Menu Close

Tag: RBI

How do e-Wallets like Paytm work?

abhishek-ray   In the dawn of demonetisation, most of us have found ourselves adapting to new payment mechanisms and methods. The government’s strong push towards a cashless society seems to be ushering in the age of the e-wallet. Paytm alone is responsible for more transactions per day than the combined average daily usage of all the debit and credit cards in India. Mobile wallets, which many of you are using these days, are a type of pre-paid instrument. But what are pre-paid instruments? How do they work?

Here are some frequently asked questions, which should provide some clarity on the conceptual and regulatory framework behind pre-paid instruments in India.

I am hearing this term for the first time. What is a pre-paid instrument?

Pre-paid instruments are payment instruments that facilitate purchase of goods and services, including by way of funds transfer, against the value stored on such instruments. The value stored on these instruments represents the value paid for by the holders of such instruments.

The issuers of pre-paid instruments have tie-ups with various merchants, and you can use the value stored on your instruments to carry out transactions with these merchants.

Ok. That’s a very legalese definition. Did the Reserve Bank of India come up with it? What is the regulatory framework for pre-paid instruments?

Actually, yes! The Reserve Bank of India (RBI) first provided the guidelines on pre-paid instruments (let’s just call them PPIs) in 2009. Over the years the RBI, issued several notifications (yes, they were not as dynamic as today!) in relation to PPIs. It then decided to consolidate all these notifications in a Master Circular (which gets updated on a yearly basis). Pre-paid instruments are subject to the Payment and Settlement Systems Act, 2007.

The latest Master Circular – Policy Guidelines on Issuance and Operation of Pre-paid Payment Instruments in India was notified on 01 July 2016. You can have a look at that here. You will find all the definitions and other details in this Master Circular.

Cool! So I guess then a PPI is a regulated instrument and one needs to have the approval of the RBI to issue one?

Yes. The RBI provides licenses to issue PPIs. All persons proposing to operate payment systems and involved in the issuance of PPIs have to seek authorisation from the Department of Payment and Settlement Systems, RBI, under the Payment and Settlement Systems Act, 2007.

Ok. If mobile wallets are one type of PPIs, what are the other types?

PPIs can be issued as smart cards, magnetic strip cards, internet wallets, mobile accounts, mobile wallets, paper vouchers and any such instrument, which can be used to access the pre-paid amount. A mobile wallet (Paytm, Mobikwik etc.) is one type of PPI. However, this is a dynamic sector and entrepreneurs are devising new prepaid mechanisms everyday.

mobile-wallets-ppi

Mobile Wallets like Paytm and Mobikwik are Pre-Paid Instruments

Broadly the RBI classifies PPIs into the following types: Closed, Semi-Closed and Open Payment Instruments.

What are Closed System Payment Instruments?

These are payment instruments issued by a person for facilitating the purchase of goods and services from him/it. These do not permit cash withdrawal or redemption. As these instruments do not facilitate payments and settlement for third party services, issue and operation of such instruments are not classified as payment systems. (A pre-paid card in your canteen or a food court can be considered a type of closed system payment instrument.)

What are Semi-Closed System Payment Instruments?

These are payment instruments, which can be used for purchase of goods and services, including financial services at a group of clearly identified merchant locations/establishments, which have a specific contract with the issuer to accept the payment instruments. These instruments also do not permit cash withdrawal or redemption by the holder.

Mobile wallets like Paytm and Mobikwik are semi-closed payment instruments.

What are Open System Payment Instruments?

These are payment instruments, which can be used for purchase of goods and services, including financial services like funds transfer at any card accepting merchant locations (point of sale terminals) and also permit cash withdrawal at ATMs.

Debit cards are open system payment instruments.

Are there any limits in relation to the value that I can store in the PPIs?

Currently, the limit is Rs. 20,000 per month for PPIs where minimum details of the customers have been collected.

This limit can be extended up to Rs 1,00,000 per month after collecting the appropriate KYC (Know Your Customer) documents from the holders.

Ok. So what can I do with my pre-paid instruments?

