Why The HDFC Bank-Altico Tussle Has The Industry Watching
It’s an incident that got two of the country’s leading bankers taking digs at each other publicly. And now it has the whole industry watching.
In September, HDFC Bank Ltd. decided to use proceeds of external commercial borrowings raised by Altico Capital Ltd., held by the bank in the form of term deposits, to settle its loan dues. The amount was close to Rs 220 crore, BloombergQuint reported.
The decision prompted State Bank of India chief Rajnish Kumar to slam the private lender, whom he did not name, as having acted selfishly. Peer Aditya Puri, the long time chief of HDFC Bank, while speaking at a press conference on September 30, countered that by saying “it is my security and I will exercise it.”
Beyond the exchange of words between the two bankers, the incident has raised a broader question about the segregation of a bank’s role as an ‘authorised dealer’ and a lender. An authorised dealer is broadly defined as a financial institution, which is permitted to undertake foreign exchange related transactions on behalf of its clients.
The matter has now reached the Reserve Bank of India, according to two people familiar with the matter, who spoke on condition of anonymity. The regulator’s decision will lay down the ground rules for any future cases where a conflict between a bank’s different functions may arise. The Economic Times first reported on Friday that the matter had been referred to the RBI.
An email sent to the RBI on Friday was not answered. Altico Capital, HDFC Bank declined to comment on the matter.
ECB Regulations vs. Right Of Lien
The fundamental issue boils down to an interpretation of the Reserve Bank of India’s external commercial borrowing guidelines and uncertainty over whether these guidelines override a lender’s general right of lien.
ECBs are loans availed by Indian companies from a foreign lender. The RBI prescribes strict guidelines for the use of these loans. In this case, Altico had raised funds from Mashreqbank PSC for on-lending. As per regulations, these funds must be parked either with the foreign bank’s Indian branch or an authorised dealer. In this case, the authorised dealer was HDFC Bank, which was also a lender to Altico.
As such, about Rs 220 crore in foreign loans raised by Altico were lying in fixed deposits of HDFC Bank.
Calls and messages to a representative of Mashreqbank went unanswered.
What transpired with Altico in September is now well known. That non-bank lender defaulted on about Rs 20 crore worth of interest payments due to Mashreqbank. This led to a chain reaction and prompted HDFC Bank to use the Rs 220 crore in ECB proceeds lying with it to set-off a domestic loan to Altico.
According to one of the two people quoted above, the first default was the result of a number of factors including a sudden re-set in loan terms by a domestic mutual fund. Since Altico did not have enough funds to repay all its dues in the near-term, it could not have prioritised one lender over another to prevent a default.
Altico was eventually downgraded to ‘D’ by rating agencies.
HDFC Bank’s decision was not the reason behind Altico’s initial default. A default from Altico would also not have been averted if HDFC Bank had not used the ECB proceeds to set-off its loans to the NBFC.
Yet, HDFC Bank may have erred in its interpretation of the rules, according to a former RBI deputy governor, who spoke on condition of anonymity.
Generally, if ECBs funds in a deposit are not completely utilised, then the authorised dealer can use it to set-off a loan if there is a general lien on the deposit, the deputy governor quoted above said. Otherwise, the authorised dealer cannot use the ECB loans for their own purposes unless they have gotten prior permission from the RBI, this person added. The situation, however, is a first of its kind and the RBI’s decision on the case would set a precedent, this person said.
The Legal Position?
Under the Indian Contract Act 1872, there is a clause recognising a general lien for bankers. But when it comes to ECB disbursements placed in a term deposit, the domestic bank acts in a dual-capacity as an authorised dealer and as a lender’s branch or it’s agent says Babu Sivaprakasam, Partner, Economic Laws Practice.
“In a loan document the borrower may give the lender a contractual right of set off or lien on its monies or properties which coupled with filing with ROC is also recognised as a charge. Further, where the end use is prescribed and a banker dons dual hats, it is important to know if the lender has the right to exercise such right against the ECB funds. It also has to be seen whether an ECB lender normally governed under non-Indian laws, say English laws, can invoke a general lien or set off rights available for bankers under the Indian Contract Act 1872,” he said.
It is important to distinguish a bank when it acts as a lender and as an authorised dealer, said another senior lawyer, who spoke on condition of anonymity. As a lender, a bank will have a general lien on the deposits of its borrower and has the right to recovery its dues using the deposits. But when the bank is an authorised dealer, is it is purely acting as a banking channel or agent under the Banking Regulation Act, this person added.
To be sure, ECB regulations give a host of powers to authorised dealer banks, ranging from changing the currency of borrowing to changing the repayment schedule and allowing for pre-payments. However, any change to the ECB facility has to be done with the consent of both the lender and borrower, according to RBI regulations.
“There are strict provisions in the ECB policy on the end use of funds, but the banks also have a general lien on account balance against the borrowings which they can exercise, subject to the provisions of the contract with the borrower,” said Subodh Sadana, partner at Khaitan and Khaitan. “The exact interplay between the two provisions requires legal clarity. But that said, in the absence of a specific provision in the loan contract restricting the use of a ECB deposit, HDFC Bank appears to be within its rights to exercise such a lien,” Sadana said. He added that general lien provisions ordinarily take precedence over any regulatory notification.