to credit the difference between compound interest and simple interest in specified loan accounts of the eligible borrowers.

However, it is always prudent on part of borrowers and the lending institutions to exchange confirmation about the credit of such payment under the scheme.

  1. Will the eligibility be determined as on the date of this scheme or as on 29.02.2020?

The borrower account must fall in the category of specified loan account as on 29.02.2020. For example, a loan account was classified as an MSME as on 29.02.2020 and later on a subsequent change in definition has moved it out of the category of MSME, the benefit under the scheme shall still be given to the said borrower account, subject to fulfilment of the eligibility conditions.

Scope of “Facility”

  1. Which all classes or categories of loans/facilities are eligible under this Scheme?

The loans falling under any of the categories mentioned below are ‘specified loan accounts’ under this Ex-gratia Scheme.

  • MSME loans
  • Education loans
  • Consumer durable loans
  • Credit Card Dues
  • Automobile loans
  • Personal loans to professionals
  • Consumption loans
  • Housing Loans
  1. Does the specified loan account also include all personal loans, or personal loans given only to professionals?

RBI has defined the term “personal loans” in its circular dated 04.01.2018 as follows:

“Personal loans refers to loans given to individuals and consist of (a) consumer credit, (b) education loan, (c) loans given for creation/ enhancement of immovable assets (e.g., housing, etc.), and (d) loans given for investment in financial assets (shares, debentures, etc.).”

The circular dated 04.01.208 also defines “consumer credit”, and the extant definition is as follows:

Consumer credit refers to the loans given to individuals, which consists of (a) loans for consumer durables, (b) credit card receivables, (c) auto loans (other than loans for commercial use), (d) personal loans secured by gold, gold jewellery, immovable property, fixed deposits (including FCNR(B)), shares and bonds, etc., (other than for business / commercial purposes), (e) personal loans to professionals (excluding loans for business purposes), and (f) loans given for other consumptions purposes (e.g., social ceremonies, etc.). However, it excludes (a) education loans, (b) loans given for creation/ enhancement of immovable assets (e.g., housing, etc.), (c) loans given for investment in financial assets (shares, debentures, etc.), and (d) consumption loans given to farmers under KCC.

Therefore, from conjoining the above two definitions and comparing it with the list of specified loan accounts under the Scheme, we understand that Personal Loans given to individuals in respect to; a) education loans, b) credit cards dues, c) loans for consumer durables, d) auto loans, e) Personal loans to professionals, f) loans for consumption purposes g) Housing Loans shall qualify as specified loan accounts from personal loan category for the purpose under the scheme.

The expression “consumption loan” is quite wide. A loan which is not for business purposes, or for purchase of any specific asset or durable, may qualify as a “consumption loan”.

27A.  Whether loans given to doctors for business purposes are covered under the head ‘personal loan to professional’?

Going by the literal interpretation it seems that personal loans to professionals shall not include loans given for business purposes. The same is also specified in the definition of ‘consumer credit’ provided hereinabove. However, consumption loans are also not for business purposes and a personal loan by any person, including a professional, will be classified as a consumption loan. Hence, in essence there would not be a difference between the category ‘personal loan for professionals’ and ‘consumption loans’, the later being a broader term. Such an interpretation would reder this category as meaningless.

Further, restricting the meaning to only personal loan would mean that a loan given to a professional, for the profession, will disqualify on the ground that it is not a “personal loan. However, in our view, the intent seems to be cover loans to professionals. The word ‘personal’ loan seems to be a surplusage and should not be taken restrictively.

  1. A salaried employee / self-employed professional had availed of a personal loan from bank which has some amount outstanding as on 29.02.2020. Is the loan eligible for ex-gratia payment under the scheme?

Yes. Loans for consumption purposes (e.g., social ceremonies, personal expenditure, etc.) are also eligible for coverage under the scheme, besides other specified categories of loans like consumer durables, automobiles, education, credit card dues, housing and personal loans to professionals.

28 A. In case of education loans where students pay part of the interest and the remaining interest gets capitalised. Will such cases also qualify under this scheme?

In case of education loans, generally, the repayment starts after a deferment or moratorium period (say 1 or 2 years). EGS covers education loan under specified loan category, however it does not specify, whether the status of the loan account of repayment under such loans have commenced or not, or has been partially paid or not as of 29.02.2020. Therefore, in our view, education loan accounts have to be given benefit under EGS irrespective of the fact whether loan is under deferred period, or the re-payment has commenced or loan is partially being re-paid. Further, the reference date to be borne in mind for determining the outstanding amount on such loan account shall be 29.02.2020.

28B.  Will loans to Education Institutes be eligible under education loans?

No, loans given to education institutes will not be covered under the head ‘education loans’.

  1. Is there a distinction between secured loans and unsecured loans for the purpose of the Scheme?

No. There is no such distinction. As long as the loan is covered by the list of “facilities” above, it does not matter whether the loan is secured or unsecured.

  1. A business loan has been given to an MSME (private limited company), and is secured by pledge over shares of the company? Will this loan be eligible?

As per FAQ no. 20 of the FAQs issued by MoF, loans against shares shall not qualify for the Scheme. However, in our view, the intent of the MoF is to exclude loans against the financial assets, that is, loans where the intent is to use the proceeds of the loan for investing in financial assets. In the instant case, the loan is a loan taken for business purposes. The mere fact that the loan has been collateralised by pledge over shares, whether of the entity in question or any other shares, should not matter. This is our view.

  1. Will a loan taken for business purposes by a non-MSME qualify?

Loans to non- MSME for business purpose is not falling under any eligible category of Facilities, and hence not covered under the Scheme

  1. A borrower falls under the MSME category as per the new MSME classification. But such a borrower has not availed Udyam Registration, will it be eligible under the scheme?

The borrower must be classified as an MSME on 29.02.2020 irrespective of the classification under the new definition. Further, it is recommended that in case the borrower continues to be classified as an MSME, it may submit its proof of Udyam registration to the lending institution.

32.A    Is Udhyam Registration mandatory for MSME     classification?

As per the eligibility conditions, the lender has to ensure that the borrower account was a classified as MSME loan as on 29.02.2020. Further, on the said reference date, obtaining udhyam registration was not mandatory for the purpose of MSME classification. However, a declaration may be sought from the borrower in this regard that they were eligible to be classified as an MSME on such reference date.

  1. What if an auto loan for commercial use has been given by a Lending Institution? Does it mean that such auto loan is not covered under the specified loan account category?

All automobile loans are covered by the Scheme, whether the vehicle in question is used for personal or for business purposes.

Therefore, auto loans for commercial use shall also qualify as eligible “facility” for the purpose of the scheme.

A similar clarification has been issued subsequently  in MoF FAQs dated 03.11.2020 in FAQ No. 3. [Updated on 04.11.2020]

  1. Will lease transactions be included under the purview of this scheme?

Financial leases or operating leases are not covered under the Scheme.

  1. Will the loan against property (LAP) to individuals qualify as a specified loan account under the scheme?

Loan against property (LAP) is a market term, implying the nature of the security in case of the loan. For the purpose of determining whether the loan is an eligible facility or not, we are not concerned with the nature of the collateral or security. We are concerned with the end-use of the money. Hence, a LAP loan may be a consumption loan, or a business loan to an MSME, or a personal loan to a professional. Therefore, merely because the loan is a LAP, we cannot judge whether it is a qualifying facility or not.

On the other hand, a LAP loan may be given as a business purpose loan to an entity which may not be qualifying as an MSME. In that case, the facility will not qualify.

35A.  Whether loans availed against term deposits are eligible for ex-gratia payment?

Lenders have to consider that the loan account should fall under the specified loan category based on the end use of the loan as well as the type of borrower. The collateral securing such loan is irrelevant.

35B.  Whether micro loans guaranteed by Joint Liability Group (JLG) are covered under the Scheme? 

