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No beating about the bush.
Since banks are the biggest distributors for all financial products, they need to operate within a strong consumer protection framework. This is lacking
The Reserve Bank of India (RBI) is, finally, working on a consumer protection framework that will empower it to ensure that banks treat their customers fairly. This is in line with global best practices that RBI deputy governor Dr KC Chakrabarty has been espousing for a long time. The crux of the new thinking is that “self-regulation, often, does not work and a strong, intrusive and hands-on regulator/supervisor provides the confidence that markets will operate on sound principles and be free from unfair and unethical practices.”
In India, growing consumer complaints, media sting operations on banking practices, as well as RBI’s own observations based on inspection of banks, have repeatedly highlighted how they are willing to wink at the rules leading to the laundering of unaccounted money. At the same time, they happily sell toxic, third-party products to their own customers in violation of their fiduciary obligation to sell and recommend products appropriate to the customer’s needs and financial profile and after ensuring that she understands the risks involved.
Over the past year, RBI has repeatedly exhorted banks to treat customers fairly (TCF) through various public statements, meetings and circulars. But this is clearly not enough. While moral suasion may have worked in a closed economy, the freedom to fix charges and the formation of an informal pricing cartel through the Indian Bank’s Association (IBA) seems to have weakened RBI’s ability to compel good behaviour.
A voluntary code of adherence to customer services and the inadequate provisions of the Banking Ombudsman’s Act have also had little impact on critical issues such as pricing, mis-selling and grievance redress. A clear framework for customer services, empowering RBI to act against unfair practices, is the need of the hour, along with increased competition through new banks, so that banks, on their own, feel the pressure to treat their customers fairly.
RBI has already warned banks about the many practices that it considers unethical or unfair to customers. These include:
• Levying charges that are based on competition (or cartel) rather than costs for services. Levying charges when no service is provided (failure to maintain minimum balance, intersol charges, pre-payment penalty on loans, and cancellation of demand drafts) or where it is a security imperative (like text messages for transactions).
• Mis-selling of third-party products (like insurance), collective investment products (like art funds) and mutual funds, through monetary incentives to bank employees. Bundling insurance with loans, term deposits and other deals to earn fees.
• Misuse of floating rate policies to increase spread when interest rates rise, but failing to pass on interest rate cuts with the same alacrity. Offering better rates to new customers and treating existing customer unfairly. Taking advantage of the festive buying to mislead customers with false claims of zero interest through deals with manufacturers.
• Helping customers to avoid the tax reporting requirements by providing multiple customer identity numbers, splitting fixed deposits and accepting cash.
While these specifics may be covered by RBI’s customer protection framework, the conceptual raison d’être for this is the realisation, worldwide, that weak consumer protection poses a significant risk to the wider economy and the financial sector cannot be trusted to self-regulate, even in its self-interest.
For RBI to align its own customer protection framework with the demands from consumers, it would do well to consider some key suggestions from bodies such as Consumers International (CI) which is a worldwide federation of consumer groups and represents 220 members across 115 countries. Moneylife Foundation, our sister entity, has recently become a supporter member of CI. Some of the suggestions are still to be accepted by central banks across the world, although some countries have made big strides in their implementation.
CI points out that half the world’s population is still unbanked. This is a real concern in India, which probably has the largest number of unbanked persons worldwide. Unfortunately, financial inclusion has only meant various gimmicks, including the push for unique-identity-based bank accounts for delivery of subsidies, without any clear thought about how to ensure genuine usage that is cost-effective.
Banks want to charge customers for ATM transactions beyond the fifth every month, because interchange costs and taxes amount to nearly Rs20 per transaction. Banks need to push customers into making fewer transactions for higher denominations, but there is no attempt to ensure this through awareness campaigns; instead, they are toying with restrictive costs. At the same time, there is a push for biometric-enabled ATMs in the name of financial inclusion, which is sure to involve only low denomination transactions. Unfortunately, there is no pressure on banks to work with consumers, or consumer groups, to come up with innovative solutions to these issues.
CI also points to the need for a national consumer protection body that covers multiple regulators. Such an independent body was also recommended by the Financial Sector Legislative Reforms Commission (FSLRC), but has met with quiet and determined resistance from India’s multiple independent financial regulators. Interestingly, Indian financial regulators, including RBI, have signed a memorandum of understanding (MOU) to monitor large conglomerates, but there is no such understanding or cooperation for consumer protection, although it is clear that sale of third-party products by banks has cheated financial consumer the most.
