Updated ECB Norms for NBFC

Akash Dubey

17 Feb, 2024

In a recent development, the RBI issued new guidelines for External Commercial Borrowings (ECB) in NBFC funding. The new norms are a favorable move for the NBFC sector that is having a hard time raising funds from the domestic economy.

The RBI has allowed external commercial borrowings for working capital purposes, general corporate purposes and repayment of bank loans. Borrowing for on-lending (Loan to lend money to the third party) by NBFCs for the above mention maturity and end-uses is also permitted.

The step is taken to grant long term availability of funds to Non-Banking Financial Companies (NBFCs). However, the ECB’s should be raised from eligible lenders except for foreign branches/ overseas subsidiaries of Indian banks.

Earlier in its order issued as on 26 March 2019, it debarred ECB proceeding to be used for the working capital purposes, repayment of bank loans. The solution to NBFC problem of mismatch of assets and liabilities is the highlight of this notification.

Change in Provision of ECB for NBFC Funding

The changes in RBI provision in relation ECB funding are as follows:

As Per the Old Provision Dated 26th March 2019

The RBI in its order as released on March 26, 2019, said

Who is a Foreign Equity Holder?

The RBI defines Foreign Equity Holder as a person who is a direct equity holder with a minimum of 25 % direct holding in the borrowing entity. If the person is an indirect equity holder then he should possess a minimum of 51 % of equity. Additionally, a group of company with a common overseas parent also fall under this category.

As Per the New Provision Dated 30^th July 2019.

The new notification of RBI in concern with the use of ECB allowed the use of such borrowings for working capital purposes, general corporate purposes as well as for repayment of loans. The fact states that the bank credit for the NBFCs stood at 6.2 lakh crores as on April 2019.

As per the New Provision Dated 22 December 2023

The RBI has allowed non-banking finance companies to operate as infrastructure debt funds (IDF-NBFCs) to raise money through external commercial borrowings. RBI restricted the NBFCs from sourcing ECB loans from the foreign branches of Indian banks. The RBI revised the framework, which includes withdrawing the requirement for a sponsor for the IDFs, and made the tri-party agreement optional for the Public Private Partnership (PPP) Projects.

Update on MAMP

The RBI issued an MAMP for ECB, which will be three years, and the call and put option shall not be performed before the minimum average maturity period is completed. The specific categories mentioned below have the stated MAMP, which is stated in the 2.1 clause v of the paragraph in the Master Direction.

ECB for Working Capital

The RBI allowed ECB’s with a maturity period of 10 years for working capital purposes and general corporate purposes. Borrowing for on-lending by NBFCs for the above-mentioned maturity period and end-uses is also permitted. In the case of the working capital, the ECB for working capital will be the same as stated in the framework dated 30 July 2019. The RBI allowed ECBs with a Maturity period of 10 years for working capital purposes and general corporate purposes. Paragraph 2.1 clause v subclause b to e will not be raised from foreign branches or subsidiaries of the Indian bank.

“Borrowing for on-lending by non-banking financial companies for the 10-year maturity and end-uses are also permitted,” The RBI^[1] said.

ECB for Repayment of Rupee Loans

The RBI guideline on ECB repayment of rupee loans is the same as issued in the guideline dated 30 July 2019. The RBI also permitted the use of ECBs for repayment of rupee loans utilized domestically for purposes other than capital expenditure or on lending by NBFCs for the same purpose. Then, the average maturity period is 10 years. Also, the RBI allowed the use of ECBs for repayment of rupee loans utilized domestically for capital expenditure and on-lending by NBFCs for the same purpose, having an average maturity period of 7 Years.

Who are Eligible Lenders and Eligible Borrowers?

The eligibility criteria for borrowers and lenders have been prescribed by the RBI. Only such entities and people are permitted to take and lend funds via ECB route. The eligible borrowers and lenders are divided into two categories.

This distinction is on the basis of the currency that is being used in the transaction of funds. The list of recognized lenders and eligible borrowers will be the same as stated in the guideline on 30 July 2019. The lending and borrowings under the ECB framework by India Banks and their subsidiaries or branches outside India will be subjected to the guidelines of the RBI bank’s Department of Banking Regulation. The ECB framework is not applicable with respect to investment in non-convertible debts in India by registered foreign portfolio investors. There is different eligibility for funds taken in any freely convertible foreign currency and in Indian Rupee (INR) as per the Master Direction – External Commercial Borrowings, Trade Credits, and Structured Obligations laid by RBI.

Eligible Borrowers for Funds Taken in Easily Convertible Foreign Currency

This includes all the entities that are eligible to receive FDI. Further, the following entities are also eligible to raise ECB:

• Port Trusts
• Units in Special Economic Zones
• SIDBI
• EXIM Bank of India.

