Banks in India have moved beyond their traditional role as providers of debt financing. As per data released by the Reserve Bank of India ("RBI"), as on June 16, 2023, scheduled banks have invested close to INR 6,710 Crores as investors. It therefore becomes important to understand the approach and perspective of the RBI and banks in relation to such investments.
It is pertinent to note that banks have sent notices to companies where they have invested, calling upon them to declare dividend on investments by the banks. In certain cases, the notices specify that if the dividend becomes overdue, the bank's investment would be categorized as a "non-performing investment" ("NPI"). Companies which have received investments from banks have sought clarity regarding the ramifications of being classified as an NPI.
References to the concept of an NPI primarily appear in the Master Direction – Classification, Valuation and Operation of Investment Portfolio of Commercial Banks (Directions) 2021 ("Master Direction") issued by the RBI. In the Master Direction, RBI has directed all commercial banks to classify their investments as NPI in the following circumstances:
- where fixed dividend on the preference shares is not paid within 90 days of it becoming due;
- where interest or installments are due and remain unpaid for more than 90 days; and
- in the case of equity shares, where the investment in the shares are valued at Re. 1, due to non-availability of the latest balance sheet of the company.
It is important to note that the Master Direction clarifies that if the committed dividend on shares is not declared or paid, it shall be considered to be due or unpaid.
Broadly speaking, a company can raise funds through either equity or debt. These two sources of finance are inherently different from each other in terms of returns, tenure, security of capital, and involvement in the management of the investee company.
Banks provide debt with the intent of earning recurring income, where the capital is secured, and there is a regulatory framework for recovery of secured dues. Equity investments are generally undertaken with the intention of earning capital returns at the time of exit, without assured or periodic returns.
Through the Master Direction, the RBI has attempted to regulate the assured returns on investments. It appears that RBI seeks to mitigate the risk inherent to investments by ensuring regular payment of dividends to banks. However well-intentioned this may be, enforcing dividend payments falls squarely against the fundamentals of private equity investments, since returns on investment are directly related to the profits, performance and growth of the company.
From a business perspective, the profits are often ploughed back into the company to catalyse the growth of the company. Sophisticated investors understand this approach, and do not aim for short-term returns from regular dividends. A company that does not declare dividend is not necessarily a "non-performing" company.
Through NPI, the Master Direction appears to disincentivize the banks from making private investments in high-growth companies in today's start-up ecosystem. The introduction of NPI is likely to discourage promoters from accepting capital from banks.
There is also a lack of clarity regarding how the NPI construct may evolve over time. Further directions by the RBI or internal policies of banks regarding NPI may have far-reaching consequences for companies categorized as NPI.
Further, the RBI has not clarified how companies may remove the NPI classification. This is particularly concerning, given that the consequences of being an NPI are far from clear. Banks may choose to disclose names of portfolio companies classified as NPI in their annual reports. The tag of NPI may therefore carry serious reputational risks for promoters, which could impede their ability to raise funds.
With the exponential growth of the Indian start-up ecosystem and, where Indian entities are taking up the global business mantle, unambiguous regulations for investments by banks would incentivise entities to seek capital from banks. At present, the regulations pertaining to NPI create ambiguities which could sour the pitch for this growing ecosystem. The RBI should consider re-examining the regulatory rationale for "non-performing investments" to address these concerns.
Authored by Bhavin Gada, Senior Partner, Soumya Shanker, Partner & Vishakha Dube, Associate.
* The contents of this article do not necessarily reflect the views / position of Stratage Law Partners but remain solely those of the author(s). This article is meant for general information and shall not be deemed to be legal advice or opinion. This article is neither intended to be an advertisement nor solicitation.