Alerts & Updates 4th Apr 2024

Reserve Bank of India Guidelines on Guarantees and Co-acceptances by Banks in India

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Mukesh Chand Senior Counsel | Mumbai

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  • The Reserve Bank of India (RBI) has issued consolidated guidelines for issuance of Guarantee and Co-acceptance of Bill by the Banks in India (vide Master Circular DOR. STR.  EC.5/13.07.010/2023-24 dated April 1, 2023) . This circular consolidates all instructions on the subject which have been issued up to March 31, 2024 and does not contain any new instructions/guidelines.

    These guidelines ensure prudence, transparency, and compliance in the issuance of guarantees and co-acceptances by banks in India. They emphasize the importance of responsible conduct in guarantee business, including careful risk assessment, adherence to regulatory frameworks, and robust internal control systems. Banks are encouraged to prioritize financial guarantees over performance guarantees and exercise caution in extending non-fund based facilities. Additionally, strict measures are outlined for issuing guarantees on behalf of directors, government schemes, and brokers.

    The RBI also emphasizes the need for prompt payment upon invocation of guarantees and prudent co-acceptance practices to mitigate risks. Compliance with regulations such as the Foreign Exchange Management Act (FEMA) and adherence to prudential norms are essential aspects of maintaining the integrity and credibility of the banking system in India.

    Following are the gist of the guidelines under different heads:

