India: Analysis Of Lending Restrictions On NBFCS In Real Estate Sector

1. INTRODUCTION

1.1 The Reserve Bank of India ("RBI") on October 22, 2021 ("said Circular 1")¹ had introduced a revised regulatory framework for Non-Banking Financial Companies ("NBFCs") placed in different layers. The said Circular 1 inter alia imposed certain restrictions on NBFCs in relation to granting loans in real estate sector and further specified that detailed circular in this behalf will be issued by the RBI in due course. The RBI subsequently on April 19, 2022 ("said Circular 2")² issued detailed guidelines regarding regulatory restrictions on lending in respect of NBFCs which has come into effect from October 01, 2022. This article deals with the clarification provided by the RBI in the said Circular 2 in respect of loans and advances granted by NBFCs in

2. BACKGROUND

2.1 The evolution of NBFCs in India and their changing risk profile has warranted the formulation of guidelines to regulate the business model of NBFCs and imposing of certain restrictions on lending in real estate sector.

2.2 In light of the said Circular 2, while approving loans and advances³ involving real estate sector, the RBI has directed that NBFCs shall ensure that the borrowers have obtained prior permissions from government and other statutory authorities for their projects. To ensure that the loan approval process is not hampered on account of this restriction, the RBI directs that NBFCs may sanction the loan proposals in normal course, however, the disbursements shall be made only after the borrower has obtained requisite clearances from government and other statutory authorities.

2.3 The said Circular 2 which has come into effect from October 1, 2022, is applicable to middle layer⁴ and upper layer⁵ NBFCs only.

3. INDUSLAW VIEW

3.1 Although the said Circular 1 and said Circular 2 provides that requisite approvals in relation to the projects shall be in place prior to disbursement of loans, it does not expressly spell out on what could be construed as 'requisite approvals' for such disbursements.

3.2 In our view, the question as to what could be construed as 'requisite approvals' is determined basis the location of the project for which loan is to be disbursed. In India, different jurisdictions will have different approvals/licences for different kind of projects. Generally, in case of a real estate project, the NBFCs should ensure that all permissions pertaining to the project land should have been obtained by the builder/developer prior to any loan disbursements.

3.3 From the point of view of construction of a real estate project, the NBFCs should verify and ascertain that requisite approvals like building plans, layout approvals, and all specific approvals that may be germane to that specific project (if applicable) have been obtained by a builder/developer prior to any loan disbursements. Further, the compulsory requirement of registration of a real estate project (where applicable) with the concerned real estate regulatory authority under the Real Estate (Regulation and Development) Act, 2016 ("RERA") may also be considered as 'permission' under the said circulars, as without registration under RERA, sale of units in a project is not permissible.

3.4 The said circulars will also be in line with the view taken by Karnataka High Court recently in the case of Mudit Saxena Vs. Union of India⁶ . In the aforesaid case, the Karnataka High Court had restrained Punjab National Bank Housing Finance Limited from taking any coercive measures against the homebuyers to recover the loan amount as Punjab National Bank Housing Finance Limited had disbursed the loan amount directly to the developer without ascertaining the stages of construction, though the extant RBI circulars mandate such ascertainment.

4. CONCLUSION

4.1 This step will make it necessary for NBFCs granting loans and advances in the real estate sector to ensure that project approvals relating to a project have been obtained. At the same time, one needs to be mindful of the fact that all approvals for a project are not granted upfront and generally done in a phased manner. But in this case, permissions required for the commencement of construction and sale should be obtained prior to disbursement. We will see in the coming times what views lenders will take vis-à-vis the requirements laid out by the RBI as part of the 'permissions'. It will also be interesting to see if the RBI clarifies in future as to what constitutes 'requisite approvals' as this will have impact on lending by NBFCs in real estate sector.

Footnotes

1 https://www.rbi.org.in/Scripts/NotificationUser.aspx?Id=12179&Mode=0

2 https://www.rbi.org.in/Scripts/NotificationUser.aspx?Id=12294&Mode=0

3 'loans and advances' does not include loans or advances against government securities, life insurance policies, fixed deposits, stocks and shares.

4 Middle layer NBFCs shall mean of (a) all deposit taking NBFCs (NBFC-Ds), irrespective of asset size, (b) non-deposit taking NBFCs with asset size of ₹1000 crore and above and (c) NBFCs undertaking the following activities (i) Standalone Primary Dealers (SPDs), (ii) Infrastructure Debt Fund - Non-Banking Financial Companies (IDF-NBFCs), (iii) Core Investment Companies (CICs), (iv) Housing Finance Companies (HFCs) and (v) Infrastructure Finance Companies (NBFC-IFCs).

5 Upper layer NBFCs shall mean shall comprise of those NBFCs which are specifically identified by the Reserve Bank as warranting enhanced regulatory requirement based on a set of parameters and scoring methodology.

6 WP No.17696/2021 filed in the High Court of Karnataka.

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