Eligible Borrowers for Funds Taken in Indian Currency (INR)

• All entities eligible to raise ECB in Convertible Foreign Currency;
• Registered entities engaged in micro-finance activities, viz., registered Not for Profit companies, registered societies/trusts/ cooperatives, and Non-Government Organisations.

Eligible Lenders for Lending Funds via ECB Route

The lender should be resident of FATF or IOSCO compliant country, including on transfer of ECBs. However,

• Multilateral and Regional Financial Institutions where India is a member country are eligible lenders;
• Individuals as lenders can only be permitted if they are foreign equity holders or for subscription to bonds/debentures listed abroad; and
• Foreign branches/subsidiaries of Indian banks are eligible lenders only for FCY ECB (except FCCBs and FCEBs).
• Foreign branches/subsidiaries of Indian banks, subject to applicable prudential norms, can participate as arrangers/underwriters/market makers/traders for Rupee denominated Bonds issued overseas. However, underwriting by foreign branches/subsidiaries of Indian banks for issuances by Indian banks will not be allowed.

Need for New ECB Norms for NBFC Funding 2019

The new norms came in the awakening of the prevailing problem of Liquidity crunch in the sector. The banks stopped lending to NBFCs significantly after the NBFC crisis surfaced. The situation created an environment of panic for the 10000 odd NBFC in the country.

Bank loans, mutual funds borrowings, and funding are three primary sources of NBFC borrowings. In case of crisis, the NBFC sector faced a tough time in raking funds from any of the three within the domestic market.

As per the industry experts, the trouble faced by the sector is not mainly because of the lending practices but because of the borrowing patterns of the NBFCs. NBFCs used to take a borrowing in short term debt papers or commercial papers for a period of 6 months to 3 years.

On the other hand, they used to lend loans for a longer period of 8 to 10 years. This is more in practice among NBFCs working in real estate and property loan sector.

Need for ECB Norms 2023 for NBFC funding.

In April 2022, the ECBs dropped due to the increase in the interest rate in global economies, so the Master Direction was introduced to ease the end-use restrictions and give access to foreign funds for the repayment of debt to maintain harmony in the financial sector. The framework made the borrowings easy for all eligible borrowers under the ECB route. As per the guidelines, the ECB will not be able to raise from the foreign branches of India Bank to not disrupt the Indian economy, and it also raised the compliance of the Minimum Maturity Period in every aspect for the benefit of the lenders and borrowers. The RBI has allowed Non-Banking Financial Companies (NBFC) to operate as Infrastructure Debt Funds to raise money through External Commercial Borrowings and revised the guidelines for the withdrawal of the requirement of sponsor for the IDFs. The Master Direction also introduced the tri-party agreement option for the public-private partnership projects. The RBI opens up a route for the defaulting Indian Corporations to access foreign funds for repayment of their domestic debts to stress-free the banking system and maintain the liquidity crisis. The RBI made the changes to avoid the crisis in the Indian banking sector and enable the NBFCs to borrow from foreign sources and use their on-lending activities as a step to protect the market or financial sectors due to sudden market challenges.

Role of NBFC Crisis in Liberalization of ECB Rules

The NBFC crisis took over the sector by storm. The default of Mumbai-based Infrastructure Leasing & Financial Services (IL&FS) in September 2018 wrecked the sector in a doomed state on the investments front. The 3-decade old NBFC giant reported holding projects worth Rs 1.75 lakh crores (25Billion US dollars).

The situation became so bad that it was compared to the 2008 Lehman Brother crisis that leads to the recession of 2008. Waking up to the possibilities of sectorial fall, the government took up a step to intervene in the matter to prevent possible damages.

The flawed working model of lending long terms loans by generating fund by the issue of short term commercial papers is cited as the reason for new norms. The short term loans or debt papers needed to be either renewed or freshly issued to new buyers.

The model worked fine in times of economic stability. However, this way of raising NBFC funding becomes a difficult task when it not all green in the economy. This mismatch in the asset and liability of NBFC’s is the main reason for increasing default rate.

The maturity period of 10 years for working capital purposes and general corporate purposes and 7 year maturity period for loan repayment is aimed to reduce this asset-liability mismatch.

The Impact of ECB Norms For NBFC 2019

The RBI notification came in a time when the NBFC’s are struggling to raise funds from the domestic market. The move is expected to provide relief to such entities in raising overseas funds. The minimum ECB maturity period is 10 years for working capital purposes and general corporate purposes as per the new ECB norms by RBI

The inflow of NBFC funding via ECB route is expected to help NBFC’s who are struggling to maintain a positive working capital ratio. The funds will provide flexibility in business operations.

The other benefit came in the permission of utilizing ECB for bank loans repayment. This is expected to balance the default rates among NBFC. The government expects that it will provide financial stability in the NBFC sector and make available for a cheaper source of NBFC funding.

