Banking and Finance Legal Milestones | Trilegal Quarterly Roundup Jan-Mar 2022

With the Union Budget 2022-2023 being announced on 1 February 2022, the previous quarter has been an eventful period in the financial sector. The Reserve Bank of India has continued its reforms spree and introduced some relevant initiatives.

The Union Budget 2022-2023 (Budget) announcements as well as the initiatives of the Reserve Bank of India (RBI) have focused on increasing credit access by promoting microfinance and digital outreach. Avenues for credit remain robust with the re-opening of the voluntary retention route (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 (AIFs) designed to invest in the distressed asset market.

The original version of this article was first published in the Trilegal Quarterly Roundup.

Key Developments

1. Master Direction – Reserve Bank of India (Regulatory Framework for Microfinance Loans) Directions, 2022

The RBI notified the Master Direction – Reserve Bank of India (Regulatory Framework for Microfinance Loans) Directions, 2022 on 14 March 2022, effective 1 April 2022 (Microfinance Regulations). Before this, RBI’s erstwhile microfinance regulatory framework prescribing pricing caps, a ceiling on loan amounts and limit on the number of lenders was applicable only to non-banking financial company-microfinance institutions (NBFC-MFIs). The Microfinance Regulations now provide a harmonised framework for all regulated entities lending to the microfinance segment (Regulated Entities), including scheduled commercial banks, small finance banks, NBFC-MFIs and NBFC-Investment and Credit Companies. Some key highlights of the Microfinance Regulations are:

• The Microfinance Regulations now provide a common definition of microfinance loans linked solely to the annual household income of the borrower, regardless of the lending institution, end-use of the loan and the mode of application/processing/disbursal.
• The distinction drawn under the earlier framework between rural and urban area households has also been done away with. This coupled with the increase in the household income threshold to INR 3,00,000 is likely to boost the consumer bases of the Regulated Entities.
• The loans in the microfinance segment are required to be collateral-free and cannot be backed by a lien on the borrower’s deposit account. Further, repayment obligations are capped (at 50% of the monthly household income, which will include both principal and interest payments of all existing loans as well as loans under consideration), interest rates cannot be usurious, prepayment penalty cannot be charged and any penalty for delayed payment can only be applied on the amount overdue.
• The regulatory ceiling on the interest rate that NBFC-MFIs could charge under the erstwhile regulations has also been removed, bringing them to the same footing as other Regulated Entities.
• The restriction on a borrower availing of microfinance loans from more than two NBFC-MFIs under the erstwhile regulations has also been removed.
• Regulated Entities are required to put in place board-approved policies for the assessment of household income, pricing of microfinance loans (including a well-documented approach for arriving at the all-inclusive interest rate) and flexibility of repayment periodicity, among others.
• For entities to qualify for an NBFC-MFI licence, they should have at least 75% of assets in the microfinance portfolio. The cap applicable on NBFCs has also been increased to 25% of their total assets from 10%.

2. Introduction of Special Situation Funds as a sub-category of Alternative Investment Funds

The Securities Exchange Board of India (SEBI) has amended the Securities and Exchange Board of India (Alternative Investment Funds) Regulations, 2012 on 24 January 2022 (AIF Regulations), to introduce Special Situation Funds (SSFs) as a sub-category of category 1 AIFs. SSFs are AIFs set up for investment in ‘special situation assets’ which include:

• Stressed loans available for acquisition pursuant to the Master Direction – Reserve Bank of India (Transfer of Loan Exposures) Directions, 2021 (Loan Transfer Master Directions), or as part of a resolution plan approved under the Insolvency and Bankruptcy Code, 2016 (IBC), or under any similar policy that may be issued.
• Security receipts issued by an asset reconstruction company.
• Securities of investee companies (i) whose borrowings are available under the Loan Transfer Master Directions, (ii) against whose borrowings security receipts have been issued by an asset reconstruction company, (iii) whose borrowings are subject to the corporate insolvency resolution process under the IBC, and (iv) who have disclosed payment defaults continuing for a period of at least 90 days.

SSFs must have a corpus of INR 100 crore with each investors’ contribution being at least INR 10 crore. Further, SSFs are exempt from certain investment conditions applicable to other AIFs in the same category, such as restrictions on investing more than 25% of its funds in a single company.