Individual loans from the eight eligible categories of borrowers, including those categorised as Micro, Small and Medium Enterprises (MSME) by the lending institution, are covered under the scheme irrespective of the nature of
guarantee.  [Mof FAQs dated 04.11.2020]

  1. What is the meaning of the word “professionals” in case of personal loans?

In technical parlance, the word “profession” has a narrow meaning. It mostly means those regulated professions where there is a professional body for the purpose of a recognised profession which entitles the professional to practice the same. Examples may be doctors, chartered accountants, architects, etc. However, in the context of the Scheme, it appears that the word “profession” has been used in the wider sense of a profession, vocation or calling, not being in the nature of business. Such a wide meaning is prevalent under taxation laws for recognition of income under the head “business” or “profession”. There does not seem to be sufficient reason for restricting the meaning of the word “profession” for the purpose of the Scheme to only regulated professions.

Hence, there are two types of loans – business loans, and personal loans. Business loans will qualify for the Scheme if the same is extended to MSMEs. Personal loans, to entities other than those engaged in businesses, may either be a personal loan given to a professional, or a consumption loan to a salaried employee. In our view, both the latter categories will qualify.

  1. A large number of NBFC loans are given to retail and wholesale traders. Do they qualify?

The fact that retail and wholesale traders are excluded from the definition of MSME would imply that they shall not fall under the category of ‘MSME loans’. However, in case the end use of the loan is for consumption by the trader, the same can qualify as ‘consumption loans’

  1. Will a loan given to a practising CA or CS firm qualify as a personal loan to professionals? Can it be classified under the head “MSME loans” in case the firm is registered as MSME?

The loan given to a practicing CA or CS (for purposes other than business) shall qualify as a personal loan to professionals. Further, a loan given to a practising CA/CS firm for business purposes can be classified as ‘MSME loan’ provided the firm is registered as an MSME.

  1. Will the gold loans to individuals fall under the specified loan account category?

The answer to this question is far from clear. On one hand, it is possible to contend that most of the gold loans are, in fact, consumption loans. We have discussed above that what should matter for the purpose of the Scheme is the end use of the loan and not the nature of the collateral. On the other hand, the MoF FAQs have specifically excluded loans taken for investment in financial assets. Gold is not one of the financial assets referred to in the FAQs. However, if the underlying philosophy of the Scheme is considered, gold loans do not seem to be those which were disrupted by the Covid pandemic. In most of the gold loans, there are no periodic payments too – therefore, if the underlying spirit of the Scheme is to relieve the borrower from the burden of compound interest for availing the moratorium, one may have a divergent view in case of gold loans.

Please also see our FAQs on the Covid Moratorium for further discussion about gold loans- http://vinodkothari.com/2020/03/moratorium-on-loans-due-to-covid-19-disruption/

 

Nevertheless, the ministry has also clarified in its FAQs dated 04.11.2020 that Consumptions loans, including those backed by gold as collateral, are eligible under the scheme. [updated on 05.11.2020]

 

  1. Will agri loans/ tractor loans be covered?

Our initial view was that agricultural loan is not specified in the category of specified loans under EGS. However, tractor loans may qualify under the head ‘automobile loans’.

However, FAQs issued by the MoF dated 29.10.2020 has clarified that crop loans and tractor loans etc. are agriculture and allied activities loans and are not part of specified loan accounts. Hence will not qualify under EGS. The ministry’s view seems to be on the presumption that tractors are used for agricultural purposes, whereas it can be used for transport as well. [Revised answer on 30th October 2020].

40A.   Will a tractor loan always be considered as agri loan?

A tractor has dual usage- both for cultivation as well as for travelling. In case a farmer has availed tractor loan and same has been categorised as auto loan considering the end use to be for travelling, there is no reason to exclude such loans from ambit of the Scheme. However, the MoF in its FAQs seems to have taken a view that tractor loans, irrespective of the end use shall not qualify under the Scheme.

  1. Are loans for construction equipment falling under the specified loan account category?

In case the construction equipment loan is availed by an MSME, the same may be categorised under the head ‘MSME loans’. Further, in case the equipment is wheel mounted, the same may be classified as ‘Automobile loans’. Apart from the aforesaid, loan for construction equipment shall not be covered under the Scheme.

  1. What should be the meaning of the term “automobile loans”? Should the word “automobile” be read in the same sense as a vehicle under the Motor Vehicles Act?

In typical industry parlance, the word “automobile loan” or “auto loan” is read in the sense of a loan to purchase a motor vehicle. Hence, for want of a better definition, the word “motor vehicle” as defined in sec. 2 (28) of the Motor Vehicles Act may guide the meaning.

  1. Are working capital loans getting covered under any category?

To the extent the WC loan is to an MSME, the same shall be eligible, otherwise it may not fall in specified loan category under EGS.

  1. Does the specified loan accounts cover unsecured loans given by fintech entities?

Loans given by Fintech entities or Micro Finance Institutions (MFI) may qualify under the EGS as they may be classified as specified loans under ‘consumption loans’ category.

  1. Does EGS cover loans against securities or other movable properties?

As clarified by the MoF in its FAQs, loans against fixed deposits [including Foreign Currency Non-Resident (Bank) {(FCNR(B)} account, bonds and other interest bearing instruments], and shares etc., and loans given for investment in financial assets (shares, debentures etc.) are not eligible for coverage under the EGS.

  1. Will Inter Corporate Deposits (ICD) qualify as specified loan accounts for the purpose of the scheme?

Inter Corporate Deposits made by the lending Institutions to MSMEs shall qualify as specified loan accounts under the Scheme. Any other ICD to non-MSME entity shall not be eligible under EGS.

Other qualifying conditions

  1. A borrower was having standard account classification as on 01.03.2020, but is currently an NPA and the Lending Institution has initiated a recovery mechanism. Is the Lending Institution still required to pass on the benefit of the EGS to such Borrower?

While the benefit of the Scheme is applicable, it does not imply that the ex gratia payment is an outflow to the borrower. That is, the Lending Institution may retain the amount as a payment received from the borrower. Hence, even in case of initiation of recovery proceedings against an eligible borrower, the ex-gratia payment can be retained by the lender and such credit amount could be set off from such lender’s claim.

  1. Assume a borrower had not opted for the moratorium or the moratorium was not granted to the borrower. Hence, EMIs continued to become payable during the Reference Period. The CI is now replaced by SI. Does that mean retrospectively, the CI will have to be replaced by SI, so that the overdue interest or other consequences for default during the Reference Period will also have to be recomputed?

There is no provision for recomputation of the loan obligations. The benefit by the CI shall be provided to the eligible borrowers by transferring their burden of paying interest on interest during the Reference Period only. However, the computation of overdue interest or other consequence based on the then prevailing EMIs will not be reversed.

  1. If a Lending Institution has not charged compound interest on the loan, is it still possible to compute CI and avail of the benefit of the Scheme?

If the terms of the loan are clear that the interest shall be simple interest, then the benefit under the Scheme is not even called for.

  1. In case of EMI-based loans, where there is no formal declaration or disclosure of a compound interest, but an IRR or effective interest rate is computed, can it be implied that there is a compound interest? In essence, can it be contended that IRR and compound interest are the same?

In the cases where an IRR or effective rate is charged from the borrower, the EMI computation already factors the interest compounded over the loan tenure. In case the borrower has availed moratorium, the amount is accrued but not payable.Therefore, interest charged over the interest component of the amount accrued during moratorium period shall be the ex-gratia amount and the same will be credited to borrowers account. In case the borrower has not availed moratorium, the borrower pays the amount on its accrual. The EMI computation however, already considered the compounding effect of the interest. Hence, the ex-gratia amount shall be the interest compounded during the Reference Period.

  1. In several forms of lending, it is a common practice for lenders to charge a “flat rate”, that is, a rate of interest computed with reference to the original loan, even though the borrower continues to pay the EMIs over time. In such a case, is the EGS applicable?

The RBI specifically instructs the lenders to disclose an annualised rate of interest, irrespective of the payment terms. The annualised rate is the IRR which is the contractual term agreed between the parties. Hence, the EGS benefit shall be applicable and the computation of simple interest and compound interest shall be based on such IRR.