The reports state the NBFC collected 4.01 crores from sale of commercial paper in the financial year 2019. The permit to use ECB fund will reduce the dependency on commercial papers.

Interestingly, NBFCs are the main source of funds for the MSME sector. Therefore the stability in the NBFC sector is crucial for the growth of MSME. Experts believe that funding via ECB route in NBFCs will provide flexibility to its lending operations.

Impact of ECB Norms 2023

The RBI Master Directions issued on 22 December 2023 to provide the following measure to the ECB policies, which has provided relief to such entities is raising funds from overseas. The following amendment has made impactful changes in the various areas of the policy such as:

• The limit and leverage under the automatic route limit state that all eligible borrowers can raise ECB up to USD 750 million or equivalent per financial year under the automatic route.
• The ECB borrowers are allowed to park the ECB proceeds in term deposits with AD Category 1 bank in India for a maximum period of 12 months.
• The ECB norms redefine the benchmark in all-in-cost ceiling per annum was temporary in the previous guidelines, but in the new framework, it is stated presently as the benchmark rate plus 550 bps spread for the existing ECBs linked to LIBOR whose benchmarks are changed to ARR and for the New ECBs is 500 bps spread.
• The end uses negative list for which the ECB proceeds cannot be utilized is added the four new points such as:
• Working Capital Purposes and general corporate purposes except in the case of ECB mentioned in clause v(b) and v(c) in the master direction in paragraph 2.1.
• Repayment of Rupees loans except in ECB mentioned case at v(d) and v(e) in the master direction in paragraph 2.1.
• On lending to entities except in the case of ECB raised by NBFCs as given in paragraph 2.1 at v (c), v(d) and v (e) of master direction.
• In the case of eligible corporate borrowers who have availed of the rupee loan domestically for capital expenditure in the infrastructure and manufacturing sector, they can also avail the ECB for repayment of these loans under a one-time settlement with lenders.

The RBI master direction introduced in December 2023 on the trade credit norms has made the following amendment in redefining the benchmark, such as a benchmark rate plus 350 bps spread for the existing ECB and 300 bps for the new ECBs. The AD Category 1 bank is required to furnish data on the issuance of bank guarantees for the Trade Credit quarterly and as per the consolidated statement and the format of that statement is mentioned in Master Directions January 2016.

Read Also: How to Raise Fund in NBFC, Is FDI a Good Option?

Experts Opinion on ECB Funds

The provisions are not sufficient to curtail the present NBFC crisis. According to industry experts, the maturity period of 10 years may attract less foreign investors due to the long period of maturity.

According to them, the lock-in period of 3 to 5 years is ideal to increase the flow of foreign investments in NBFC via External Commercial Borrowing.

The Regulatory Outlook

The big question is that why RBI issued a longer period of maturity for ECBs. The RBI is acting guard to prevent a fall out of the NBFC sector. As per the experts, the RBI look no short term provisions to tackle the situation.

The apex body wants to ensure sustainable and long term solutions to ensure healthy functioning of the NBFC sector. The primary problem of asset-liability mismatch was the pain point of prevailing times. A long maturity period is cited to ensure long term availability of NBFC funding.

At the same time, the dependency of the MSME sector on NBFCs is also a point of concern. Therefore, the stability by way of maturity period was necessary to provide funds availability to the MSME sector.

For a fact, The RBI has bought debt papers worth rupees 3 lakh crores in the financial year 2019  to help the banking systems in the country.

Main sources of NBFC Funding

Option 1 – Compulsory Convertible Preference Shares (‘CCPS’)

NBFCs can issue CCPS without obtaining prior approval of RBI if the conversion is capped at less than 26 percent. Hence, we can say that approval is not required in case there is no progressive increase in the shareholding.

However, at the time of conversion of preference shares into equity, prior approval of RBI is necessary. CCPS can be issued for a maximum period of 20 years. Now if we talk about the tax implications then in case CCPS issued at par or face value there shall be no tax implication.

There are some prescribed NBFCs that are allowed to take FDI through 100 automatic route by complying with the other conditions as prescribed by the RBI.

Prior written permission from RBI is required in case of any change in the shareholding of the NBFC, on a progressive basis which would result in acquisition/transfer of shareholding of 26 percent or more of the paid-up equity capital of the NBFC.

Option 2 – Issue of Different Class of Equity Shares

The NBFCs can raise funds by issue of a different class of equity shares. However, the voting rights of this class of equity shares should be less than 26 %.

There are some prescribed NBFCs that are allowed to take FDI through 100 automatic route by complying with the other conditions as prescribed by the RBI.

Prior written permission from RBI is required in case of any change in the shareholding of the NBFC, on a progressive basis which would result in acquisition/transfer of shareholding of 26 percent or more of the paid-up equity capital of the NBFC.

