Banking and financial legal milestones | Quarterly tri-legal report January-March 2022
With the announcement of the Union Budget 2022-2023 on February 1, 2022, the previous quarter was a turbulent time in the financial sector. The Reserve Bank of India continued its wave of reforms and launched some relevant initiatives.
The Union budget 2022-2023 (Budget) as well as the initiatives of the Reserve Bank of India (RBI) focused on improving access to credit by promoting microfinance and digital outreach. Credit leads remain strong with the reopening of the voluntary retention channel (VRR) for foreign investors, the extension of the emergency credit guarantee scheme for key sectors affected by the pandemic and the introduction of alternative investment funds (FIA) designed to invest in the distressed asset market.
The original version of this article first appeared in the Tri-legal quarterly report.
1. Principal Directorate – Directorates of the Reserve Bank of India (Regulatory Framework for Microfinance Lending), 2022
March 14, 2022, March 14, 2022, effective April 1, 2022 (Microfinance regulation). Previously, the old RBI microfinance regulatory framework prescribing price caps, a cap on the amount of loans and a limit on the number of lenders was only applicable to non-bank financial companies and credit institutions. microfinance (NBFC-IMF). The Microfinance Regulations now provide a harmonized framework for all regulated entities lending to the microfinance segment (Regulated entities), including regular commercial banks, small finance banks, NBFC MFIs and NBFC investment and credit companies. Here are some highlights of the Microfinance Regulations:
- The Microfinance Regulations now provide a common definition of microfinance loans linked only to the annual income of the borrower’s household, regardless of the lending institution, the end use of the loan and the mode of application/processing/disbursement.
- The distinction made in the previous framework between rural and urban households has also been removed. This, coupled with the increase in the household income threshold to INR 3,00,000, is likely to boost the consumption bases of regulated entities.
- Microfinance segment loans must be unsecured and cannot be secured by a lien on the borrower’s deposit account. In addition, repayment obligations are capped (at 50% of monthly household income, which will include both principal and interest payments on all existing loans as well as student loans), interest may not be usurious, no prepayment penalty may be charged and any late payment penalty may only be applied to the overdue amount.
- The regulatory cap on the interest rate that NBFC-MFIs could charge under the old regulations was also removed, putting them on the same footing as other regulated entities.
- The restriction on a borrower to avail microfinance loans from more than two NBFC-MFIs under the old regulations has also been removed.
- Regulated entities are required to have board-approved policies in place for assessing household income, pricing microfinance loans (including a well-documented approach to arriving at the all-inclusive interest rate) and flexible repayment schedules, among others.
- For entities to be eligible for an NBFC-MFI license, they must have at least 75% of the assets in the microfinance portfolio. The cap applicable to NBFCs has also been increased to 25% of their total assets, from 10%.
2. Introduction of special situation funds as a subcategory of alternative investment funds
The Securities Exchange Board of India (SEBI) amended the Securities and Exchange Board of India (Alternative Investment Funds) Regulations 2012 on 24 January 2022 (FIA regulations), to introduce special situations funds (SSFs) as a sub-category of category 1 AIFs. SSFs are AIFs created to invest in “special situation assets” which include:
- Distressed loans available for acquisition in accordance with the 2021 guidelines of the Master Directorate – Reserve Bank of India (Transfer of Loan Exposures) (Main loan transfer instructions), or as part of an approved resolution plan under the Insolvency and Bankruptcy Code, 2016 (IBC), or under any similar policy which may be issued.
- Security receipts issued by an asset recovery company.
- Securities of recipient companies (i) whose borrowings are available under the Master Loan Transfer Guidelines, (ii) against whose borrowings collateral receipts have been issued by an asset recovery company, (iii) whose borrowings are subject to the corporate insolvency resolution process under the IBC, and (iv) which have disclosed persistent defaults for a period of at least 90 days.
SSFs must have a corpus of INR 100 crore, with each investor’s contribution being at least INR 10 crore. In addition, SSFs are exempt from certain investment conditions applicable to other AIFs of the same category, such as restrictions on investing more than 25% of its funds in a single company.