Let’s only consider semi-closed PPIs from now on, as these are the most commonly used. Your scope of usage of a semi-closed PPI is dependent upon the number of merchants the PPI issuer has tied up with. Generally you can use your PPI for payment of utilities with these merchants and for transferring money to other PPIs.

e.g. Paytm has a tie up with Uber and not with Ola. So you can use your Paytm wallet to make a payment for Uber but not for Ola.

Ok. So what happens to the money after I transfer it to my PPI?

Every PPI issuer (like Paytm, Mobikwik etc.) is required to create an escrow account with a bank, where all the money collected from its customers are credited. This account is a non-interest bearing account. The PPI issuer is required to create a security on this account in favour of the PPI holders (customers like you and me). Therefore the holders are secured and in the event of liquidation/bankruptcy of the PPI issuer, the merchants/PPI holders shall be given preference to the other creditors of the PPI issuer.

ppi-01

ppi-02

There are strict norms, which regulate any debit or credit of this escrow account. However at no point of time can the amount in the escrow account be less than the aggregate of the balance amount in all the corresponding PPIs and all pending payment instructions in favour of the merchants. So don’t worry, your money is safe with a PPI issuer!

Can I redeem the money stored in my PPI?

No. You are not allowed to redeem your money from a semi-closed PPI. However if that particular PPI is being closed or if the RBI decides to stop this entire product of PPIs (highly unlikely, the RBI usually does not reverse a decision), the customers shall be allowed to redeem the amounts stored in the PPI, within the expiry date of the PPI.

Who can issue PPIs? Are all PPI issuers NBFCs or banks?

Only banks can issue Open PPIs. Non Banking Financial Companies (NBFCs) and other persons can issue Closed and Semi-closed PPIs. These persons need to have a minimum paid-up capital of Rs. 500 lakh and minimum positive net-worth of Rs. 100 lakh at all times. Only companies incorporated in India are eligible.

As mentioned earlier, the authorisation of the RBI is required.

If I keep my money in my bank account it earns me interest. Can I earn interest on the amount stored in my pre-paid instrument?

The money in the wallet or PPI can only be used for transactions against the value stored in such instruments.

You will not earn interest on the amount stored in the wallet.

I heard of an offer where I can get cashback points if I use a mobile wallet. How does this work?

These are usually marketing offers. The merchant may be offering the product at a discount to increase sales. The discounted amount is then credited back into the PPI.

At times, the PPI issuer may also credit the PPI with an additional amount to incentivise customers. A PPI can be funded/reloaded by third parties, so the PPI issuer is transferring the cashback amount to your PPI.

Hope this is of help! Do take some time to go through the RBI Master Circular for more details.

Abhishek is a legal and business strategy consultant with ePaylater, one of India’s first one- click checkout payment solutions. This article should not be construed as legal advice. The views expressed in this article are his personal views and opinions. He can be reached at abhishek.ray@epaylater.in.

Written by myLaw

India Post: Biting off more than it can chew?

 

India Post applies for Banking Licenses

Photograph by Parul Kumar.

The finance world has been abuzz since the Reserve Bank of India (“RBI”) announced its intention to grant banking licences to a few more private sector entities. The July 1 deadline has passed and there are 26 contenders for these licences.

While no one was surprised to see established private sector groups like Tata, Birla, and Reliance on the list, entities like Muthoot Finance (the gold loan company) and some Non-Banking Finance Companies like Edelweiss Financial are also part of it. But the one that interests me the most is India Post.

India Post brings rural access to the table. At its current infrastructure, about 90% of its branches are in rural India. The RBI, with its focus on financial inclusion, has already made it compulsory for new lenders to have at least 25% of their branches in rural areas. So, you might think, who better than India Post to lead the ‘financial inclusion’ brigade?

The answer appears to be—almost everyone else. This is because:

1. New banks for private sector only: The RBI’s intention is to expand the representation of the private sector in banking, and to thereby fuel competition in the market. The new licensing norms titled ‘Guidelines for Licensing of New Banks in the Private Sector’ make that evident. So where does that leave India Post? To be a serious contender, either the department (a part of the Ministry of Communications and Information Technology) becomes a corporate entity, or the RBI will have to find a place for a government department in its new regulations.

2. Regulation of a government department: Let us assume that the RBI allows the latter option. How will the RBI enforce regulations on or penalise a government department?