51A. What if the contractual rate is 0%, will benefit under the Scheme still be provided?

In case the contractual rate is NIL or 0%, there is no question of granting any benefit to the borrower, given that the borrower has not paid any interest at all. However, in case the loan account falls under the category of consumer durable loan and no interest is charged for a specified period, then lender’s base rate or marginal cost of funds based Lending Rate (MCLR) whichever is applicable shall be considered as on 29.02.2020 to calculate the differential amount of interest. [Updated as of 02.11.2020]

  1. The Scheme provides that in case of consumer loans where there is no interest, there may still be an imputed interest based on the lender’s base rate / MCLR whichever is applicable. Can the same principle be applied in case of loans where only simple interest is charged?

The EGS specifically mentions the treatment in case of consumer durable loans where there is no interest charged by the lender for a specified period. However, in case simple interest has been charged that would essentially mean that the lender has forgone its interest over the accrued interest. Hence, the same shall not be eligible for benefit under the EGS.

  1. What will be eligibility of a borrower under EGS in any of two scenarios covered below?

Scenario 1: The borrower has taken moratorium benefit until the first three months under moratorium scheme, i.e. from 01.03.2020 till 31.05.2020.

Scenario 2: The borrower has taken the moratorium benefit for the last three months of the moratorium scheme, i.e. from 01.06.2020 till 31.08.2020.

Yes, the borrower shall be eligible for ex-gratia payment in both of the scenarios mentioned above. The Ex-gratia scheme is applicable on all the specified loan accounts, whether moratorium benefit is completely availed, or partially availed, or not availed at all.

All the payments made by such a borrower towards its eligible loan account between 01.03.2020 and 31.08.2020 will be ignored. For the purpose of uniformity, the difference between compound interest and simple interest is to be reckoned at an outstanding amount as on 29.02.2020 for a period of six months.

  1. Will it be right to say that all specified accounts of eligible borrowers are entitled for Ex-gratia payment under the scheme, irrespective of whether payment deferment have been availed or not under the moratorium scheme?

Yes, all the specified loan accounts of eligible borrowers are entitled to ex gratia payment under the Ex-gratia Scheme.

  1. Will the lending institutions continue to charge over dues and other penal interest on borrower’s account even including those to whom the benefit is granted under the scheme?

Yes. The ex-gratia scheme’s objective is to pass the differential benefit of compound interest and simple interest in specified loan accounts by crediting such loan accounts of eligible borrowers.

All the over dues charges and other penal interest shall continue to apply on all borrowers as may be applicable.

  1. What are the rates of interest on which the difference between compound interest and simple interest on the amount outstanding as on 29.02.2020 will be calculated?

The rate of interest would be prevailing as on 29.02.2020, any change thereafter shall not be reckoned for purpose of computation. Additionally penal interest rate or late payment penalty not to be included as contracted rate or WALR.

A ready reference on manner of determining the rate of interest on eligible loans has been provided in image below:

Time Periods under the Ex-gratia Scheme

  1. What is the time period for credit/payment of an ex-gratia amount by the lender?

The scheme provides that the exercise of crediting the amount under the scheme shall be completed by respective lending institutions on or before 05.11. 2020.

Therefore, the amount under this Ex-gratia scheme has to be credited to the borrower’s account by the lending institutions within the stipulated time.

  1. What shall be the compounding frequency if the loan agreement/document provides that interest shall be compounded semi-annually or quarterly?

The operational guidelines of the scheme in para 7 provides the manner of claiming reimbursement. As under the scheme compound interest shall be reckoned on a monthly basis, except where the contrary is provided. Therefore, where a contractual term specifically provides that the annualised rate should have quarterly or semi annually resets then in all such cases the adjustment shall be given to the same. If the contract or document is silent on the same the compound interest shall be calculated based on monthly resets.

  1. What would be the change in ex-gratia payout if loan installments are payable quarterly or semi-annually?

The payment of loan installment interval i.e. either monthly / semi-annually or  quarterly will have no effect on ex-gratia payment computation if the interest rate is compounded with monthly resets.

Modus operandi for passing on the benefit to the Borrowers

  1. Does this Ex-gratia Scheme mean that no interest will be charged by the lending institutions for the period of 01.03.2020 till 31.08.2020 on specified loan accounts?

No, this Ex-gratia scheme is in the form of waiver of interest on interest in the specified loan account category, irrespective of whether moratorium benefit was extended/availed completely, partially or not availed at all on such loan accounts.

Therefore, all the eligible borrowers in specified loan accounts will receive payment under the Scheme from their respective lending institution. The credit amount would be such part of interest which would have been chargeable by the lending institutions on the accrued interest component during the six months deferment period from 29.02.2020 till 31.08.2020. That is the difference between the Compound interest and Simple Interest on the outstanding amount will be payable by the lending institution which shall be reimbursed to them by the Government.

Illustration:

Outstanding loan amount in the specified loan account as on 29.02.2020 was Rs. 1,00,000 (Rupees One Lakh).

Interest Rate as applicable on such a loan account as on 29.02.2020 is taken @ 10% annualised rate, compounded monthly.

Therefore, the balance 105.33/- shall be credited to the specified account of the borrower by the lending institution.

  1. What is the exact manner of passing on the benefit to the borrower? Is it merely a credit to the account of the borrower, or does it lead to any cash benefit being transferred to the borrower?

In our view, the Scheme is simply a limited relief on compound interest. The interest differential as computed under the Scheme is simply credited to the account of the borrower by the 05.11.2020 as specified. Crediting the amount does not mean any actual cash transfer. The interest differential is treated as an amount paid by the borrower. The question of any refund will arise only if the outstanding amount by the borrower is less than the amount of the differential, or the account is fully squared off.

  1. The borrower’s account has a principal outstanding, but no EMIs or other sums are currently due. In that case, what is the treatment of the interest differential?

If there are no currently dues by the borrower, the interest differential may be treated as a payment of principal by the borrower. Of course, it will be counter-intuitive to apply the clauses pertaining to prepayment, for instance, a prepayment penalty..

  1. A borrower loan account has been closed in the books of the lending institution as on 30.04.2020. However, the borrower was eligible under the scheme as on 29.02.2020. Will the borrower receive any benefit under the Scheme?

Since the eligibility is to be determined as on 29.02.2020, the fact that the loan account has been closed should not deprive the borrower of the benefit under the Scheme.

Such borrowers are eligible for refund of differential interest from 01.03.2020 upto the date of closure of account.

Illustration

The outstanding amount in a specified loan account as on 29.02.2020 is Rs. 1,00,000 (Rs. One Lakhs Only). The borrower paid all the dues towards the loan amount by 30.04. 2020. The contracted annualised rate compounded monthly as on 29.02.2020 is at 10%.

The ex-gratia payment as under the scheme guidelines should be as follows:

Therefore, the borrower shall be entitled to Rs. 6.94 under the ex-gratia scheme.

It will be credited to the borrower’s savings/ current account. If no such account is maintained by the borrower with the lending institution, the borrower can advise the lending institution the details of the account in other banks where the amount can be credited /remitted to.

63A. Will the treatment of loans that have matured during 01.03.20 to 31.08.20 but are still active in system due to some pending charges, be same as closed loans?

If the loan has been closed during the reference period, and there are pending charges, the treatment shall be the same as a foreclosed account. Accordingly, the credit for differential interest amount can be adjusted with the overdues.

63B.  What if the loan is closed in between the month (say 20th of April) how to compute compound interest in such a situation?

The interest shall be computed for the broken period by converting the number of days into a fraction of the month. The same can be done by dividing the number of days by 30 (considering a month has 30 days on average).

63C. A specified loan account is transferred to another lending institution during the period between 01.03.2020 to 31.08.2020. Which lending institution will provide ex-gratia benefit to the customer?

The transferor lending institution shall provide the benefit to the customer. The reference period for calculating compound interest and simple interest differential amount will be from 01.03. 2020 till the date such loan account is tranferred.