  • General Guidelines
    • Banks should primarily focus on providing financial guarantees, exercising caution with performance guarantee business. They are advised to guarantee shorter maturities as under the Guidelines, no bank guarantee should normally have a maturity of more than 10 years. Also, guarantees with maturity beyond 10 years should be as per the Board approved policy, considering its impact on Asset Liability Management.
    • Non-fund-based facilities should generally be reserved for customers with existing credit facilities, with exceptions subject to comprehensive board-approved policies. Banks are permitted to grant non-fund based facilities, including partial credit enhancement, to those customers, who do not avail any fund-based facility from any bank in India, as per board-approved policy. At the time of granting non-fund-based facilities, banks are required to obtain declaration from the customer about the non- fund-based credit facilities already enjoyed by them from other banks. Banks should undertake the same level of credit appraisal as has been laid down for fund-based facilities.
    • Instructions related to KYC / AML / CFT, submission of credit information to Credit Information Companies and other prudential norms applicable to banks, including exposure norms, issued by RBI from time to time, shall be adhered to in respect of all such facilities.
    • Banks are prohibited from negotiating unrestricted LCs of non-constituents. In cases where negotiation of bills drawn under LC is restricted to a particular bank and the beneficiary of the LC is not a constituent of that bank, the bank shall have the option to negotiate such LCs, subject to the condition, that the proceeds are remitted to the regular banker of the beneficiary.
    • BG /LC may be issued by scheduled commercial banks to clients of co-operative banks against counter guarantee of the co-operative bank as permitted hitherto.
    • In this regard the Banks are to follow the provisions of paragraph 2.3.8.2 of the Master Circular on Loans and Advances-Statutory and Other Restrictions dated July 1, 2015 as amended from time to time.
    • Further, in such cases, banks must satisfy themselves that the concerned co-operative banks have sound credit appraisal and monitoring systems as well as robust Know Your Customer (KYC) regime.
    • Banks must satisfy themselves that KYC check has been done properly in these cases.
    • The guarantee of parent companies may be obtained in the case of subsidiaries whose own financial condition is not considered satisfactory.
    • As a rule, banks should avoid giving unsecured guarantees in large amounts and for medium and long-term periods. They should avoid undue concentration of such unsecured guarantee commitments to particular groups of customers and/or trades.
    • Unsecured guarantees on account of any individual constituent should be limited to a reasonable proportion of the bank’s total unsecured guarantees.
    • Guarantees on behalf of an individual should also bear a reasonable proportion to the constituent’s equity.
    • In exceptional cases, banks may give deferred payment guarantees on an unsecured basis for modest amounts to first class customers. These customers should have entered into deferred payment arrangements in consonance with Government policy.
    • Guarantees executed on behalf of any individual constituent, or a group of constituents, should be subject to the prescribed exposure norms.
    • Ghosh Committee recommendations on serially numbered security forms for guarantees are emphasized.
    • In order to prevent unaccounted issue of guarantees, as well as fake guarantees, as suggested by IBA, bank guarantees should be issued in serially numbered security forms and should, in their own interest, verify the genuineness of the guarantee with the issuing bank.
  • Internal Control Systems
    • Bank guarantees issued for INR 50,000/- and above should be signed by two officials jointly. Exceptional deviations should undergo rigorous scrutiny during internal inspections to prevent fraud. In case, exceptions are made for affixing of only one signature on the instruments, banks should devise a system for subjecting such instruments to special scrutiny by the auditors or inspectors at the time of internal inspection of branches.
    • In the case of performance guarantee, banks should exercise due caution and have sufficient experience with the customer to satisfy themselves that the customer has the necessary experience, capacity and means to perform the obligations under the contract and is not likely to commit any default.
  • Guarantees on Behalf of Banks’ Directors
    • Section 20 of the Banking Regulation Act, 1949 prohibits banks from granting loans or advances to any of their directors or any firm or company in which any of their directors is a partner or guarantor.
    • Certain facilities which, inter alia, include issue of guarantees, are not regarded as ‘loan and advances’ within the meaning of Section 20 of the Act.
    • Banks issuing guarantees for directors must ensure commitments are met by the principal borrower, avoiding any circumvention of regulations. Also, the bank would not be called upon to grant any loan or advance to meet the liability, consequent upon the invocation of the guarantee.
  • Bank Guarantee Scheme of Government of India
    • Banks are advised to adopt the prescribed Model Form of Bank Guarantee Bond for government schemes, ensuring conformity and facilitating prompt identification.
    • Guarantees are furnished by the banks in favour of Government Departments in the name of the President of India,. However, any correspondence thereon should be exchanged with the concerned ministries/ departments and not with the President of India.
  • Guidelines for Guarantees on Behalf of Share and Stockbrokers/Commodity Brokers
    • Banks may issue guarantees for brokers, subject to margin requirements and prudent risk assessment. Risk mitigation measures, including minimum margins and adequate monitoring, are stipulated.
    • Banks have been advised to obtain a minimum margin of 50 percent while issuing such guarantees.
    • A minimum cash margin of 25 per cent (within the above margin of 50 per cent) should be maintained in respect of such guarantees issued by banks.
    • The above requirement will also apply to guarantees issued by banks on behalf of commodity brokers in favour of the commodity exchanges, registered with Securities and Exchange Board of India (SEBI), in lieu of margin requirements as per the commodity exchange regulations.
    • Banks should assess the requirement of each applicant and observe usual and necessary safeguards including the exposure ceilings.
  • Irrevocable Payment Commitment (IPCs)
    • Only those custodian banks are permitted to issue IPCs who have a clause in the Agreement with their clients. This clause should give them an inalienable right over the securities to be received as payout in any settlement.
    • However, in cases where transactions are pre-funded – i.e. there are clear INR funds in the customer’s account and, in case of FX deals, the bank’s nostro account has been credited before the issuance of the IPC by custodian banks- the clause of inalienable right over the security to be received as payout in the agreement with the clients will not be insisted upon.
  • Guidelines for Obtaining Personal Guarantees
    • The RBI provides guidelines on obtaining personal guarantees from promoters, directors, managerial personnel, and shareholders of borrowing concerns by banks. These guidelines stress the importance of careful examination before requiring personal guarantees and outline circumstances where guarantees may or may not be warranted.

    A. Circumstances Where Guarantees May Not Be Necessary:

    • For public limited companies with satisfactory management, economic viability, and financial stability, personal guarantees may not be required.
    • Guarantees may be waived for companies under professional management or where directors are not significant shareholders.

    B. Circumstances Where Guarantees May Be Helpful:

    • Personal guarantees may be useful for closely held companies or when changes in management pose risks.
    • Guarantees may be warranted for unsecured advances, companies with financial weaknesses, or delays in creating asset charges.

    C. Worth of Guarantors and Payment of Guarantee Commission:

    • Guarantee amounts should align with the guarantors’ worth and should not serve as a source of income for directors or managerial personnel.
    • Exceptions for guarantee commission may apply in specific cases, subject to stringent conditions.