There are no tax implications for raising funds by this method if the shares are issued at fair market value by merchant banker as per the Rule 11UA of the Income Tax rules.

As per the companies act, the conditions in relation to the issue of differential voting rights shall not be applicable to a private limited company, only if where the Company has provided the same in the memorandum or articles of association

Option 3 – Issue Debt or Redeemable Instruments

NBFC can issue redeemable instruments i.e., Redeemable Preference Shares (‘RPS’) or Optionally Convertible Preference Shares (‘OCPS’). The OCPS / RPS can be redeemed for the maximum period of 20 years. Now if we talk about the tax implications then in case OCPS issued at par or face value there shall be no tax implication.

As per the FDI regulations, the investment made by an FOCC in equity / CCPS / CCD of another Indian company is considered as Downstream Investment. On the other hand, as per the RBI, FOCC can subscribe to other instruments such as RPS, OCPS which shall not be regarded as a Downstream Investment.

Read our article: Analysis of NBFC Liquidity Crunch in NBFC Sector

The Road Ahead for NBFC Funding

The new ECB norms are helpful but not sufficient to curb the prevailing issues in the NBFC sector.  The other ways which can be used to facilitate NBFC funding are Public bond Issue, Sale of Assets, etc.

The ECB route to gather NBFC funding will repair the balance sheet of NBFCs for now. However, there is a need for strict norms. The major focus should be on improving the underwriting quality of the sector.

There is a need to increase the forensic capabilities to spot the black sheep of the sector. Interestingly, the RBI is also looking for detailed collection of data from NBFCs. Finally, the factor of liquidity will also be taken into consideration.

Ensuring strict norms will help to flow funds via External commercial borrowings route. Moreover, the NBFC sector plays a catalyst role in the growth of the GDP of the country. The Government projects the GDP growth rate at 8 % whereas the RBI projects it to be 7%. The state of the NBFC sector will have a considerable impact on GDP growth.

The Indian economy came back strongly to a growth in the GDP from 9.1% in 2021-2022 to 7.2% in 2022-23, and the expected real GDP growth is by 6.5% in 2024-25. The RBI has projected real GDP growth at 6.5% for the financial year 2024-2025.

A recent change in FDI policy in the light of hostile takeovers

The Government of India has brought a change in foreign direct investment (FDI) policy and strict measures to curb opportunistic takeover due to Covid-19 crisis. This is done primarily to prevent Chinese funds and banks which started picking up the stocks of several Indian or India based critical companies. It has been provided that an entity of a country that shares a land border with India can invest only through Government Approval route, i.e., only after receiving the government approval. This move by the Government of India is expected to have a significant impact on investment by Chinese players. The amendment says that “an entity of a country, which shares a land border with India or where the beneficial owner of investment into India is situated in or is a citizen of any such country, can invest only under the government route”.

Impact of FDI Amendments on ECBs Remains Unaffected

Currently, the eligible borrowers are allowed to raise finance in the form of ECBs from recognised lenders, other than foreign branches and overseas subsidiaries of Indian banks. This borrowing from foreign investors comes with a minimum average maturity period of 10 years for working capital purposes and general corporate purposes.

Here, it is quite necessary to notice that the current change in the government’s FDI policy has only amended the specific provisions of FDI, which could be used for a hostile takeover of the Indian enterprise.

However, the regulation of non-equity instruments or the possibility of foreign investors (especially Chinese companies) to invest their funds through ECBs has not been prohibited. Indian companies are open to meet their fund requirements through the medium of ECBs. The step was taken only to prevent instances where Chinese investors wanted to gain ownership control over a few major Indian corporate houses in a hostile manner. Therefore, Fintech and other NBFC companies would be allowed to raise ECBs from Chinese investors to meet the working capital requirement in India. It is only the end-use of the ECB funds and other RBI regulatory conditions that will be applicable.

When would ECBs be impacted through these New FDI policy norms?

The minimum average maturity period for on-lending by NBFCs for working capital purposes or general corporate purposes is 10 years. Under RBI regulations, the conversion of ECBs, including those which are matured but unpaid, into equity is permitted. However, some stringent restrictions regarding ECBs procured from foreign countries, or Chinese investors can also be envisaged. This is applicable where any loans taken from these foreign persons, (and which are convertible into equity) is the case. Such loans which are convertible into equity investments would then attract levy of these FDI amendment norms if such a loan was taken prior to the amendment of Companies Act and for an average maturity period of more than 10 years. In this case, the activity of the lending and borrowing company will be covered under the Government approval route for Foreign Direct Investment (FDI). To summarise, if a loan gets converted to equity, then the above FDI norms for government approval would apply for Chinese Investments as well.

Read our article: External Commercial Borrowing (ECB) Regulations

ECB Norms for NBFC

• Change in Provision
• ECB for Working Capital

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