  1. In case the borrower account has been closed, can the difference amount be retained by the Lending Institution as repayment by Borrower?

Yes, if there is an amount pending to be paid by the borrower.

64A. In case the account is foreclosed during the Reference Period, will the benefit of this scheme be applicable?

On October 29, 2020, the Department of Financial Services issued a set of FAQs, which state that for the accounts foreclosed during the Reference Period, the benefit of the scheme shall be available.

  1. Does the outstanding amount as on 29.02.2020 include overdue instalments or any other overdue charges such as overdue interest, penalty, etc?

The amount outstanding as on 29th Feb would include all amounts showing as outstanding from the borrower. If the overdue interest or any other charges have been debited to the loan account, and are shown as a part of the outstanding, in the loan account of the borrower, in our view, the same should form part of the reference amount, both for reckoning the limit of Rs 2 crores, as also for computing the interest differential. [Revised answer on 29th October 2020]

  1. Will it be possible for the lenders to ensure the credit of the differential amount to all the borrowers before 05.11.2020?

The determination of the eligible borrowers, the computation of the differential amount and the process of crediting the same to their respective accounts will be a cumbersome and lengthy process. It will be a burden for the lending institutions and seemingly the Government may have to extend the timelines.

Modus operandi for claiming the payment from the CG

  1. Where shall the lending institutions file their reimbursement claims after crediting the ex-gratia amounts in specified accounts of eligible borrowers?

The claims shall be submitted to the designated officer (s) /cell   at State Bank of India (SBI). The SBI shall act as a nodal agency of the Central Government for settlement of all the claims of lending institutions.

  1. What are the procedures to be followed by lending institutions for reimbursement of claims processing?

The following timelines and procedures need to be complied by all the lending institutions falling under the scheme.

  • The last date for filing claims of reimbursement of amounts credited to specified loan accounts of eligible borrowers is by 15.12.2020.
  • The reimbursement claim amount should be pre-audited by a statutory auditor of the lending institution.
  • A certificate by an auditor shall be attached with the claim.

68A.  In co-lending transactions, can one entity pass on the benefit to borrower and get the  credit from CG?, or same shall be availed from CG in the ratio of disbursement?

In co-lending transaction, the primary co-lender may pass on the benefit to the borrower on behalf of both the lenders and reclaim the same from the CG at the blended rate of interest. The claim amounts once received from CG shall be shared subsequently in the ratio agreed under the terms of co-lending.

Grievance Redressal Mechanism

  1. What is the timeline for lending institutions to address grievances of borrowers? 

As under the operational guidelines of the EGS, each lending institution is required to put in place a grievance redressal mechanism for eligible borrowers within one week from date of issuance of ex-gratia guidelines i.e. latest by 30.10.2020.

  1. Lending institutions usually have a grievance redressal mechanism in place. Is there a need to establish a separate mechanism for the purpose of this scheme?

The scheme does not require the lenders to develop a separate mechanism for redressal of grievances arising due to the scheme. The same may be a part of the existing grievance redressal mechanism of the lender. However, the scheme states that the lenders can consider communication dated 1.10.2020 from the Indian Banks’ Association (IBA) in respect of the resolution framework for COVID-19 related stress.

​For the purpose of incorporating the ​aforesaid​ in the existing grievance redressal mechanism, ​necessary ​communication in this regard may be circulated internally​ by the Nodal Officer or such other personnel authorised under the Grievance Redressal Policy of the lending institution​.

  1. What are the requirements under the abovementioned communication from IBA?

The said communication form the IBA lays down the following:

  • A web-based platform shall be developed for automatic lodgement and handling of grievances. The grievances may be received on the said portal/branch office of the lender. Grievances received at the branch should also be fed into the portal and the system shall generate a digital receipt for the customer.
  • The grievances should be directly handled at zonal/circle level based on the hierarchical structure of the lender. Preliminary remarks should be provided to the customer within a maximum of 72 hours by the Nodal Officer and final response should be provided within 7 working days.
  • Escalation matrix may be provided separately for different kinds of loans such as for retail and commercial banking customers. The grievance related to commercial loans may be handled at a higher level.
  • The framework should provide for re-opening of the grievance if the customer is not satisfied by the response.
  • A dashboard on the status of grievances viz. no. of grievances received, pending status etc. should also be made available to controllers/regulators for close monitoring.
  1. Is it mandatory to abide by the above guidelines provided by the IBA?

The scheme does not mandate compliance of the guidelines from the IBA. However, the same may be mandatory for the banks who are members of the IBA (owing to their membership) and recommendatory for other lending institutions.

  1. What are the remedies for a lending institution having grievances concerning the Scheme?

Grievances of lending institutions shall be resolved through designated cell at State Bank of India (SBI) in consultation with the Ministry of Finance, GoI. However in respect to the issues/queries related to interpretation of the scheme, the decision of GoI shall be final.

 

The timeline below summarises the important dates to be abided by Lending Institutions under the ex-gratia scheme.

 

Calculation Table-

 

[1] Our write up ‘Moratorium Scheme: Conundrum of Interest on Interest’ dated 16-09-2020, <http://vinodkothari.com/2020/09/moratorium-scheme-conundrum-of-interest-on-interest/>

[2] Operational guidelines on ex-gratia payment scheme  dated 23-10-2020, <https://financialservices.gov.in/sites/default/files/Scheme%20Letter.pdf>

[3] Department of Financial Services GOI notification dated 26.10.2020 < https://financialservices.gov.in/sites/default/files/FAQs%20on%20Ex%20gratia%20Package_26.10.2020_v1.pdf>; Department of Financial Services GOI notification dated 29.10.2020 <https://financialservices.gov.in/sites/default/files/FAQs.pdf>;

Department of Financial Services GOI notification dated 03.11.2020

<https://financialservices.gov.in/sites/default/files/FAQs%20dated%203.11.2020.pdf>; Department of Financial Services GOI notification dated 04.11.2020 <https://financialservices.gov.in/sites/default/files/FAQ_4.11.2020-converted.pdf>

[4] Writ Petition(s)(Civil) No(s). 825/2020; Supreme Court of India

[5] FAQs on moratorium- http://vinodkothari.com/2020/03/moratorium-on-loans-due-to-covid-19-disruption/

[6] FAQs on moratorium 2.0- http://vinodkothari.com/2020/05/moratorium-2-0-on-term-loans-and-working-capital/

 

Other Related Write-ups:

 

 

Modes of Restructuring of Stressed Accounts

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

 

RBI refines the role of the Compliance-Man of a Bank

Notifies new provisions relating to Compliance Functions in Banks and lays down Role of CCO.

By:

Shaivi Bhamaria | Associate

Aanchal Kaur Nagpal | Executive

Introduction

The recent debacles in banking/shadow banking sector have led to regulatory concerns, which are reflected in recent moves of the RBI. While development of a robust “compliance culture” has always been a point of emphasis, RBI in its Discussion Paper on “Governance in Commercial Banks in India’[1] [‘Governance Paper’] dated 11th June 2020 has dealt extensively with the essentials of compliance function in banks.  The Governance Paper, while referring to extant norms pertaining to the compliance function in banks, viz. RBI circulars on compliance function issued in 2007[2] [‘2007 circular’] and 2015[3] [‘2015 circular’], placed certain improvement points.

In furtherance of the above, RBI has come up with a circular on ‘Compliance functions in banks and Role of Chief Compliance Officer’ [‘2020 Circular’] dated 11th September, 2020[4], these new guidelines are supplementary to the 2007 and 2015 circulars and have to be read in conformity with the same. However, in case of or any common areas of guidance, the new circular must be followed.  Along with defining the role of the Chief Compliance Officer [‘CCO’], they also introduce additional provisions to be included in the compliance policy of the Bank in an effort to broaden and streamline the processes used in the compliance function.

Generally, in compliance function is seen as being limited to laying down statutory norms, however, the importance of an effective compliance function is not unknown. The same becomes all-the-more paramount in case of banks considering the critical role they play in public interest and in the economy at large. For a robust compliance system in Banks, an independent and efficient compliance function becomes almost indispensable. The effectiveness of such a compliance function is directly attributable to the CCO of the Bank.