    D. Personal Guarantees for Stressed Units:

    • Personal guarantees from directors and managerial personnel may be obtained for stressed units to instill accountability and ensure financial discipline.
    • Banks may require guarantees from parent/holding companies for units within the same group at their discretion.

    Overall, these guidelines aim to balance the need for accountability and financial prudence while ensuring fair treatment of borrowing concerns and their stakeholders.

  • Guidelines for Guarantees of State Government
    • The guidelines for taking personal guarantees of directors and other managerial personnel, should also be followed in respect of proposal of State Government undertakings/projects. Guarantees may not be insisted upon unless absolutely warranted.
    • In other words, banks could obtain guarantees of State Governments on merits and only in circumstances absolutely necessary, after thorough examination of the circumstances of each case, and not as matter of course.
  • Stipulations for Issuing Bid Bonds and Performance Guarantees for Export
    • Banks are encouraged to adopt a flexible approach in issuing bid bonds and performance guarantees for exports, ensuring compliance with regulatory requirements.
    • Banks can safeguard their interests by obtaining coverage from Export Credit Guarantee Corporation of India Ltd. (ECGC), wherever considered necessary.
    • Banks may consider sanctioning separate limits for issue of bid bonds.
  • Unconditional guarantees in favor of overseas employers/importers and precautions in project exports

    The RBI guidelines on unconditional guarantees in favor of overseas employers/importers and precautions in project exports aim to ensure prudent risk management and compliance with regulatory frameworks:

  • Unconditional Guarantees for Overseas Employers/Importers:
    • Banks issuing unconditional guarantees on behalf of Indian exporters must obtain an undertaking from the exporter to honor the guarantee regardless of any dispute with the importer.
    • Incorporating suitable clauses in agreements is advised to prevent non-honoring of guarantees, which could impact the country’s export promotion efforts.
  • Precautions in Project Exports:
    • Lending banks should thoroughly assess project proposals, contractor capacity, protective clauses in contracts, security adequacy and credit ratings of overseas subcontractors.
    • AD banks/Exim Bank have been authorized to consider according post-award approvals for high value overseas project exports. However, the responsibility of project appraisal and that of monitoring the project lies solely on the lending banks.
    • Careful evaluation is essential due to the high values involved and the potential for foreign exchange losses and damage to the Indian entrepreneurs’ image.
    • While bid bonds and performance guarantees are necessary, banks should evaluate the need for guarantees in all cases of overseas borrowings for project financing, avoiding automatic execution.
    • Such guarantees should not be executed as a matter of course, merely because of the participation of Exim Bank and availability of counter-guarantee of ECGC.
    • Post-award follow-up and monitoring arrangements should be made to mitigate risks effectively.
  • Guarantees for Export Advances:
    • Guarantees are permitted for exporters’ liabilities on account of exports from India, but banks should exercise caution to prevent overextension of commitments and ensure compliance with FEMA regulations.
    • Guarantees contain inherent risks. It would therefore not be in the banks’ interest or in the public interest to encourage parties to over-extend their commitments and embark upon enterprises solely relying on the easy availability of guarantee facilities.
    • Banks should therefore, be careful while extending guarantees against export advances so as to ensure that no violation of FEMA regulations takes place and banks are not exposed to various risks the export advances received by the exporters. They should also be in compliance with the regulations/ directions issued under the Foreign Exchange Management Act, 1999. It will be important for the banks to carry out due diligence and verify the track record of such exporters to assess their ability to execute such export orders.
    • The export advances received by the exporters should be in compliance with the regulations/ directions issued under the Foreign Exchange Management Act, 1999.
    • Export performance guarantees, where permitted to be issued, shall strictly be in the nature of performance guarantee and shall not contain any clauses which may in effect allow such performance guarantees to be utilized as financial guarantees/Standby Letters of Credits.
    • Compliance with A.P. (DIR Series) Circular No. 20 dated March 13, 2018 regarding ‘Discontinuance of Letters of Undertaking (LoUs) and Letters of Comfort (LoCs) for Trade Credits’ is to be ensured.
    • Compliance with Foreign Exchange Management Act (FEMA) regulations, particularly regarding export advances, is imperative.
    • Export performance guarantees should strictly serve as performance guarantees and not morph into financial guarantees or standby letters of credit.
  • Review of Bank Procedures
    • Periodic review of bank procedures is advised to expedite export credit decisions, with the designation of specialized branches for efficient handling of export credit proposals.
  • Overseas Investment Guarantees
    • Banks can issue guarantees to or on behalf of a foreign entity, or any of its step down subsidiary in which an Indian entity has acquired control through the foreign entity. This should be backed by a counter-guarantee or collateral by the Indian entity or its group company.
    • These guarantees shall not be issued by banks, including overseas branches / subsidiaries of Indian banks, for the purpose of raising loans / advances of any kind by the foreign entity except in connection with the ordinary course of overseas business.
    • Banks should ensure effective monitoring of the end use of such facilities and its conformity with the business needs of such entities.
  • Restrictions on Guarantees for Placement of Funds with NBFCs or Non-Bank Entities:
    • Banks are prohibited from executing guarantees for placing funds with NBFCs or other non-bank entities directly or indirectly. Guarantees for transactions like seller’s bills discounted by an accommodating company or deposits kept with borrowers under a bank’s guarantee are discouraged.
  • Conditions for Issuing Guarantees Favoring Other Banks/Financial Institutions:
    • Banks must have robust risk management systems and a well-defined policy approved by the Board of Directors.
    • Guarantees should only be extended to borrower constituents for additional credit facilities.
    • The guaranteeing bank should assume a funded exposure of at least 10% of the guaranteed exposure.
    • Guarantees/Letter of Comfort to overseas lenders including those assignable to overseas lenders, are not permitted, except as per FEMA guidelines.
    • Guarantees attract appropriate risk weight and should be reported and reviewed periodically.
    • Banks are advised against providing guarantees for corporate bonds or debt instruments, except for partial credit enhancement under specific conditions.

