Changes to account opening – Help or hindrance?

By Sawant Singh and Aditya Bhargava, Phoenix Legal

On 6 August 2020, the Reserve Bank of India (RBI) issued directions to banks to regulate instances in which current accounts and cash credit (CC) or overdraft (OD) accounts may be opened. Previously, companies could use multiple current accounts, which made their cash inflows difficult to monitor. The directions will introduce checks and balances on the use of multiple accounts by customers with a view to strengthen credit discipline and to prevent the diversion of funds. In this regard, a noteworthy provision of the directions is that the funds of term loans must be remitted by banks directly to the suppliers of goods and services for which the loans were obtained.

Sawant Singh

The directions prescribe that no current accounts may be opened for customers that have existing CC or OD accounts, and that transactions must be routed only through such accounts. Further, only banks that have provided at least 10% of the aggregate of all fund based and non-fund based credit facilities made available by banks to a customer can provide CC or OD facilities to that customer. Banks with an exposure of less than 10% can only offer working capital demand loans and working capital term loans.

Where a bank customer has not used any CC or OD facilities, it may open current accounts. Where a customer has not used any banking credit facilities, banks may open current accounts for such customers in accordance with their internal policies. Where aggregate credit facilities lower than ₹50 million (US$680,000) have been provided by the banking system to a customer, any bank may open a current account for such customer provided that the customer undertakes to inform the bank if the aggregate of such credit facilities increases to ₹50 million or more. Where aggregate credit facilities provided by the banking system are more than ₹50 million but less than ₹500 million, banks with a lending relationship with the customer may open current accounts for such customers, but non-lending banks may only open collection accounts for such customers.

Aditya Bhargava
Phoenix Legal

However, if aggregate credit facilities provided by the banking system to a customer are more than ₹500 million, banks are required to put in place an escrow mechanism, and current accounts for such customers can only be opened and maintained by the escrow bank. Aside from opening the escrow account, other banks that are lenders may only open collection accounts for such customers, and funds should be remitted from such collection accounts only to the escrow account. Banks that are not lenders cannot open any current accounts for such customers.

Notably, the mechanism for the operation of such escrow accounts has not been prescribed by the RBI. While there is merit in regulations not being overly prescriptive so as to provide flexibility in implementation, clarity on the opening and operating of the escrow account would have been welcome in view of the intent of the directions. Considering the current multiplicity of current and escrow accounts, such lack of clarity may be a source of confusion for stakeholders.

In order to provide some lead time for implementation, a period of three months has been allowed for those affected to comply with the directions. However, reorganizing the accounts of customers, and closing the existing current accounts and CC or OD accounts to comply with the RBI directions may be an arduous task for banks, particularly where they have reduced manpower due to COVID-19 related restrictions.

Currently, public sector banks tend to be more active, by volume, in lending, while private sector banks tend to be more active in cash management services. The implementation of the directions may result in the scales being tipped in favour of public sector banks. This may have the unintended consequence of distorting competition in the near term.

While the intent of the directions is welcome, it has led to some confusion, particularly considering that various structured lending transactions require dedicated escrow accounts and also considering that the implementation of its somewhat complicated framework is likely to be haphazard. If the core intention is to prevent the diversion of funds, a simpler solution would have been to require funds from credit facilities to be routed through the lending bank only. The directions contain laudable provisions such as remittances being made directly to suppliers. However, there is a perception among stakeholders that these directions would require some re-working to ensure that day-to-day activities in various sectors are not hampered.

Sawant Singh and Aditya Bhargava are partners at Phoenix Legal. Sristi Yadav, an associate, assisted on the article.

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