3. Ability to run banking operations: Fundamentally, there are two functions that make an entity a bank — accepting deposits and lending funds. In a way, India Post is already running certain schemes that explain why it has any banking ambitions at all. The Post Office Savings Schemes allow people across the country to create savings accounts that offer good rates of interest and, in some cases, tax rebates. It is in the second function however, that it runs into a major roadblock. Our postal department has no experience in lending. There are no rules, guidelines, or paperwork to tell the department how to go about lending the corpus of funds that they collect from the deposits.

This is India Post’s biggest challenge. You see, they have the infrastructure, but they don’t have the people. You cannot convert your local postman into a bank branch manager. It would involve a colossal operational, not to mention a philosophical change, within the department for it to be equipped to handle banking operations. And experience tells us that change does not come to the Indian public sector easily.

Only five or six licences are expected to come out of this round, and it is unlikely that the RBI will announce its decision until 2014. I, for one, am interested to see the final take on India Post.

(Deeksha Singh is a member of the faculty on myLaw.net.)

Written by myLaw

CCI clears differential interest rates by housing loan providers

In a series of recent orders, the Competition Commission of India (“the Commission”) has ruled that the practice followed by housing finance providers of charging new borrowers a lower interest rate than old borrowers at the same point in time is not illegal as per the Competition Act, 2002. The orders are grounded on two reasons—firstly, that no bank can be said to have a dominating position in the market by itself and secondly, the fact that not all banks and lenders are following this policy of charging differential rates of interest shows that there are no signs of cartelisation. The Commission also reached the conclusion that employing pre-payment charges, including cases where a charge is levied for the foreclosure of a loan in case of a borrower seeking to switch between lenders or banks, is not an unfair trade practice.

Image above is from woodleywonderworks photostream on Flickr.

Image above is from woodleywonderworks photostream on Flickr.

The Commission, while deciding complaints relating to three specific banks in Govind Aggarwal and Others v. ICICI Bank Limited and Others and  V. Ramachandra Reddy and Others v. HDFC Bank Limited and Others (orders dated June 7, 2011 and May 31, 2011 respectively), held that as per the investigation of the Director General of the Commission, there was no truth to the charge that banks were colluding to ensure that the benefits of lowered interest rates were not passed on to their customers by the banks. It was held that this perception existed because of the lack of transparency in the system of fixing the rate of interest in a “floating rate” scheme. This is perceptional issue would be dealt with now that the RBI had mandated a change from the Prime Lending Rate (“PLR”) to the ‘base rate’ system. The ‘base rate’ is the minimum rate for all commercial loans and lenders, including those providing housing loans. Under the base rate system, interest is charged at the base rate in addition to customer-specific charges based on factors such as the credit-worthiness of the customer, nature of the loan, and nature of the property. The PLR on the other hand, is the rate at which banks lend to each other and is thus not a factor that is available to or understood by the original customer. The RBI mandated the shift from the PLR to the base rate in 2010. 

The Commission also accepted the report of the investigation by the Director General where it reached the conclusion that it was not possible for banks to employ a uniform interest rate for all borrowers, new and old, because of borrower-specific circumstances. The Commission also reached the conclusion that an agreement between the banks could not be inferred simply from the factum of banks employing a differential rate of interest between customers. In doing so, the Commission disagreed with a supplementary report filed by the Director General in one case, which had reached the conclusion that prepayment charges violate Sections 3(1) and 3(3)(b) of the Competition Act, 2002. Both sections deal with activities that inhibit fair competition in the market and the Director General had concluded that since prepayment charges deter customers from switching their loan to a different bank, such charges go against the letter of the law. The Commission rejected this finding, while facing strong dissent from members.

It was similarly decided in the suo moto hearing regarding Charging of differential rate of interest by banks (MRTP case DGIR/2007/IP/104-RTPE case 33/2007), passed within a few days of the previous orders, that while there is prima facie evidence of different rates of interest, these can be explained by differing perceptions of risk in different cases and that, as such, no further investigation was required. This order also saw a strong dissent from Mr. R. Prasad, who had dissented in the earlier cases as well, that differential rates are an abuse of dominant position (regulated under Section 4 of the Competition Act, 2002). He based his decision on the understanding that preventing switching of loans, as well as enticement of new customers by offering lower rates of interest, hurt consumers through abuse, by the lenders, of their dominant position vis-a-vis the consumer and hurt the growth of free competition by discouraging new lenders and even innovation by existing lenders who would not seek to offer new products since prepayment charges would ensure that borrowers would not be able to try out such new products. On the issue of the dominant position of a bank, the Commission reached the conclusion that since no bank singly enjoys a dominant position in the market, such provisions of the Competition Act would not be attracted in these cases.