Some of the other issues flagged by CI for the protection of financial consumers:
1. Information Design and Disclosure: Consumers should receive clear, sufficient, reliable, comparable and timely information about financial service products. The pricing should be clear and allow consumers to appreciate costs before buying a product and information must be provided in standard formats. Failure to do so should make contracts void. Financial products must be tested for quality and comprehension by companies and audited by regulators. This is a clear shift away from disclosure-based regimes.
2. Contracts, Charges and Practices: Regulators should introduce a requirement of comprehensibility and prohibit products that are not comprehensible to ordinary consumers without expert knowledge. Conflict of interest in the provision of advice and sale of financial services needs to be addressed. Financial advice to consumers should be separated from sales-based remuneration. And contracts with consumers should be void-able, if they fail to get informed consent of the consumer, charge unfair or unreasonable fees, or are contracts designed to ensure a waiver of basic consumer protection and sale of inappropriate products, based on the consumer’s profile.
3. Redress and Dispute Resolution Systems: Ensure that consumers have access to adequate redress mechanisms that are ‘expeditious, fair, inexpensive and accessible’.
While India surely needs to look at the global debate on this issue, it needs to formulate a policy that works best for India, taking into account our own socio-economic milieu. A strong national consumer protection body, as recommended by the FSLRC in India or Consumers International overseas, may not be immediately feasible in India. Instead, since banks remain the big and trusted source for selling a host of financial products, including wealth management and advisory services, a strong consumer protection framework under RBI is an immediate imperative.
Sucheta Dalal is the managing editor of Moneylife. She was awarded the Padma Shri in 2006 for her outstanding contribution to journalism. She can be reached at [email protected]
About 50% of the refinancing amount, equivalent to 13% of the banking system net worth as on FY13, may present a significant underwriting challenge to bankers under the prevailing macroeconomic situation, says Ind-Ra
Bank loans worth an estimated Rs1.9 lakh crore to Rs2.1 lakh crore belonging to top 100 corporates, including non-financial and non-public sector, are due for refinancing in the next 12-15 months. About 50% of this refinancing amount, equivalent to 13% of the banking system net worth as of FY13, may present a significant underwriting challenge to bankers under the prevailing macroeconomic situation, says India Ratings and Research (Ind-Ra).
According to the ratings agency, around 24% of the refinancing requirement (about 4%-5% of the banking system net worth) is attributed to the 20 companies already in distress. While another 26% of the refinancing requirement attributed to 20 corporates, belongs to a category which Ind-Ra has termed as elevated refinancing risk (ERR).
Companies at ERR have weak credit metrics. Generally, as a group, their asset coverage ratios are low and financial flexibility of the promoter is also limited. Under normal market conditions, they should be able to refinance at a high cost or with stringent covenants. However, this group may face significant challenges in debt refinancing during stressed market conditions, Ind-Ra said.
The ratings agency feels around 34 corporates have refinancing risks which is manageable. "Of these, 12 accounting for 27% of the refinancing requirement will be able to refinance debt at a reasonable cost even under stressed market conditions. This category can be termed as high ease of refinancing (HER)," it said.
Ind-Ra said, "The other 22 corporates accounting for 23% of the refinancing amount, which can referred to as moderate ease of refinancing (MER), will also be able to refinance debt but with moderate ease. However, they may have to bear a high cost, especially under stressed market conditions."
According to the ratings agency, nearly 26 of the 100 top corporates considered have no significant refinancing exposure or are at negligible refinancing risk (NRR) till FY15. They have moderate levels of debt maturing or are likely to have sufficient free cash flows to service the maturing debt.
"While driven possibly by credit rationing (at the bankers’ end), banks’ exposure to the MER and ERR group has grown at a much more muted level. The potentially low eagerness on the part of bankers may prove to be a challenge in debt refinancing to such categories. While the cautious approach adopted by bankers has an intuitive explanation, the banking system may face the dilemma that if refinancing decisions are not taken promptly (when required), some of the large-value loans belonging to the ERR category may become distressed," Ind-Ra said.
"In addition," it said, "some corporates, particularly those with a low asset cover, may face underwriting challenges. Furthermore, given the low interest coverage of the corporates in the ERR category, a higher interest rate (possibly reflective of their risk) may affect their debt servicing ability further. As such, among these top 100 corporates, those in the NRR, HER and MER categories have shown a reduced dependency on the Indian banking system, while the dependency of those in the ERR and stressed categories has broadly remained unchanged."