Need for the circular

The compliance function in banks is monitored by guidelines specified by the 2007 and 2015 circular. These guidelines are consistent with the report issued by the Basel Committee on Banking Supervision (BCBS Report)[5] in April, 2005.

While these guidelines specify a number of functions to be performed by the CCO, no specific instructions for his appointment have been specified. This led to banks following varied practices according to their own tailor-made standards thus defeating the entire purpose of a CCO. Owing to this, RBI has vide the 2020 circular issued guidelines on the role of a CCO, in order to bring uniformity and to do justice to the appointment of a CCO in a bank.

Background of CCOs

The designation of a CCO was first introduced by RBI in August, 1992 in accordance with the recommendations of the Ghosh Committee on Frauds and Malpractices in Banks. After almost 15 years, RBI introduced elaborate guidelines on compliance function and compliance officer in the form of the 2007 circular which was in line with the BCBS report.

According to the BCBS report:

‘Each bank should have an executive or senior staff member with overall responsibility for co-ordinating the identification and management of the bank’s compliance risk and for supervising the activities of other compliance function staff. This paper uses the title “head of compliance” to describe this position’.

Who is a CCO and how is he different from other compliance officials?

The requirement of an individual overseeing regulatory compliance is not unique to the banking sector. There are various other laws that the provide for the appointment of a compliance officer. However, there is a significant difference in the role which a CCO is expected to play. The domain of CCO is not limited to any particular law or its ancillaries, rather, it is all pervasive. He is not only responsible for heading the compliance function, but also overseeing the entire compliance risk[6] in banks.

Role of a CCO in a Bank:

The predominant role of a CCO is to head the compliance function in a Bank. The 2007 circular lays down the following mandate of a CCO:

  1. overall responsibility for coordinating the identification and management of the bank’s compliance risk and supervising the activities of other compliance function staff.
  2. assisting the top management in managing effectively the compliance risks faced by the bank.
  3. nodal point of contact between the bank and the RBI
  4. approving compliance manuals for various functions in a bank
  5. report findings of investigation of various departments of the bank such as at frequent intervals,
  6. participate in the quarterly informal discussions held with RBI.
  7. putting up a monthly report on the position of compliance risk to the senior management/CEO.
  8. the audit function should keep the Head of compliance informed of audit findings related to compliance.

The 2020 circular adds additional the following responsibilities on the CCO:

  1. Design and maintenance of compliance framework,
  2. Training on regulatory and conduct risks,
  3. Effective communication of compliance expectations

Selection and Appointment of CCO:

The 2007 circular is ambiguous on the qualifications, roles and responsibilities of the CCO. In certain places the CCO was referred to as the Chief Compliance officer and some places where the words compliance officer is used. This led to difficulty in the interpretation of aspects revolving around a CCO. However, the new circular gives a clear picture of the expectation of RBI from banks in respect of a CCO. The same has been listed below:

Basis 2020 circular 2007 circular
Tenure Minimum fixed tenure of not less than 3 years The Compliance Officer should be appointed for a fixed tenure
Eligibility Criteria for appointment as CCO The CCO should be the senior executive of the bank, preferably in the rank of a General Manager or an equivalent position (not below two levels from the CEO). The compliance department should have an executive or senior staff member of the cadre not less than in the rank of DGM or equivalent designated as Group Compliance Officer or Head of Compliance.
Age 55 years No provision
Experience Overall experience of at least 15 years in the banking or financial services, out of which minimum 5 years shall be in the Audit / Finance / Compliance / Legal / Risk Management functions. No provision

 

Skills Good understanding of industry and risk management, knowledge of regulations, legal framework and sensitivity to supervisors’ expectations No provision
Stature The CCO shall have the ability to independently exercise judgement. He should have the freedom and sufficient authority to interact with regulators/supervisors directly and ensure compliance No provision
Additional condition No vigilance case or adverse observation from RBI, shall be pending against the candidate identified for appointment as the CCO. No provision
Selection* 1.      A well-defined selection process to be established

2.      The Board must be required to constitute a selection committee consisting of senior executives

3.      The CCO shall be appointed based on the recommendations of the selection committee.

4.      The selection committee must recommend the names of candidates suitable for the post as per the rank in order of merit.

5.      Board to take final decision in the appointment of the CCO.

No provision
Review of performance appraisal The performance appraisal of the CCO should be reviewed by the Board/ACB No provision
Reporting lines The CCO will have direct reporting lines to the following:

1.      MD & CEO and/or

2.      Board or Audit Committee

No provision
Additional reporting In case the CCO reports to the MD & CEO, the Audit Committee of the Board is required to meet the CCO quarterly on one-to-one basis, without the presence of the senior management including MD & CEO. No provision
Reporting to RBI 1.      Prior intimation is to be given to the RBI in case of appointment, premature transfer/removal of the CCO.

2.      A detailed profile of the candidate along with the fit and proper certification by the MD & CEO of the bank to be submitted along with the intimation, confirming that the person meets the supervisory requirements, and detailed rationale for changes.

No provision
Prohibitions on the CCO 1.      Prohibition on having reporting relationship with business verticals

2.      Prohibition on giving business targets to CCO

3.      Prohibition to become a member of any committee which brings the role of a CCO in conflict with responsibility as member of the committee. Further, the CCO cannot be a member of any committee dealing with purchases / sanctions. In case the CCO is member of such committees, he may play only an advisory role.

No provision

*The Governance paper had proposed that the Risk Management Committee of the Board will be responsible for selection, oversight of performance including performance appraisals and dismissal of a CCO. Further, any premature removal of the CCO will require with prior board approval. [Para 9(6)] However, the 2020 circular goes one step further by requiring a selection committee for selection of a CCO.

Dual Hatting

Prohibition of dual hatting is already applicable on the Chief Risk Officer (‘CRO’) of a bank. The same has also been implemented in case the of a CCO.

Hence, the CCO cannot be given any responsibility which gives rise to any conflict of interest, especially the role relating to business. However, roles where there is no direct conflict of interest for instance, anti-money laundering officer, etc. can be performed by the CCO. In such cases, the principle of proportionality in terms of bank’s size, complexity, risk management strategy and structures should justify such dual role. [para 2.11 of the 2020 circular] 

Role of the Board in the Compliance function

Role of the Board

The bank’s Board of Directors are overall responsible for overseeing the effective management of the bank’s compliance function and compliance risk.

Role of MD & CEO

The MD & CEO is required to ensure the presence of independent compliance function and adherence to the compliance policy of the bank.

Authority:

The CCO and compliance function shall have the authority to communicate with any staff member and have access to all records or files that are necessary to enable him/her to carry out entrusted responsibilities in respect of compliance issues.

Compliance policy and its contents

The 2007 circular required banks to formulate a Compliance Policy, outlining the role and set up of the Compliance Department.

The 2020 circular has laid down additional points that must be covered by the Compliance Policy. In some aspects, the 2020 circular provides further measures to be taken by banks whereas in some aspects, fresh points have been introduced to be covered in the compliance policy, these have been highlighted below:

1. Compliance philosophy: The policy must highlight the compliance philosophy and expectations on compliance culture covering:

  • tone from the top,
  • accountability,
  • incentive structure
  • Effective communication and Challenges thereof

2. Structure of the compliance function: The structure and role of the compliance function and the role of CCO must be laid down in the policy

3. Management of compliance risk: The policy should lay down the processes for identifying, assessing, monitoring, managing and reporting on compliance risk throughout the bank.

The same should adequately reflect the size, complexity and compliance risk profile of the bank, expectations on ensuring compliance to all applicable statutory provisions, rules and regulations, various codes of conducts and the bank’s own internal rules, policies and procedures and must create a disincentive structure for compliance breaches.

4. Focus Areas: The policy should lay special thrust on:

  • building up compliance culture;
  • vetting of the quality of supervisory / regulatory compliance reports to RBI by the top executives, non-executive Chairman / Chairman and ACB of the bank, as the case may be.