    Conditions for Lending Banks:

    • Banks extending credit facilities against guarantees of other banks/FIs must comply with risk weight guidelines.
    • Exposure assumed against such guarantees should be within inter-bank exposure limits.
    • Continuous monitoring of exposure assumed on the guaranteeing bank/FI is required.tions:

    Resolution of Stressed Units:

    • Banks facing temporary liquidity constraints may provide guarantees to banks participating in rehabilitation packages. Guarantees will remain until the providing banks are re-compensated.

    Seller’s Line of Credit Scheme:

    • Under schemes like the Sellers Line of Credit (now Direct Discounting Scheme) by institutions like IDBI Bank Ltd. and all India financial institutions like SIDBI, PFC, etc for sale of machinery, primary credit is extended to sellers through bills drawn on buyers.
    • Buyer’s banks can provide guarantees or co-acceptance facilities for bills drawn under seller’s credit lines.

    Guarantees for Loans with Inadequate Security:

    • Guarantees can be issued to HUDCO, State Housing Boards, and similar bodies for loans to private borrowers lacking clear title to property.
    • Issuance is subject to banks being satisfied with borrowers’ capacity to service loans adequately.

    Guarantees for Development Agencies/Boards:

    • Banks can issue guarantees for obtaining soft loans or development assistance from agencies like Indian Renewable Energy Development Agency, National Horticulture Board, etc.
    • Conditions include rigorous credit appraisal, adherence to prudential exposure norms, and adequate security arrangements.
  • Summary of RBI Guidelines on Guarantees in – Infrastructure Projects

    Infrastructure Projects:

    Discretion for Guarantees:

    • Banks have discretion in issuing guarantees for infrastructure projects with certain conditions.
    • The guarantor bank must fund at least 5% of the project cost and undertake normal credit appraisal and monitoring.
    • The guarantor bank must also have a satisfactory record of compliance with prudential regulations.
    • Payment of Invoked Guarantees: Guarantees must be honored without delay when invoked, and banks should establish procedures to ensure immediate payment.
    • Obligations of Guarantor Banks: Guarantor banks must ensure that beneficiaries can fulfill their obligations in performance and financial guarantees.
    • Top management, including the CEO, must oversee the prompt honoring of guarantees, addressing complaints promptly.

