TIME TO SAY GOODBYE TO CREDIT LINES?

The RBI had raised concerns on supply chain finance products based on revolving lines of credit in November last year. After that the FIDC also made representations to the RBI requesting clarifications and allowing NBFCs to continue to offer these facilities.

Fast forward to yesterday, the RBI seems to have directed some large NBFCs to stop offering these products.[1]

As a response, the industry is divided - I see people confused about what happened? asking questions about who has been asked to stop? Is there a notification on this? Is there going to be a regulatory crackdown?

Let me simplify this for you!

WHAT ARE REVOLVING CREDIT LINES?

The RBI describes revolving credit facilities as exposures where the borrower is permitted to vary the drawn amount and repayments within an agreed limit. This is a flexible lending arrangement that allows borrowers to access funds on-tap, whenever they need it (of course up to a pre-approved limit). They can draw from, repay, and redraw as needed.

The credit limit is reduced with each drawdown and reinstated (to the extent of repayment) upon repayment of the outstanding loan. There is a similar concept called credit lines. The only point of difference being, the limit is not reinstated in case of a credit line that is non-revolving.

USE CASES OF REVOLVING CREDIT STRUCTURES

As new as it might sound to you, trust me you have seen a revolving line all around. Credit cards are the most common example that works on a revolving credit line structure.

• Sometimes digital personal loans or BNPLs can also be in a revolving form. ?
• Most working capital loans and supply chain finance also operate on this mechanism.
• In international trade transactions, revolving letters of credit are quite common and based on a similar structure, allowing the importers to have their shipments financed on-tap, without the need to request the bank for a letter of credit for every import transaction.

WHY SHOULD YOU CARE ABOUT A REVOLVING CREDIT LINE? ?

If you're a lender, you will have certain motivations to offer this:

• Lenders are required to maintain the minimum regulatory capital on the loans extended by them. A structure like this allows them the flexibility to maintain the capital only for the disbursed amount and not the entire sanctioned amount. [2]
• Typically, the fine print of revolving credit line agreements contains an unconditional option for the lender to cancel the line. This allows them to have the flexibility to choose to not disburse when they don't have the financial capacity.
• Being a one-time approval product, this helps the lender build the loan portfolio quicker and with a lesser number of customers.
• And because of the above reason, loan book can be grown without repetitive due diligence, hence, lower customer acquisition cost.

?

If you're a borrower, you would like this structure because:

• It allows you on-tap access to credit after the one-time sanction.
• A revolving line is open-ended and can be used for any purchase and general uses.

WHAT DOES THE RBI THINK ABOUT REVOLVING LINES?

1. With the rise in digital consumption loans, lenders developed credit line models to offer extremely short-term loans. Under this, customers can avail multiple short-term loans up to a pre-sanctioned credit limit without going through the approval process for each credit request. Revolving BNPL facilities were earlier structured through prepaid payment instruments (“PPIs”). In June 2022, RBI barred all non-bank Prepaid Instrument (“PPI”) issuers from loading revolving credit lines on PPIs.?
2. The RBI guidelines, in various instances, acknowledge this product. For instance, the guidelines on the minimum regulatory capital require NBFCs to maintain regulatory capital in the manner discussed above and the guidelines on the manner of asset classification of revolving lines of credit.[3] RBI bars guarantees on these revolving lines of credit but do not bar the revolving line of credit product itself.[4] Similarly, securitisation of revolving credit lines is also not allowed.[5]
3. The RBI issued a framework for extending pre-sanctioned credit lines on Unified Payments Interface (“UPI”) by banks in September 2023, enabling banks to offer credit lines to customers on UPI. There is no specific bar on revolving credit lines. Further, the regulator seems positive towards credit line products by banks.
4. On the contrary, the regulator seems to have concerns about certain practices pertaining to revolving credit in the NBFC industry, such as:

• Some revolving credit line products resemble too closely with credit cards.
• The lack of defined tenure in some products raises concerns over potential misuse or excessive lending.
• Due diligence is not done at the time of drawdown. In various instances, the customer may be defaulting or showing signs of credit stress and yet, can get access to funding from the credit line.
• There is no monitoring of end-use of funds.
• The practices followed by NBFCs for recording and reporting Special Mention Accounts (“SMA”) and Non-Performing Assets (“NPAs”) are inconsistent.
• The practices to manage regulatory capital and liquidity to fund the drawdowns are inadequate; and
• NBFCs do not review the credit limits periodically.

Given that the RBI has not issued an official statement and these are directions given during one-on-one interactions, it seems that the RBI has issues with certain practices and a continuation of these practices may ultimately lead to concerns on the product itself.

WHAT NEXT??

As the industry awaits a clear stance, NBFCs must exercise caution, ensuring compliance with evolving guidelines and adapting their practices to meet the regulator's expectations. It will be worthwhile to see what the regulator has to say!

[1] https://economictimes.indiatimes.com/industry/banking/finance/rbi-directs-large-nbfcs-to-stop-new-lines-of-credit-and-renewals/articleshow/118717321.cms

[2] Para 6(d)(i), RBI (Securitisation of Standard Assets) Directions, 2021.

[3] Para 85, Master Direction – Reserve Bank of India (Non-Banking Financial Company –Scale Based Regulation) Directions, 2023

[4] Para 7, Prudential Framework for Resolution of Stressed Assets

[5] RBI’s FAQs on Guidelines on Default Loss Guarantee in Digital Lending

[6] Para 6, RBI (Securitisation of Standard Assets) Directions, 2022