The RBI has implemented some of the recommendations of the Nair Committee report, resulting in a lot more clarity on priority sector treatment, both in case of securitisation and direct assignments
The priority sector lending norms were announced on 1 July 2012 and were changed on 20 July 2012 (http://rbidocs.rbi.org.in/rdocs/notification/PDFs/19072012RG.pdf), to implement the recommendations of the Nair Committee.
The Nair Committee, in its report (http://rbidocs.rbi.org.in/rdocs/PublicationReport/Pdfs/FRNC210212F.pdf), had made several recommendations, primarily putting a limit to the extent to which banks can fulfil their priority sector lending (PSL) requirements by buying portfolios generated by others. PSL requirements are one of the central themes of banking in India, built on the ideals of financial inclusion. PSL requirements treat certain sectors, such as agriculture, small industry, housing, etc, as priorities for banks, and require banks to extend a part of their banking credit to these sectors. While the idea of PSL norms is healthy, most banks neither have the bandwidth nor the organisational focus to lend to these segments—therefore they buy out the portfolios generated by other banks, or NBFCs, to meet their PSL requirements. This has had several implications—first, that there is only a perfunctory service to the priority sector, as NBFCs may cleverly structure a gold loan or a commercial vehicle loan as a priority sector loan and sell the same off to a bank. Secondly, the PSL market led to the buoyant growth of the NBFC sector which would lend to the so-called priority sector at completely non-priority rates, and yet sell the same to banks with high spreads.
Against this background, the Nair Committee had made recommendations which were quite drastic.
The Reserve Bank of India (RBI) has implemented some of these with immediate effect. Several of the recommendations of the Committee, which were unpleasant, have been dropped. The result is a lot more clarity on priority sector treatment, both in case of securitisation and direct assignments. In addition, some of the recommendations, such as a new structure of transferable participation structures, have been discarded.
There was uncertainty whether portfolios originated by banks or NBFCs, and acquired by other banks, would qualify as PSL portfolio. The new norms state that they will so qualify. By itself, this would have been a great booster for non-banking finance companies, which are the prime originators of such pools, but there is still a hitch in form of the securitisation guidelines.
The securitisation guidelines were implemented by the Reserve Bank of India (RBI) in May this year in case of banks. In case of NBFCs, they have not been implemented as yet, but since the buyer of the pool in the instant case is a bank, the guidelines will still apply. The securitisation guidelines classify a transaction into (a) an SPV-structure; and (b) a bilateral or direct assignment structure. There is a diametrically opposite treatment in case of SPV structures and direct assignments. While in case of SPV structures, a minimum risk retention by the seller is a must, the risk retention is completely prohibited in case of direct assignments. In case of SPV-based transactions, there are other requirements—that the originator must have held each asset in the pool for a minimum seasoning period ranging between six months and nine months.
The SPV structures have other issues too—there has been a raging tax issue as regards taxability of the SPV. The income-tax (I-T) department claims that the transactions have not been properly structured to comply with the basic requirements of a pass-through vehicle. The matter is currently being debated in judicial forums.
While the market may still learn to handle securitisation guidelines, the Nair Committee report is still a welcome measure.
However, there is lot of confusion left behind. For example, in case of securitisation, one of the preconditions for PSL treatment is that the rate of interest on the underlying assets charged by the originating entity should not be higher than 8% over the base lending rate of the investing bank. In case of securitisation, one wonders, how could one ever identify, at the time of either origination or pooling, as to which investing banks are, and what are their base lending rates. By definition, a securitisation transaction may have multiple investors. Nay, these investors may also change over time. While it is impossible to identify the investors at the time of origination, even if this is one of the filters applied in selection of the loans, it would be impossible to find the base lending rates of each of the banks that ultimately buy the securities.
But is this the idea of financial inclusion?
Regrettably, however, the priority sector treatment still remains a perfunctory chase for what would, on paper, qualify as priority sector. More often than not, the borrower in question is not a farmer at all—based on some holding of farm land, the borrower buying a truck would say that he intends to carry his farm produce in the truck and seek loan as a farmer.
Unsurprisingly, gold loan companies were doing the same thing—taking a certificate of being a farmer from each borrower, and contending that every gold loan is a farming loan—before the RBI disqualified gold loan companies from PSL treatment altogether.
Some wise people say that the whole approach of the RBI to priority sector assets is flawed. Directing bank credit into certain sectors by mandatory lending norms leads to perfunctory compliances of the sort noted above. Instead, the RBI should have envisaged credit enhancement or cost absorption devices—taking out the primary risks of financial inclusion lending. The present directed lending approach creates biggest challenges for foreign banks doing business in India which don’t have any bandwidth at all to do such lending, and therefore, are left with the only option of buying out portfolios originated by others. Thereby, the cost to the ultimate target of priority sector, the borrowers, does not come down; intermediaries such as NBFCs pick up neat spreads while the buying banks are exposed to the risks of the portfolios they have no clues about.