Here is the list of top 100 corporate borrowers…
A number of corporates have fraudulently raised money in the guise of 'deposits' thereby avoiding the taxation applicability. To curb such a practice, a retrospective amendment to Section 2 (22) (e) to the Income Tax Act can be expected to include 'deposits' within the purview of 'loans and advances'
One of the most frequently asked question in terms of corporate funding is whether ‘deposits’ are synonymous to ‘loans and advances’ and can the same be used interchangeably? This debate intensified when reference were made to Sections 295 and 370 under the Companies Act, 1956 (Act, 1956) and Section 2 (22) (e) under the Income Tax Act, 1961 (IT Act).
The controversy surrounding Section 370 under the Act, 1956 was put to rest when the Companies (Amendment) Act, 1988, amended the section to include ‘deposits’ within its ambit; however the definition under Section 295 (pertaining to ‘loans’ to directors) continued to be neglected. This Section has now been replaced by Section 185 of the Companies Act, 2013 which failed to learn a lesson from the Act, 1956 and continues to carry forward the faulty trend.
With regard to Section 2 (22) (e) of the IT Act, a recent judgment was passed by the Income Tax Appellate Tribunal, Kolkata, in the matter of IFB Agro Industries Ltd Vs. Joint Commissioner of Income-tax which deals with this very pertinent question.
Facts of the case
In the present case, IFB Agro Industries (Appellant) received inter-corporate deposit (ICD) to the tune Rs11.20 crore from IFB Automotive Pvt Ltd (IFB), which was treated as deemed dividend u/s 2 (22) (e) of the IT Act by the Revenue. The Appellant contended that since Section 2 (22) (e) of the IT Act applies to only ‘loans and advances’, the ICD, not being in the nature of loan, will not come within its purview.
The Income Tax Appellate Tribunal, taking into view the explanation of ‘deposit’ contained u/s 269T and 269SS of the IT Act, held that ‘deposit’ and ‘loans’ were indeed two different and distinct terms and that if a section recognises only the term ‘loan’ then a deposit received by an assessee cannot be treated as a 'loan' for that section. Relevant extract of the said Order is reproduced below:
“Admittedly, the provisions of section 2(22)(e) of the Act refers to only ‘loans’ and ‘advances’ it does not talk of a ‘deposit’. The fact that the term ‘deposit’ cannot mean a ‘loan’ and that the two terms ‘loan’ and the term ‘deposit’ are two different distinct terms is evident from the explanation to section 269T as also section 269SS of the Act where both the terms are used. Further, the second proviso to section 269SS of the Act recognises the term ‘loan’ taken or ‘deposit’ accepted. Once it is an accepted fact that the terms ‘loan’ and ‘deposit’ are two distinct terms which has distinct meaning then if only the term ‘loan’ is used in a particular section the deposit received by an assessee cannot be treated as a ‘loan’ for that section. Here, we may also mention that in section 269T of the Act, the term ‘deposit’ has been explained vide various circular issued by CBDT. Thus, the view taken by the Ld. CIT(A) that the Intercorporate deposit is similar to the loan would no longer have legs to stand.”
“In other words, the word "loan" in section 370 must now be construed as dealing with loans not amounting to deposit, because, otherwise, if deposit of moneys with corporate bodies were to be treated as loans, then deposits within scheduled banks would also fall within the ambit of section 370 of the Companies Act.”
It is post this judgment in the Durga Prasad Mandelia case, that Section 370 of the Act, 1956 was amended by the Companies (Amendment) Act, 1988, to include ‘deposits’ into its ambit, thereby, clearly indication the distinction between ‘deposits’ and ‘loans and advances’.
“The two expressions loans and deposits are to be taken different and the distinction can be summed up by stating that in the case of loan, the needy person approaches the lender for obtaining the loan therefrom. The loan is clearly lent at the terms stated by the lender. In the case of deposit, however, the depositor goes to the depositee for investing his money primarily with the intention of earning interest.”
From the above judgments it becomes clear that it is the intension between the parties which demarcates the difference between ‘deposits’ and ‘loans and advances’. Under ‘loans and advances’ it is the borrower who approaches the lender for borrowing money, however, to be termed as ‘deposit’ it is the person advancing the money, who approaches the borrower.