3. Extension of the Emergency Credit Line Guarantee Scheme till March 2023

The Emergency Credit Line Guarantee Scheme (ECLGS) envisages a 100% guarantee by National Credit Guarantee Trustee Company Limited (NCGTC) to be provided to member lending institutions for certain eligible credit facilities extended by them to specific eligible borrowers. During the pandemic, this scheme was introduced to provide relief to borrowers reeling under cash flow stress and was originally made available until March 2022. Post the Budget announcement, the ECLGS has been extended till March 2023. Further, the NCGTC has expanded the coverage, scope and extent 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 permitted to avail of loans up to 50% of their total fund-based credit outstanding, as against the earlier limit of 40%, subject to the existing maximum limit of INR 200 crore per borrower.
• Eligible borrowers in the civil aviation sector are now permitted to avail of loans up to 50% of their total fund-based and non-fund based credit outstanding, subject to an increased maximum limit of INR 400 crore per borrower.

4. Re-opening of the Voluntary Retention Route 

VRR was introduced on 1 March 2019 to facilitate stable investments by Foreign Portfolio Investors (FPI) in debt instruments issued in India. Initially, a dedicated investment limit of INR 1,50,000 crore was prescribed for this route along with dispensation of certain restrictions otherwise applicable to FPI investments under the normal route. Due to the positive response from investors and the available limits having been exhausted earlier, the RBI issued fresh directions on 10 February 2022, notifying an increase in the investment limits under VRR to INR 2,50,000 crore with effect from 1 April 2022. 

5. Changes to the stamp duty regime in Maharashtra

The Maharashtra Stamp (Amendment) Act, 2021 has introduced incremental stamp duty rates on certain key transactions. Important changes introduced are:

• The maximum stamp duty payable on agreements relating to deposit of title deeds, pawn, pledge or hypothecation (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 amount secured 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 deposit of title deeds, pawn, pledge or hypothecation, and (ii) mortgage deeds, executed for the benefit of consortium of banks is now capped at INR 50 lakh. 

While the increase in the 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 prescribed cap on security documents in consortium lending is a welcome move – given the Supreme Court’s judgment in Chief Controlling Revenue Authority v Coastal Gujarat Power Limited where it was held that transactions with each lender forming part of a consortium of lenders would be treated as distinct transactions, requiring stamp duty to be paid for each such transaction. 

6. Key budgetary announcements 

• Digitisation of the credit ecosystem in India, including the introduction of a digital currency by the RBI. A new scheme for taxation of virtual digital assets. To read our update on this development, click here.
• Launch of digital banking units in 75 districts across India and integration of 1.5 lakh post offices into the core banking system adopted by banks.
• Upper and middle layer NBFCs with ten or more fixed point service delivery units will have to implement a ‘core financial services solution’ system by 30 September 2025 similar to the core banking solution adopted by banks.

7. Supreme Court’s decision on security enforcement

The Supreme Court in Union Bank of India v Rajasthan Real Estate Regulatory Authority has held that in the event of a conflict between the Real Estate (Regulation and Development) Act, 2016 (RERA) and the Securitisation and Reconstruction of Financial Assets and Enforcement of Security Interest Act, 2002 (SARFAESI Act), the provisions of RERA would prevail. Accordingly, it ruled that the Real Estate Regulatory Authority can entertain complaints by homebuyers of a real estate project against a bank that seeks to enforce its rights over the project as a secured creditor under the SARFAESI Act (by taking possession or otherwise), thereby confirming that the rights of the homebuyers are paramount. 

The opening of the VRR limits will hopefully clear the backlog of investments by FPIs which were in limbo for want of VRR limits. While the extension in the timelines for ECLGS and introduction of the SSFs appear to be a step in the right direction to address the situation of stressed borrowers in India, it will be interesting to see if the introduction of SSFs leads to a significant increase in activity in the distressed assets space. The budgetary proposals for digitisation may also significantly promote credit access in the long run if they are implemented in a timely and effective manner.

The world’s eyes are now fixed on the Russia-Ukraine conflict. While there has not been an immediate adverse impact of the conflict on India’s economy, it remains to be seen how the ripples in the world economy affect India in the future.

To view more content from the latest issue of the Trilegal Quarterly Roundup, click here.