5. Review of the policy: The policy should be reviewed at least once a year

Quality assurance of compliance function

Vide the 2020 circular, RBI has introduced the concept of quality assurance of the compliance function Banks are required to develop and maintain a quality assurance and improvement program covering all aspects of the compliance function.

The quality assurance and improvement program should be subject to independent external review at least once in 3 years. Banks must include in their Compliance Policy provisions relating to quality assurance.

Thus, this would ensure that the compliance function of a bank is not just a bunch of mundane and outdated systems but is improved and updated according to the dynamic nature of the regulatory environment of a bank.

Responsibilities of the compliance function

In addition to the role of the compliance function under the compliance process and procedure as laid down in the 2007 the 2020 circular has laid down the below mentioned duties and responsibilities of the compliance function:

  1. To apprise the Board and senior management on regulations, rules and standards and any further developments.
  2. To provide clarification on any compliance related issues.
  3. To conduct assessment of the compliance risk (at least once a year) and to develop a risk-oriented activity plan for compliance assessment. The activity plan should be submitted to the ACB for approval and be made available to the internal audit.
  4. To report promptly to the Board/ Audit Committee/ MD & CEO about any major changes / observations relating to the compliance risk.
  5. To periodically report on compliance failures/breaches to the Board/ACB and circulating to the concerned functional heads.
  6. To monitor and periodically test compliance by performing sufficient and representative compliance testing. The results of the compliance testing should be placed before the Board/Audit Committee/MD & CEO.
  7. To examine sustenance of compliance as an integral part of compliance testing and annual compliance assessment exercise.
  8. To ensure compliance of Supervisory observations made by RBI and/or any other directions in both letter and spirit in a time bound and sustainable manner.

 Actionables by Banks:

Links to related write ups –

[1] https://www.rbi.org.in/Scripts/BS_PressReleaseDisplay.aspx?prid=49937

[2] https://www.rbi.org.in/Scripts/NotificationUser.aspx?Id=3433&Mode=0

[3] https://www.rbi.org.in/Scripts/NotificationUser.aspx?Id=9598&Mode=0

[4] https://www.rbi.org.in/Scripts/NotificationUser.aspx?Id=11962&Mode=0

[5] https://www.bis.org/publ/bcbs113.pdf

[6]  According to BCBS report, compliance risk is the risk of legal or regulatory sanctions, material financial loss, or loss to reputation a bank may suffer as a result of its failure to comply with laws, regulations, rules, related self-regulatory organization standards, and codes of conduct applicable to its banking activities”

The new PSL Master Direction and its Impact on NBFCs

-Siddharth Goel (finserv@vinodkothari.com)

Introduction

The Reserve Bank of India (RBI) issued Master Directions-Priority Sector Lending (PSL) Targets and Classification on September 4, 2020 (‘Master Directions’).[1] The Master Directions consolidates various circulars and guidelines issued by RBI with respect to PSL.

The changes made in the Master Directions primarily deal with targets and sub-targets for classification of loans as priority sector loans. Further there are some addition of new sectors in Eligible categories, along with increase in lending limit of some of the existing eligible categories for priority sector lending.

Our detailed write-up on the topic can be viewed here.

Changes in priority sector norms do not have a direct impact on the NBFCs, but they have an indirect impact. Banks are allowed to acquire loans under Direct Assignment arrangements or invest in pass through certificates backed by loans which qualify the definition of PSL, in order to meet the prescribed targets. Mostly, the banks acquire these receivables from NBFCs who does the origination of the loans. Additionally, banks also engage in co-lending arrangements with NBFCs to originate PSLs. Therefore, it is worthwhile to examine the impact of these changes on NBFCs.

Co-origination of loans by Banks for lending to Priority Sector

RBI through its vide notification RBI/2018-19/49 dated September 21, 2018 issued guidelines on Co-origination of loans by Commercial Banks and NBFC-ND-SI (“Co-origination Guidelines”).[2] These guidelines excluded Regional Rural Banks (RRBs) and Small Finance Banks (SFBs). Essentially, the banks could claim priority sector status in respect of its share of credit while engaging in the co-origination arrangement with NBFC under the Co-origination Guidelines. Provided, the priority sector assets on the bank’s books should at all times be without recourse to the NBFC.

It is pertinent to note that the PSL Master Directions under its para 25 covers Co-origination of loans by Banks and NBFC-ND-SI. The Master Direction specifically excludes, RRBs SFBs and Urban Co-Operative Banks (UCBs) and Local Area Banks (LABs) under the above para. Moreover, the Master Directions under the said para, specifically stipulates that detailed guidelines in this regard are to be governed as provided under Co-origination Guidelines dated September 21, 2018. Hence there are no changes intended to be introduced vis-a-vis Master Direction, to the co-origination of loans by banks and NBFCs.

PSL- Lending by Banks to NBFCs for On-Lending

In the earlier regime, after the review of Priority sector lending by banks to NBFC for On-Lending notification dated August 13, 2019[3], RBI through its notification dated March 23, 2020,[4] extend the priority sector classification for bank loans to NBFCs for on-lending for the FY 2020-21. Further, existing loans disbursed under the on-lending model continued to be classified under Priority Sector till the date of repayment/maturity. The extension notification also stipulated an overall capping limit for calculating bank’s total priority sector lending as produced herein below;

“3. Bank credit to registered NBFCs (other than MFIs) and HFCs for on-lending will be allowed up to an overall limit of five percent of individual bank’s total priority sector lending. Further, banks shall compute the eligible portfolio under on-lending mechanism by averaging across four quarters, to determine adherence to the prescribed cap.”

Para 22 of the Master Directions governs Bank loans to registered NBFCs (other than MFIs). It is highlighted that there is no change in sub-category for On-lending by NBFC, and limits also remain unchanged. The above para in the Master Direction, clearly stipulates that on-lending will be eligible for classification as priority sector under respective categories which is subject to the following conditions:

(i) Agriculture: On-lending by NBFCs for ‘Term lending’ component under Agriculture will be allowed up to ₹ 10 lakh per borrower.

(ii) Micro & Small enterprises: On-lending by NBFC will be allowed up to ₹ 20 lakh per borrower.

The above dispensation is valid up to March 31, 2021 and will be reviewed thereafter. However, loans disbursed under the on-lending model will continue to be classified under Priority Sector till the date of repayment/maturity. Caping of overall limit of Bank Credit to 5 percent has been prescribed under para 24 of the Master Directions.

Investments by Banks in Securitised Assets & Direct Assignment

Investments by banks in securitised assets or assignment/outright purchase of a pool of assets, representing loans by banks and financial institutions to various categories of priority sector, except ‘others’ category, are eligible for classification under respective categories of priority sector depending on the underlying assets. However, earlier the requirement was that the interest rate charged to the ultimate borrower in securitised assets and in case of transfer of assets through direct assignment, shall be capped at Base Rate of the investing bank plus 8 percent per annum.

Therefore, investments by banks, in securitised assets and purchase of assets originated by NBFCs in eligible sectors had to comply with above capping in order to qualify as eligible for PSL. To encourage MSME lending in smaller areas where cost of intermediation is high for the smaller NBFCs, the UK Sinha committee in its report has proposed the cap at Base Rate of the investing bank plus 12% per annum initially and periodical review thereafter. The intent of the recommendation stood on the grounds that price caps are not applicable to banks when they originate directly through branches.

Accordingly, such capping limit has been relaxed and as per the as per the revised requirement the all-inclusive interest charged to the ultimate borrower by the originating entity should not exceed the External Benchmark Lending Rate (EBLR)/ MCLR of the investing bank plus appropriate spread which will be communicated separately. It is expected that the RBI shall be separately communicating the limits to the banks.

The aforesaid relaxation in the interest rate capping would widen the eligibility of loans originated by the NBFCs for securitisation and direct assignment to banks, for meeting the PSL requirement.