(The writer is a chartered accountant, trainer and author. He is an expert in such specialised areas of finance as securitisation, asset-based finance, credit derivatives, accounting for derivatives and financial instruments and microfinance. He has written a book titled “Securitisation, Asset Reconstruction and Enforcement of Security Interests”, published by Butterworths Lexis-Nexis Wadhwa. He can be contacted at [email protected]. Visit his financial services website at www.vinodkothari.com.)
Obama can use the gun issue to appeal to moderate Republicans across the US and a campaign advertisement featuring Mayor Michael Bloomberg may not be such a bad idea. It is time for President Obama to take a stand
In the multi-cultural suburb of Aurora in Denver, Colorado, during the first show of the new Batman film, in a theatre situated in a mall, a young man called James Holmes went berserk. He had red hair like the Joker, the villain of the last Batman film and threw two canisters of teargas and then opened fire in the theatre killing fourteen and injuring fifty.
He had a shot gun, a semi automatic gun and a .22 bore hand gun as he calmly went on his shooting spree. The carnage would have been much worse had one of the guns not jammed. The young man Mr Holmes, 24 years old, was apprehended outside the theatre with three guns and it was reported that he had bought 6,000 rounds of ammunition on line recently.
There is an old adage in America which goes something like this “Guns don’t kill people, people kill people” and this is regarded as sacred by many Americans who believe that the Second Amendment to the US Constitution which protects the right to bear arms is the most fundamental right than American citizens have. America is probably the only country in the world which protects the right to own guns in the Constitution. The Supreme Court is quiet zealous of protecting this right and restrictions on the right are frowned upon.
America was a frontier country when the Constitution was created. So it may be understandable that the right to bear guns figures in the Constitution but the continuing romance with guns and America is quite puzzling. What is also quite puzzling is the fact that while guns have become more and more powerful simultaneously the restrictions on them have been curtailed. There are now more than 300 million guns in America, more than one for each person. An important reason for the widespread prevalence of guns in America is also the power and influence of the National Rifle Association (NRA) which is one of the most powerful and well-funded lobbies in America and outspends those in favour of gun control by 10:1.
They also target in elections of senators and congressman who oppose guns. This is one of the reasons that gun control has not made much headway in America though there is support among the electorate for laws which provide for mandatory background checks for people buying guns and other restrictions. It is indeed surprising that the last President to do something serious about gun control was President Bill Clinton in 1994 who introduced the Brady Handgun after the Violence Preventive Act which was named after James Brady Jr, who was grievously injured in a shooting during an attempted assassination of President Reagan on 30 March 1981. He was the press secretary to the President.
The Brady Act requires that background checks be conducted on individuals before a fire arm may be purchased from a federally licensed dealer manufacturer or importer unless an exemption applies. The short point is that there is not much appetite for restrictions on guns in either party. This is particularly frowned upon in the red states (Republican states) and while Democrats are far more reasonable and moderate than the Republicans on these issues, they have no appetite for confrontation in this issue. President Clinton also got an assault weapon ban through congress in 1994. But this expired in 2004 and was not renewed.
However, Mayor Michael Bloomberg of New York immediately seized on the opportunity of goading President Obama and Governor Mitt Romney to do something about gun control immediately following the Aurora attack. As usual, he was the most sensible and moderate voice in America. But as the days passed after the Aurora shooting there was a groundswell of support from citizens and the political class for at least a relook of the issue. The country was in mourning so that no concrete suggestions had been made yet but the Aurora shooting had clearly put guns in the middle of the campaign.
I do hope that President Obama picks up the gauntlet thrown by Mayor Michael Bloomberg and makes some sensible plans for gun control. I do think that in the present atmosphere it may have tremendous resonance with independent voters in swing states and may be to the president’s advantage. It may also get Governor Romney to talk about something other than the faltering economy. Governor Romney in 2004 was the governor of Massachusetts when the assault weapon ban expired and immediately made the assault weapon ban permanently for the state. He will find it difficult to duck the issue now though he may well say that it is for states to legislate on the issue and not the federal government which is a usual Republican dodge. President Obama can really use the gun issue to appeal to moderate Republicans across the country and a campaign advertisement featuring Mayor Michael Bloomberg may not be such a bad idea. It is time for President Obama to take a stand.