The orders of the majority and the dissenting members (Mr. R. Prasad in all three cases and Mr. Parashar in one case) show a very differing understanding of the scope of competition law. While the majority clearly see competition law as an area of law regulating inter-corporate relations, the dissenting members seem to subscribe to a view of competition law that is more customer or consumer-oriented. In this, they may well find support from international competition law regimes such as that of the European Union, which are more consumer-oriented and where the idea of curtailing banks’ freedom to levy such charges as prepayment charges has been considered for the purpose of protecting their customers. Competition law, after all, is an area that has as much to do with economic policy as well as the black letter of the law and the way it is understood by the Commission, and the courts, will have a major impact on how businesses operate in India.

 

(Sarim Naved is a New Delhi-based advocate)

 

Written by myLaw

The right to prepay a loan

In a recent decision (DLF Limited v. Punjab National Bank, W.P.(C), 8520/2010, decision dated May 27, 2010, (“the DLF judgment”)) the Delhi High Court has dealt with two important issues in relation to prepayment fees being charged by Indian banks, that is, (i) whether in the absence of a provision in the loan agreement, a borrower is entitled to prepay the loan amount; and (ii) in case of a prepayment, can the bank charge a “prepayment fee” unless such fee is specified in the loan agreement?

The Delhi High Court judgment will also encourage banks to justify the manner in which prepayment penalty is calculated, says the author. Image above is from Wikimedia Commons. Image (but not the rest of the article) has been published under a Creative Commons Attribution-ShareAlike 2.0 Generic License.

The Delhi High Court judgment will also encourage banks to justify the manner in which prepayment penalty is calculated, says the author.
Image above is from Wikimedia Commons.
Image (but not the rest of the article) has been published under a Creative Commons Attribution-ShareAlike 2.0 Generic License. 

What is prepayment premium? 

term loan (as opposed to an on demand loan which is repayable any time the lender wants to after the date of advance) is required to be repaid on specified payment date or dates (called the repayment schedule or maturity dates). Prepayment is where the borrower prepays the loan in advance of the repayment schedule.

Banks are generally reluctant to allow the prepayment of a loan. This is because the bank makes treasury allocations in anticipation of the specified term of a loan, the repayment schedule, and the interest expectation. An early prepayment disrupts this schedule and also means that the borrower has to pay lesser interest (since interest is calculated from the time the loan is disbursed, till it is repaid). Under a fixed-rate loan, the lender will also lose profit resulting from the prepayment of principal if the market interest rates have declined since the loan was originally extended (and hence once the lender re-disburses the money, he earns a lower amount). Even if the interest rate remains where it is expected to be for each interest period, prepayment within an interest period may result in a loss for the lender. For this reason, lenders tend to require prepayments to be made only on specified interest payment dates.

The other common instance where a borrower wishes to prepay the loan is when he is able to refinance the loan, that is, is able to borrow an amount equivalent to the existing outstanding under the loan from another lender at a lower cost.

To compensate for this loss of earning, a loan agreement, if it permits prepayment, provides for a prepayment penalty, or “break costs”. The intent of this clause is to compensate the bank for the loss of earnings as a result of the prepayment.

From a borrower’s perspective two important aspects need to be kept in mind while negotiating the prepayment clause and the prepayment penalty, (i) the flexibility to prepay the loan without the lender’s permission; and (ii) predictability (that is, certainty on what the quantum of the prepayment penalty, if any would be).

For example, the Loan Market Association (“the LMA”), the definitive organisation for loans in the European market, in its standard agreement, defines break costs as the difference between the interest which a lender should have received in the interest period in which the prepayment is made and the amount which the lender would be able to obtain by placing the same funds on deposit with a leading bank in the interbank market for the relevant interest period. What this definition does is, (i) impose an obligation on the lender to deposit the funds with a leading bank (and not let them stay idle); and (ii) restrict the borrower’s obligation to one interest period. It is assumed that by the time the interest period is completed, the lender would have found other avenues where the funds can be parked.

