To improve credit discipline among borrowers, the Reserve Bank of India (RBI) issued a circular in August 2020 on the opening of current accounts (guidelines). Since May 2004, the RBI has required borrowers to obtain a no-objection certificate (NOC) from lending banks when opening current accounts. It reiterated its position in August 2004 when it stated that banks were allowed to open current accounts for customers that enjoyed credit facilities in the banking system only after they had obtained an NOC from the lending banks and had waited for a minimum of 14 days. In its circular of July 2015, the RBI asked banks to use the information available in the Central Repository of Information on Large Credits and not to limit due diligence in seeking NOCs.
The RBI considers that, despite the prevailing guidelines and penal provisions, borrowers have misused funds through opening multiple current accounts with different banks. The guidelines have been issued to enable lenders to control current account usage and monitor cash flows, and replace the requirement to obtain NOCs. Customers now applying to open current accounts fall into three categories. Banks with customers who have existing credit facilities in the banking system in the form of cash credits (CC) or overdrafts (OD) cannot open current accounts for them. Transactions must be routed through the CC/OD account. If a bank’s exposure to a borrower is less than 10% of the exposure of the banking system to that borrower, it may open CC and OD accounts. However, debits from such accounts can only go to the CC or OD account of the borrower maintained at a bank with a 10% or more exposure of the banking system to that borrower.
Banks with customers who have existing credit facilities in the banking system but do not have a CC or OD facility can open current accounts. Where the exposure of the borrower to the banking system is ₹500 million (US$6.8 million) or more, current accounts can be opened only with the escrow managing bank with a mandatory escrow mechanism in place. Lending banks may open collection accounts subject to the condition that funds in these accounts can only be remitted to escrow accounts. Non-lending banks cannot open current accounts for such borrowers. If the exposure of the borrower is ₹50 million or more but less than ₹500 million, lending banks can open current accounts. However, non-lending banks can only open collection accounts as above. Where exposure is less than ₹50 million any bank may open a current account provided that the borrower undertakes that they will inform the bank when their credit facilities in the banking system reach ₹50 million.
Banks with customers who have not used any credit facility in the banking system may open current accounts subject to their due diligence policies. In the guidelines, exposure means a sum of sanctioned fund-based and non-fund based credit facilities. In the FAQs of December 2020 on the guidelines, the RBI clarified that only the exposure of scheduled commercial banks and payments banks are included in the determination of the aggregate exposure of the banking system. All the exposure of non-banking financial companies and other financial institutions is excluded.
Recognizing the challenges faced by the banks and borrowers in implementing the guidelines, the RBI in its circular of December 2020 (exemption guidelines) permitted banks to open specific accounts without following the restrictions of the guidelines, provided that the accounts are only used for permitted or specified transactions. All lending and other account holding banks must also monitor current accounts, CC and OD accounts on a half-yearly basis and ensure that they comply with the guidelines.
The guidelines and exemption guidelines are a welcome step in strengthening the banking system by enforcing better repayment discipline on large borrowers and preventing the misuse of funds. However, implementation poses a challenge to bankers. There is, for example, no centralized framework in which information on customer fund flows can be shared. The sharing of information will enable banks to take timely and effective action to prevent the diversion of cash flow. The guidelines will also have to survive accusations of being anti-competitive in that they deny non-lending banks, the business opportunity and to customers, the choice of banking.
Nishtha Arora and Ayushi Parmani are associates at SNG & Partners
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