(Harsh Desai has done his BA in Political Science from St Xavier's College & Elphinstone College, Bombay and has done his Master's in Law from Columbia University in the city of New York. He is a practicing advocate at the Bombay High Court.)
The RBI issued directions but has not clearly spet out its intentions, which may give room to confusion in the mind of those who carry out factoring as an ancillary business
On Monday, the Reserve Bank of India (RBI) brought into force a new kind of Non Banking Financial Company—Factors (Notification DNBS. PD.No. 247/CGM(US)-2012, dated 23 July 2012). An NBFC-Factor has to comply with the requirements of the Factoring Regulation Act, 2011 (“Act”). The RBI’s direction would be applicable to all the NBFC- Factors which are registered with the RBI under Section 3 of the Act, which mandates every factor to obtain a certificate of registration from the RBI for carrying out or commence the business of factoring. Factoring is a financial transaction where an entity sells its receivables to a third party called a ‘factor’, at discounted prices. A factor means an NBFC, a body corporate or any other company.
It is unclear whether only those entities which are primarily engaged in a factoring business, i.e. the financial assets in the factoring business constitute at least 75% of its total assets and its income derived from factoring business is not less than 75 % of its gross income, shall require classification as NBFC-Factors. The language under direction 4(i) of the Directions state that “every company intending to undertaking factoring business shall make an application for grant of certificate of registration (CoR) as NBFC- Factor to the bank as provided under Section 3 of the Act”. Even though the Directions highlight the requirements of factoring business as a principal business, the applicability of the Act and consequently the Directions for obtaining registration to carry out a factoring business, whether or not as principal business, is not free from doubt.
Therefore technically, any entity (being a factor) carrying out a factoring business is required obtain registration as an NBFC-Factor. The only exceptions to the requirement of registration are banks or any corporation established under any statute of the Parliament or the state legislature, government (such as RBI, IDBI, National Bank for Agriculture and Rural Development, etc.) and a government company as defined under Section 617 of the Companies Act.
Implications on the existing entities carrying out factoring business
The obvious implication is for the existing entities (being factors) to make an application for reclassification as NBFC-Factors. The time limit for making such application has been set at six months from the date of the Directions.
This would mean that the conditions applicable to an NBFC-Factor shall be satisfied by the existing entities carrying out factoring business prior to reclassification as NBFC-Factor. In the event of an existing registered NBFC carrying out factoring business, as its principal business, that constitute less than 75 % of total assets/income shall have to submit to the RBI within six months from the date of the Direction a letter of its intention either to become a factor or to unwind the business totally, and a road map to this effect. Therefore, the NBFC-Factor has to ensure to comply with this essential requirement of factoring business to constitute at least 75 % of total assets income. If the existing NBFCs fail to meet the said benchmark, they will be forced to unwind the factoring business.
Additional burden on the existing entities is to increase their net owned fund (“NOF”) to at least Rs5 crore, which in case of an NBFC, not being NBFC-Factor, is a maximum of Rs2 crore.
It is essential to obtain a certificate from a statutory auditor indicating that all conditions have been complied with by the entity for classification/registration as NBFC-Factor and that the certificate has been issued under Section 3 of the Act. If foreign direct investment (“FDI”) is applicable, the minimum capitalization norms under the extant FDI policy of the RBI shall also be complied with.
An NBFC-Factor is also subject to the provisions of Non-Banking Financial (Non-deposit Accepting or Holding) Companies Prudential Norms (Reserve Bank) Directions, 2007 or Non-Banking Financial (Deposit Accepting or Holding) Companies Prudential Norms (Reserve Bank) Directions, 2007, as the case may be.
Where NBFC-Factors intends to deal in forex through export/import factoring, compliance with the Foreign Exchange Management Act, 1999, and the rules, regulations, notifications, directions or orders made there under from time to time, shall also be ensured.
Effect of the Directions
The ambiguity of applicability of the Act and consequently the Directions continues to prevail and there is no clarity on whether those entities not carrying out factoring business as their principle business are required to obtain registration as NBFC-Factor. Furthermore, language of the Directions also point towards a requirement for registration as NBFC-Factor even if the entity intends to go for a factoring business.
Going by the language of direction 6 of the Directions, which requires an NBFC-Factor to ensure that the financial assets in the factoring business constitute at least 75% of its total assets and the income derived from factoring business is not less than 75% of its gross income, clearly shows that the factoring business shall be a principal business of a factor.
In our view the RBI has not clearly spelt out its intention to this effect, which may give room to confusion in the mind of those who carry out factoring business as an ancillary business.
(The author is an associate at Vinod Kothari & Company and can be contacted at [email protected].)