Unfortunately in India, there is no standard for determining the prepayment fee and there is no obligation on a lender to provide evidence on how the prepayment fee has been arrived at. It is quite common for borrowers to agree at an arbitrary percentage, or even worse—that the prepayment fee shall be as determined by the bank from time to time. Further, in several contracts, there is no provision for prepayment at all, which was the case in the loan agreement, which was the subject matter of the DLF judgment. 

Facts of the case 

The petitioner DLF, had taken a loan of Rupees One thousand crores from Punjab National Bank (“PNB”). DLF prepaid the loan amount and then applied for release of the security, which had been deposited with PNB. PNB refused to release the security till prepayment charges of Rupees Twenty crores were paid.

DLF filed a writ petition stating that PNB was illegally withholding the release of the security and since the loan agreement did not provide for prepayment penalty, PNB was not entitled to charge the same. DLF also stated that a claim for prepayment penalty in the absence of a clause in the loan agreement violated the guidelines of the Reserve Bank of India (“the RBI”), which mandate that all charges be intimated to the borrower upfront.

There was a preliminary challenge by PNB to the maintainability of the writ on the ground that it was a contractual matter and not subject to writ jurisdiction. This was dismissed and is not relevant to the present post.

PNB argued that the reason why prepayment charges were not mentioned is because DLF had never expressed the intention to prepay the loan and since DLF had subsequently requested prepayment, they could only do so after payment of prepayment fees, which PNB had intimated to DLF. PNB also argued that they had displayed a policy to levy a prepayment fee of two per cent on their website, which was in compliance with the RBI guidelines. PNB challenged the very right of a borrower to prepay a loan in the absence of a specific provision in the loan agreement and stated that before the scheduled repayment date, DLF could not repay the loan.

The Court’s decision

The Court held that, whilst under law DLF was obliged to re-pay the debt immediately, PNB had by contract allowed suspension of this obligation (that is, PNB’s right to call for repayment) till the repayment dates specified in the loan agreement. This did not mean that DLF was restricted from the obligation prior to the specified dates. In fact, unless the agreement specifically provides for a prohibition, the borrower has a right of prepayment, since “every borrower has an inherent right to free himself from the loan.”

Further, since PNB had not in any manner informed DLF of its obligations with respect to a prepayment penalty, their actions of demanding such penalty at the time of discharge of the obligation is violative of the RBI Guidelines and PNB’s own Fair Practices Code.

The Court also rejected PNB’s argument that the prepayment penalty of two per cent was specified in the bank’s website and therefore DLF was obliged to pay the same, since the loan agreement did not any manner specify that other general practices of the bank would become applicable to the loan. Without incorporation of the general terms and conditions specified on the website in the loan agreement, PNB could not rely on any such terms and conditions becoming a part of the agreement with DLF.

Interestingly, the judgement records that the Judge had asked counsel for PNB to justify the basis on which the two per cent prepayment charge was based. The learned counsel could provide no rational justification, except that the amount was specified in the website of the bank.

Conclusion 

The two most important conclusions that can be arrived from the judgement are (i) that in the absence of specific contractual obligations, a borrower has an inherent right to prepay a loan; and (ii) that unless the loan agreement specifically allows for the same, a lender is not entitled to charge a prepayment penalty.

The judgment is an eye-opener for banks in terms of the importance of contractual provisions reflecting the bank’s rights. If the bank requires that amounts cannot be prepaid (or that they can be prepaid only on payment of prepayment penalty) then such a right should be specifically recorded in the loan agreement. Further, banks should also be prepared to justify the manner in which prepayment penalty is calculated; failing which there is a genuine chance that the amount may be dismissed as a penalty and not compensation. Even for borrowers however, the prudent idea would be to have their prepayment right clearly recorded in the agreement, so that they do not have to go to court to prove their rights.

 

 

(Deepto Roy heads the energy and infrastructure practice of PXV Law Partners. He is based in New Delhi.) 

 

Written by myLaw