Adjustments for weights in PSL Achievement

To address the regional disparities in flow of credit at the district level, currently districts have been ranked on the basis of per capita credit flow. Higher weight (125%) is assigned to the incremental priority sector credit in districts with low per capita credit flow. Similarly, lower weight (90%) has been assigned to incremental PSL in districts with comparatively higher credit flow. The higher PSL credit (125 %) districts are specified in ANNEX-I A and districts with comparatively low PSL credit (90%) are specified in ANNEX-IB of the Master direction. Districts not mentioned in either of the Annex will be having weightage of 100%. PSL incremental credit shall be applicable from F.Y. 2021-2022 onwards.

Thus, for the purpose of above incentives, banks will get incremental PSL credit, if they invest as following:

  • Investment in securitsed assets/direct assignment/outright purchase, of loans originated by NBFCs from high priority districts. The entire investment in PTCs made by the banks, the proportion which is represented by those as priority districts will be weighted at 125% and low priority districts at 90% and others at 100%.
  • On-lending by Banks to NBFCs, wherein NBFCs are further lending in districts with high priority.
  • Incremental credit incentive will be available to Banks, on proportion of their share of loans, to district with high priority under Co-Origination model.

Impact of new Master Directions on NBFCs

The new Master Direction does not seem to impact legal relationship between banks and NBFCs in respect to co-origination of loans and co-lending materially, since all the regulations are similar to the earlier PSL regime. However, the incentives introduced by way of incremental PSL credit to Banks will channel the credit to districts with low credit penetration. Therefore, banks will be benefitted by dealing with NBFCs having portfolio of loans (eligible for PSL) and presence in districts with lower credit penetration.

Further, change in capping, of investments by Banks in securitised assets and direct assignment/ outright purchase of loans, originated by NBFCs is intended to cover loans originated with higher spreads. Further lending to new sub sectors introduced through Master Direction, would also qualify towards PSL target investments by Banks.

The indicative list of new sub-sectors and sub-sectors with enhanced credit limit is reproduced herein below for ready reference.

Agriculture Lending Including Farm Credit (Allied Activities), lending for Agriculture Infrastructure and Ancillary Activities. ·        Inclusion of loans to farmers for installation of stand-alone Solar Agriculture Pumps and for solarisation of grid connected Agriculture Pumps.

·        Inclusion of loans to farmers for installation of solar power plants on barren/fallow land or in stilt fashion on agriculture land owned by farmer

·        Inclusion of loans up to ₹50 crore to Start-ups, as per definition of Ministry of Commerce and Industry, Govt. of India that are engaged in agriculture and allied services.

·        Inclusion of loans up to ₹2 lakh to individuals solely engaged in Allied activities without any accompanying land holding criteria. This change is in line with recommendation by M.K. Jain Committee7.

·        Inclusion of loans for construction of oil extraction/ processing units for production of bio-fuels, their storage and distribution infrastructure along with loans to entrepreneurs for setting up Compressed Bio Gas (CBG) plants.

·        Laying of Indicative list conveying permissible activities under Food Processing Sector as recommended by Ministry of Food Processing Industries.

·        A credit limit of ₹5 crore per borrowing entity has been specified for Farmers Producers Organisations (FPOs)/Farmers Producers Companies (FPCs) undertaking farming with assured marketing of their produce at a pre-determined price. This inclusion is as per the M.K Jain Committee Recommendations8.

 

Other Finance to MSMEs In line with the series of benefits being extended to MSMEs, loans up to ₹50 crore to Start-ups, as per definition of Ministry of Commerce and Industry, Govt. of India that confirm to the definition of MSME has been included under the PSL catergory. (On the basis of recommendations by UK Sinha Committee, to financially incentivise the startups in India)

 

 

Housing Loans

 

·        Increase in Loans up to ₹ 10 lakh (earlier ₹ 5 lakh) in metropolitan centres and up to ₹6 lakh (earlier 2 ₹ Lakh) in other centres for repairs to damaged dwelling units.

·        Bank loans to governmental agency for construction of dwelling units or for slum clearance and rehabilitation of slum dwellers subject to dwelling units with carpet area of not more than 60 square meters. Under the earlier regime, it was based on cost of dwelling unit which was ₹ 10 lakh per unit.

·        Inclusion of bank loans for affordable housing projects using at least 50% of FAR/FSI (Floor Area Ratio/ Floor Space Index) for dwelling units with carpet area of not more than 60 sq.m.

 

Social Infrastructure

 

Inclusion of loans up to a limit of ₹ 10 crore per borrower for building health care facilities including under ‘Ayushman Bharat’ in Tier II to Tier VI centres. This is in addition to the existing limit of ₹5 crore per borrower for setting up schools, drinking water facilities and sanitation facilities including construction/ refurbishment of household toilets and water improvements at household level, etc.

 

Renewable Energy Increase in loan limit to ₹ 30 Crore for purposes like solar based power generators, biomass-based power generators, wind mills, micro-hydel plants and for non-conventional energy based public utilities etc. This is to boost renewable energy sector, the earlier limit was up to ₹ 15 Crore.

 

 

[1]https://rbidocs.rbi.org.in/rdocs/notification/PDFs/MDPSL803EE903174E4C85AFA14C335A5B0909.PDF

[2] https://rbidocs.rbi.org.in/rdocs/notification/PDFs/NT49BAA4688D36A64EAF8DB0BFD99C6FC54C.PDF

[3] https://www.rbi.org.in/Scripts/NotificationUser.aspx?Id=11659&Mode=0

[4] https://www.rbi.org.in/scripts/FS_Notification.aspx?Id=11828&fn=2754&Mode=0

 

Our related write-ups

 

 

PSL guidelines reviewed for wider credit penetration

By Siddarth Goel (finserv@vinodkothari.com)

Introduction

The Reserve Bank of India (RBI) issued Master Directions-Priority Sector Lending (PSL) Targets and Classification on September 4, 2020 (‘Master Directions’)[1]. The Master Directions are in the nature of a consolidating piece, of various circulars and guidelines issued by RBI in regard to PSL. The objective of Master Directions is to harmonise instructions guidelines for Commercial Banks[2], Small Finance Banks (“SFB”)[3], Regional Rural Banks (“RRBs”)[4], Urban Co-Operative Banks (“UCBs”)[5] and Local Area Banks (“LABs”) for PSL targets and classification under single universe.

The objective of Master Directions is to consolidate all the concerning circulars to PSL under one master direction. However, certain changes have been introduced under the Master Directions in line with the recommendations of Expert Committee on Micro, Small and Medium Enterprises (Chairman: Shri U.K. Sinha) and the ‘Internal Working Group to Review Agriculture Credit’ (Chairman: Shri M. K. Jain).

This write up endeavors to highlight major changes which has been implemented through the said Master Direction that were not forming part of the erstwhile notifications or guidelines in this regard.

Changes in Targets / Sub-targets Classification for Priority Sector

The targets and sub-targets set under priority sector lending is computed on the percentage basis of Adjusted Net Bank Credit (ANBC)/ Credit Equivalent of Off-Balance Sheet Exposures (CEOBE). The Master Directions, has increased the total priority sector lending target for Urban Co-Operative Banks, which is to be achieved through milestones-based targets in a phased manner. Further there has been increase in targets for advances to weaker sections and Small Farmer Margins (SMF) in the agriculture sector. The table below summarises the changes along with timelines for complying with Targets/Sub-targets for PSL.

Categories Domestic Commercial Banks Small Finance Banks RRB Urban Co-Operative Bank#
Total Priority Sector No change No Change No Change Increased in total priority sector target from 40 % to 75% of ANBC or CEOBE whichever is higher.
Advances to Weaker Sections Target * Increased to 12% of ANBC or CEOBE, whichever is higher.

[earlier target was 10%]

Increased to 12% of ANBC or CEOBE, whichever is higher.

[earlier target was 10%]

No Change Increased to 12% of ANBC or CEOBE, whichever is higher.

[earlier target was 10%] 

Agriculture Target * -No Change Small Marginal Farmers (SMF) target increased to 10% of the 18% of ANBC or CEOBE, whichever is higher.