    Co-acceptance of Bills:

    • RBI notes instances of casual co-acceptance of bills, leading to defaults and financial strain on banks.
    • Some bills turn out to be accommodation bills with no genuine trade transactions, causing losses to co-accepting banks.
    • Banks may co-accept bills drawn under the Sellers Line of Credit Schemes (since renamed as Direct Discounting Scheme) operated by IDBI Bank Ltd. and all India financial institutions for Bill Discounting operated by IDBI Bank Ltd. and all India financial institutions like SIDBI, PFC, etc. without any limit, subject to the buyer’s capability to pay, and compliance with the exposure norms prescribed by the bank for individual/ group borrowers.

    Safeguards for Co-acceptance:

    • Banks must assess the need for co-acceptance and ensure genuine trade transactions.
    • Proper valuation and documentation of goods covered by bills are essential.
    • Banks should set limits, monitor exposures, and maintain records to prevent disproportionate co-acceptance liabilities.
    • Oversight by internal inspectors and timely communication with controlling offices are crucial.
    • A system of obtaining periodical confirmation of the liability of co-accepting banks in regard to the outstanding bills should be introduced.
    • Periodical returns may be prescribed so that the Branch Managers report such co-acceptance commitments entered into by them to the Controlling Offices.
    • Before discounting/ purchasing bills co-accepted by other banks for Rs. 2 lakh and above from a single party, the bank should obtain written confirmation of the concerned Controlling (Regional/ Divisional/ Zonal) Office of the accepting bank and a record of the same should be kept.
    • When the value of the total bills discounted/ purchased (which have been co-accepted by other banks) exceeds Rs. 20 lakh for a single borrower/ group of borrowers, prior approval of the Head Office of the co-accepting bank must be obtained by the discounting bank in writing.

    Restrictions and Guidance:

    • Certain schemes like Buyers Line of Credit and bills drawn by NBFCs are excluded from co-acceptance.
    • Banks should not co-accept bills drawn under their own Letters of Credit (L/Cs) to avoid duplication and ensure compliance with applicable laws.
    • These guidelines aim to ensure responsible issuance of guarantees, prompt payment upon invocation, and prudent co-acceptance practices to mitigate risks and maintain the integrity of the banking system.
  • Summary of RBI Guidelines on Precautions for Letters of Credit (LCs) and Compliance:

    Precautions for Letters of Credit (LCs):

    • Vigilance in Payment Processing: Banks must exercise vigilance when making payments to overseas suppliers based on shipping documents.
    • Payments should only be released after ensuring strict conformity with the terms of the LCs.
    • Irregularities in LC transactions, such as unrecorded transactions or excessive amounts, should be addressed promptly.
    • Action Against Irregularities: Banks should take action against officials and constituents involved in fraudulent LC activities, including collusion with beneficiaries.
    • Settlement of Claims under LCs: Non-honoring of bills drawn under LCs can undermine the credibility of LCs and the entire banking payment mechanism. Banks must honor their commitments under LCs promptly to uphold the credibility of the payment system and maintain their image.
    • Compliance with Regulations: Foreign Exchange Management Act (FEMA) Compliance: Banks are required to comply with the regulations and directions issued under the Foreign Exchange Management (Guarantee) Regulations, 2000, as amended.
    • Prudential Norms Compliance: Banks must adhere to all prudential norms issued by the RBI, ensuring sound banking practices and financial stability.

    These guidelines emphasize the importance of diligence in LC transactions, prompt settlement of claims, and compliance with regulatory frameworks to maintain the integrity and credibility of the banking system.

    We hope you have found this information useful. For any queries/clarifications please write to us at insights@elp-in.com  or write to our authors:

    Mukesh Chand, Senior Counsel – Email – MukeshChand@elp-in.com

Disclaimer: The information contained in this document is intended for informational purposes only and does not constitute legal opinion or advice. This document is not intended to address the circumstances of any individual or corporate body. Readers should not act on the information provided herein without appropriate professional advice after a thorough examination of the facts and circumstances of a situation. There can be no assurance that the judicial/quasi-judicial authorities may not take a position contrary to the views mentioned herein.