3. Extension of the emergency line of credit guarantee system until March 2023
The emergency line of credit guarantee system (ECLGS) provides a 100% guarantee by National Credit Guarantee Trustee Company Limited (NCGTC) to be granted to member credit institutions for certain eligible credit facilities which they grant to specific eligible borrowers. During the pandemic, this program was introduced to provide relief to borrowers in cash flow shock and was initially made available until March 2022. After the budget announcement, the ECLGS was extended until March 2023. Additionally, the NCGTC has expanded the coverage, scope, and breadth of benefits of the ECLGS for the hospitality, travel, tourism, and civil aviation sectors. Key highlights include:
- Eligible borrowers in hospitality and related sectors are now allowed to qualify for loans of up to 50% of their total funds-based outstanding credit, up from the previous limit of 40%, subject to the upper limit existing loan of INR 200 crore per borrower.
- Eligible borrowers in the civil aviation sector are now allowed to avail loans of up to 50% of their total fund-based and non-fund-based credit outstanding, subject to an increased maximum limit of 400 crore INR per borrower.
4. Reopening of the voluntary retention process
The VRR was introduced on March 1, 2019 to facilitate stable investments by foreign portfolio investors (REITs) in debt securities issued in India. Initially, a dedicated investment limit of INR 1.50,000 crore was prescribed for this route along with the waiver of certain restrictions otherwise applicable to REIT investments under the normal route. Due to the positive investor response and the available limits having been exhausted earlier, the RBI issued further instructions on 10 February 2022, notifying an increase in investment limits under VRR to INR 2.50,000 crore with effect from April 1, 2022.
5. Changes in stamp duty regime in Maharashtra
The Maharashtra Stamp (Amendment) Act 2021 introduced additional stamp duty rates on certain key transactions. The important changes introduced are:
- The maximum stamp duty payable on agreements relating to the deposit of title deeds, pledge, pledge or mortgage (in cases where the amount secured exceeds INR 5 lakh) has been increased from INR 10 lakh to INR 20 lakh .
- The maximum stamp duty payable on a mortgage deed (in cases where the secured amount exceeds INR 5 lakh) has been increased from INR 10 lakh to INR 20 lakh.
- The maximum stamp duty payable on (i) agreements relating to the deposit of title deeds, pledges, pledges or mortgages, and (ii) mortgage deeds, executed for the benefit of a consortium of banks is now capped at INR 50 lakh.
While increasing stamp duty rates in single-lender transactions is likely to increase borrowing costs in a state that already has one of the highest stamp duty rates in India, the cap prescribed on security documents in consortium loans is a welcome decision – given the Supreme Court ruling in Chief Revenue Control Authority v Coastal Gujarat Power Limited where it was held that transactions with each lender in a syndicate of lenders would be treated as separate transactions, requiring the payment of stamp duty for each such transaction.
6. Major budget announcements
- Digitization of the credit ecosystem in India, including the introduction of a digital currency by the RBI. A new tax regime for virtual digital assets. To read our update on this development, click here.
- Launched digital banking units in 75 districts across India and integrated 1.5 lakh post offices into the basic banking system adopted by banks.
- Upper and middle layer NBFCs with at least ten fixed point service delivery units shall implement by September 30, 2025 a system of “basic financial services solution” similar to the basic banking solution adopted by banks.
7. Decision of the Supreme Court on the application of security measures
The Supreme Court of Union Bank of India v Real Estate Regulatory Authority of Rajasthan ruled that in the event of a conflict between the Real Estate (Regulation and Development) Act 2016 (RERA) and the Securitization and Reconstitution of Financial Assets and Enforcement of Security Act 2002 (SARFAESI Law), the provisions of the RERA would prevail. Accordingly, it ruled that the Real Estate Regulatory Authority may receive complaints from purchasers of a real estate project against a bank seeking to enforce its rights over the project as a secured creditor under the SARFAESI Act (in taking possession or otherwise), thus confirming that the rights of homebuyers are paramount.
The opening of VRR limits will hopefully clear up the backlog of investments from REITs that were in limbo for lack of VRR limits. While the extension of the deadlines for the ECLGS and the introduction of the SSFs appear to be a step in the right direction to deal with the situation of stressed borrowers in India, it will be interesting to see whether the introduction of the SSFs leads to a significant increase in activity in the distressed asset space. Budget proposals for digitization can also significantly promote access to long-term credit if implemented quickly and effectively.
The eyes of the world are now fixed on the Russian-Ukrainian conflict. Although there was no immediate negative impact of the conflict on the Indian economy, it remains to be seen how the ripples in the global economy will affect India in the future.
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