[earlier it was 8 % of 18%] 

Small Marginal Farmers (SMF) target Increased to 10% of 18% of ANBC or CEOBE, whichever is higher.

[earlier it was 8% of 18%]

No Target
Micro Enterprises No Change No Change No Change No Change

# Target of total priority sector to be achieved in phased manner by Co-operative Banks as below.

Existing Target March 31, 2021 March 31, 2022 March 31, 2023 March 31, 2024
40% 45% 50% 60% 75%

 

* Phased manner for achieving Small Marginal Farmers and Weaker Section Targets as below.

Financial Year SMF Weaker Section Target
2020-2021 8% 10%
2021-2022 9% 11%
2022-2023 9.5% 11.5%
2023-2024 10% 12%

Inclusion of Weights in PSL Achievement

From the UK Sinha committee recommendations,[6] in order to address regional disparities in flow of credit to district levels. Adjusted Priority Sector Lending mechanism has been implemented under the new regime, to incentivise flow of credit to underserved districts. There will be no change in the underlying sectors eligible for PSL, however an additional weightage has been given to lending to the more underserved districts. From financial year 2021-2022 onwards weights would be assigned to incremental priority sector credit as follows:

  • Higher weight (125%) would be assigned to the districts where credit flow is comparatively lower, that is per capita PSL less than ₹ 6,000.
  • Lower weight (90%) would be assigned to the districts where credit flow is comparatively higher, that is per capita PSL is greater than ₹ 25,000.

RRBS, Urban Co-operative Banks and Local Area Banks and Foreign Banks have been kept out for the purpose of calculation of PSL weights, due to their limited presence.

Inclusions in Eligible Categories

Along with the inclusion of fresh categories eligible for finance under priority sector there has been some enhancement in the credit limit of the existing categories as well. Some of the changes are as follows-

Agriculture Lending Including Farm Credit (Allied Activities), lending for Agriculture Infrastructure and Ancillary Activities.
  • Inclusion of loans to farmers for installation of stand-alone Solar Agriculture Pumps and for solarisation of grid connected Agriculture Pumps.
  • Inclusion of loans to farmers for installation of solar power plants on barren/fallow land or in stilt fashion on agriculture land owned by farmer
  • Inclusion of loans up to ₹50 crore to Start-ups, as per definition of Ministry of Commerce and Industry, Govt. of India that are engaged in agriculture and allied services.
  • Inclusion of loans up to ₹2 lakh to individuals solely engaged in Allied activities without any accompanying land holding criteria. This change is in line with recommendation by M.K. Jain Committee[7].
  • Inclusion of loans for construction of oil extraction/ processing units for production of bio-fuels, their storage and distribution infrastructure along with loans to entrepreneurs for setting up Compressed Bio Gas (CBG) plants.
  • Laying of Indicative list conveying permissible activities under Food Processing Sector as recommended by Ministry of Food Processing Industries.
  • A credit limit of ₹5 crore per borrowing entity has been specified for Farmers Producers Organisations (FPOs)/Farmers Producers Companies (FPCs) undertaking farming with assured marketing of their produce at a pre-determined price. This inclusion is as per the M.K Jain Committee Recommendations[8].
Other Finance to MSMEs In line with the series of benefits being extended to MSMEs, loans up to ₹50 crore to Start-ups, as per definition of Ministry of Commerce and Industry, Govt. of India that confirm to the definition of MSME has been included under the PSL catergory. (On the basis of recommendations by UK Sinha Committee, to financially incentivise the startups in India)
Housing Loans

 

  • Increase in Loans up to ₹ 10 lakh (earlier ₹ 5 lakh) in metropolitan centres and up to ₹6 lakh (earlier 2 ₹ Lakh) in other centres for repairs to damaged dwelling units.
  • Bank loans to governmental agency for construction of dwelling units or for slum clearance and rehabilitation of slum dwellers subject to dwelling units with carpet area of not more than 60 square meters. Under the earlier regime, it was based on cost of dwelling unit which was ₹ 10 lakh per unit.
  • Inclusion of bank loans for affordable housing projects using at least 50% of FAR/FSI (Floor Area Ratio/ Floor Space Index) for dwelling units with carpet area of not more than 60 sq.m.
Social Infrastructure

 

Inclusion of loans up to a limit of ₹ 10 crore per borrower for building health care facilities including under ‘Ayushman Bharat’ in Tier II to Tier VI centres. This is in addition to the existing limit of ₹5 crore per borrower for setting up schools, drinking water facilities and sanitation facilities including construction/ refurbishment of household toilets and water improvements at household level, etc.
Renewable Energy Increase in loan limit to ₹ 30 Crore for purposes like solar based power generators, biomass-based power generators, wind mills, micro-hydel plants and for non-conventional energy based public utilities etc. This is to boost renewable energy sector, the earlier limit was up to ₹ 15 Crore.
Others

 

Inclusion of loans for meeting local needs such as construction or repair of house, construction of toilets not exceeding ₹2 lakh provided directly by banks to SHG/JLG for activities other than agriculture or MSME.

Investments by Banks in Securitised Assets & Direct Assignment

Earlier the interest rate charged to the ultimate borrower was capped at Base Rate of the investing bank plus 8 percent per annum. Post UK Sinha Committee recommendation,[9] the all-inclusive interest charged to the ultimate borrower by the originating entity should not exceed the External Benchmark Lending Rate (EBLR)/ MCLR of the investing bank plus appropriate spread which will be communicated separately.

The intent of the recommendation stood on the grounds that price caps are not applicable to banks when they originate directly through branches. Therefore, to encourage MSME lending in smaller areas where cost of intermediation is high by the smaller NBFCs, the committee proposed the cap at Base Rate of the investing bank plus 12% per annum initially and periodical review thereafter.

Conclusion

The Master Direction aids in compilation and provides easy understandability of all the guidelines at one place. The two committee reports recommendations have aided in recognising important sub-sectors of economy which were not covered under earlier regimes. Loans to starts-ups in agriculture and allied activities, loans to healthcare, sanitation along with impetus on renewable energy will not only bolster flow of credit in these sectors but also aimed at improving socio-economic conditions in the country. The introduction of incentive on incremental PSL by ranking of districts on basis of per capita credit flow could be an enabler for the deeper penetration of credit in rural economy. Therefore, the new Master Direction is a welcome move and will help in achieving better channeling of credit in the desired sectors of the economy.

[1] https://rbidocs.rbi.org.in/rdocs/notification/PDFs/MDPSL803EE903174E4C85AFA14C335A5B0909.PDF

[2] https://rbidocs.rbi.org.in/rdocs/notification/PDFs/33MD08B3F0CC0F8C4CE6B844B87F7F990FB6.PDF

[3] https://www.rbi.org.in/scripts/NotificationUser.aspx?Id=11644&Mode=0

[4] https://www.rbi.org.in/scripts/NotificationUser.aspx?Id=11604&Mode=0

[5] https://www.rbi.org.in/Scripts/NotificationUser.aspx?Id=11274&Mode=0

[6] Para 9.24, Report of the Expert Committee on Micro, Small and Medium Enterprises, (UK Sinha Committee) https://www.rbi.org.in/Scripts/PublicationReportDetails.aspx?UrlPage=&ID=924

[7] Para 1.7.6, Report of the Internal Working Group to Review Agricultural Credit, ( M. K Jain Committee) https://www.rbi.org.in/Scripts/PublicationReportDetails.aspx?UrlPage=&ID=942#CP28

[8] Para 2.7.5, Report of the Internal Working Group to Review Agricultural Credit, ( M. K Jain Committee) https://www.rbi.org.in/Scripts/PublicationReportDetails.aspx?UrlPage=&ID=942#CP28

[9] Para 9.24, Report of the Expert Committee on Micro, Small and Medium Enterprises, (UK Sinha Committee) https://www.rbi.org.in/Scripts/PublicationReportDetails.aspx?UrlPage=&ID=924