What is the entire controversy surrounding Section 2 (22) (e) of the Income Tax Act, 1961?
To analyze the outcome of above case law of IFB Agro Industries Ltd, it is pertinent to first understand the applicability of Section 2 (22) (e) of the IT Act in context of our discussion above.
Section 2 (22) (e) of the IT Act defines the term ‘dividend’ to include within its ambit, the amounts paid by private limited companies, by way of loans and advances, to its shareholders holding 10% or more of the voting power or to a concern in which such a shareholder is a member or partner and has substantial interest.
Thus in essence, any ‘advance or loan’ made by a private company –
shall be ‘deemed dividend’ for the purpose of the IT Act.
After having discussed what the section tells us, the one thing that comes to mind is why this section is so disputed?
The reason is the consequence of falling within the purview of this section. If an amount given to the aforementioned persons is treated as ‘loans’ for the purposes of this section, such amounts, being ‘deemed dividend’, will attract income tax liability under the head ‘Income from other sources’ as per Section 56 of the IT Act and accordingly will be taxed @30%.
It is for this very reason that companies avoided coming within the purview of this section, and accordingly, the dispute that arose here was whether amounts extended, as above, would tantamount to ‘loans and advances’ or shall be treated as ‘deposits’ and accordingly would fall outside the purview of this Section.
In the shade various judicial pronouncements in this regard, a number of corporates have fraudulently raised money in the guise of ‘deposits’ thereby avoiding the taxation applicability of this Section. To curb such a practice, a retrospective amendment to Section 2 (22) (e) to the IT Act can be expected to include ‘deposits’ within the purview of ‘loans and advances’, in line with the amendment made to Section 370 of the Companies Act, 1956.
Relevance under Section 185 of the Companies Act, 2013
Section 185 of the Companies Act, 2013 (‘Act, 2013’), now enforced, corresponds to Section 295 of the Act, 1956 (which now stands inoperative). Section 185 of the Act, 2013 repeats the same flaw of Section 295 of the Act, 1956, by giving no reference to the effect that loans include deposits, thereby continuing the confusion between the two.
Section 185 provides the following provision relating to ‘Loans to Directors’:
“Save as otherwise provided in this Act, no company shall, directly or indirectly, advance any loan, including any loan represented by a book debt, to any of its directors or to any other person in whom the director is interested or give any guarantee or provide any security in connection with any loan taken by him or such other person”
The Section lays down that no loans can be advanced by a company to any of its directors as also to any person in whom the director is interested. The term ‘any person in whom the director is interested’ has been defined in the Section to mean, inter alia, a company in which a director is a director/ holds 25% voting rights/ where the Board is accustomed to act in accordance with the directions or instructions of the director.
A lot of apprehension is being expressed in connection to this Section. The questions being raised includes whether ‘inter-corporate deposits’ given to companies in which such directors are interested would also come within the purview of this Section and accordingly not permitted?
As per this Section, granting of loans to ‘anybody corporate whose Board of Directors is accustomed to act in accordance with the directions or instructions of the Board, or of any director or directors, of the lending company’, is prohibited. Given the above, this becomes a very potent question considering that it is a very common practice to advance money to companies within the same group, being holding/ subsidiary/ associate companies.
In light of the analysis in the above sections, and the various case laws to support the view, ‘loans’ cannot mean to include ‘deposit’. In the absence of any clarification from the Ministry, ‘inter-corporate deposits’ to holding / subsidiary / associate companies will not attract the provisions of this Section and therefore will continue to hold good.
The discussions above proves, time and again, that ‘deposits’ are not ’loans and advances’ and the provisions governing ‘loans and advances’ only cannot said to apply to ‘deposits’ as well. This fact has been well settled in law.
Once the Act, 2013 is fully enforced, the governing sections for deposits would be Sections 73 – 76 and the Rules made thereunder. However, as in Companies (Acceptance of Deposit) Rules, 1975, the draft Companies (Acceptance of Deposit) Rules, 2013 provides that amounts received by a company from any other company do not fall within the meaning of ‘deposit’. Accordingly, the provisions pertaining to inter-corporate deposits will not apply to such amounts given.
Section 372A of the Act, 1956 and the corresponding Section 186 of the Act, 2013 also provides for only inter-corporate loans. Therefore, in the absence of any other applicable provisions, such inter-corporate deposits remain un-governed.
(Shampita Das works as an Associate in Corporate Law Group at Vinod Kothari & Company)