Background

Banks in India are often on the look-out for potential acquisition opportunities to spur inorganic growth. While their strategic interests will determine their targets, in recent times, banks have been evaluating acquisition of non-banking financial companies (“NBFCs”) and more specifically micro-finance institutions (“MFIs”), which primarily cater to the rural and unorganised markets. Given that NBFCs focus on providing loans to consumers and small-scale businesses, they play a key role in driving the country’s economic growth. India’s NBFC sector grew by 10% (ten percent) in recent times to become the third largest in the world, behind only the United States and the United Kingdom.[1] Among other reasons, access to untapped market with an underserved population and the greater reach of NBFCs is a critical factor, as it facilitates enhanced compliance with priority sector lending requirements of banks. In this blog, we highlight the legal framework, regulatory and commercial considerations involved in the acquisitions of NBFC-MFIs by banks in India.

Legal Framework and Key Regulatory Considerations

Legal Framework:

1. Prior approval from the Reserve Bank of India (“RBI”):
   • By the acquiring bank: Pursuant to sub-section (2) of Section 19 of the Banking Regulation Act, 1949, no banking company can hold shares in any company, whether as a pledgee, mortgagee, or absolute owner, of any amount exceeding 30% (thirty percent) of the paid-up share capital of that company or 30% (thirty percent) of its own paid-up share capital and reserves. Accordingly, the acquiring bank has to seek prior RBI approval to acquire an NBFC-MFI, exceeding the thresholds mentioned herein (“Acquiring Bank RBI Approval”).
   • By the NBFC-MFI: Pursuant to paragraph 42 of the Master Direction – Reserve Bank of India (Non-Banking Financial Company – Scale Based Regulation) Directions, 2023 (“NBFC Directions”), NBFCs too require prior RBI approval for (i) any takeover or acquisition of control; or (ii) any change in the shareholding of the NBFC, which would result in the acquisition/ transfer of shareholding of 26% (twenty six percent) or more of the paid-up equity capital of the concerned NBFC; or (iii) any change in the management of the concerned NBFC, which results in change in more than 30% (thirty percent) of the directors, excluding independent directors. Accordingly, any NBFC-MFI acquisition by a bank, which meets any of the above criteria, will require the NBFC-MFI to also seek prior RBI approval (“NBFC RBI Approval”).
2. Public notice: As per paragraph 69 of the NBFC Directions, the concerned MFI and the acquiring bank or the parties concerned jointly need to issue a public notice before effecting the sale of, or transfer of the ownership by sale of shares or transfer of control, whether with or without the sale of shares. The parties are required to observe a standstill period of 30 (thirty) days after the notice is published to consider public objections (if any).

Regulatory Considerations:

1. Surrender of NBFC-MFI Registration: As part of the RBI Approvals, the RBI may grant the approval, subject to the condition that upon acquisition of the NBFC-MFI by the bank, within a certain stipulated time period (as provided in the RBI Approvals), the MFI will surrender its NBFC-MFI registration and solely operate as a business correspondent of the acquiring bank. This condition is likely to be imposed in case of acquisition of majority stake in the NBFC-MFI by the acquiring bank.  
2. Closure of Lending Business: If a bank acquires 100% (one hundred percent) stake in an NBFC-MFI, the RBI may impose certain conditions on the MFI, including but not limited to the closure of all lending businesses from the date of acquisition by the bank. In this scenario, the existing loan portfolio shall either be closed by the MFI or transferred to the acquiring bank.
3. Closure of all outstanding liabilities: As stated above, consequent to the acquisition, if the MFI is required to surrender its NBFC-MFI registration, the MFI would be required to prepay all outstanding liabilities, including non-convertible debentures (if any), availed from various banks and financial institutions.
4. External Commercial Borrowing (“ECB”): The Master Direction – External Commercial Borrowings, Trade Credits and Structured Obligations, dated March 26, 2019, issued by the RBI (“ECB Master Directions”), governs ECBs availed by Indian entities. If an MFI has availed ECB, the same would be required to be pre-paid before its acquisition by the bank. In doing so, certain issues like Minimum Average Maturity Period (MAMP) of the availed ECBs, pre-payment penalty to be payable by MFI, etc., may arise.
5. Redemption of Subordinated Debt: NBFC Directions inter alia govern subordinated debt availed by an MFI. In terms of paragraph 5.1.32 of Chapter 2 of the NBFC Directions, subordinated debt availed by an NBFC-MFI is not redeemable without the consent of the supervisory authority of such MFI. In light of this, prior RBI (being the supervisory authority) consent will be required by the MFI, for redemption of the subordinated debt availed by it, ahead of its date of maturity.

Commercial Considerations

In addition to regulatory considerations, there are several commercial aspects that the parties involved will need to factor in while negotiating and implementing such acquisition. Set out below are a few critical practical considerations:

1. Business Correspondent Arrangements: Other financial institutions typically engage NBFC-MFIs as “business correspondents”, who are retail agents engaged by banks for providing banking services at locations other than a bank branch/ ATM. Accordingly, MFIs, acting in their capacity as business correspondents, disburse loans of banks/ financial institutions that appoint them as business correspondents. Business correspondent agreements typically contain detailed provisions inter alia relating to confidentiality and ownership of customer details, exclusivity, tenure, consent for change in control of the MFIs, notice for termination, etc. When a bank proposes to acquire an MFI that is engaged as a business correspondent, it would need to assess ways to deal with these business correspondent arrangements and how it can have access to the MFI customer database.
2. Direct Assignment Arrangements: Given that MFIs are NBFCs registered with the RBI for lending purposes, MFIs have their own loan-book pursuant to the loans advanced to their customers. If the RBI requires the MFI to surrender its certificate of registration as an NBFC-MFI, the MFI would not be able to continue with such assets on its own balance sheet. Accordingly, the acquiring bank and the MFI may consider transferring the loan portfolio of the MFI to the acquiring bank. Such transfer shall be compliant with the appliable law. Key aspects to be considered for such compliance include: (i) having a board approved policy; (ii) ensuring transfer of economic interest without change in the underlying terms and conditions of the loan contracts; and (iii) transferring the right to transfer or dispose to the transferee.
3. Existing Subsidiaries Carrying Out Same Business: If the acquiring bank has an existing subsidiary that is engaged in the same business as that of the target NBFC-MFI, then as per policy and practice, the RBI may direct the acquiring bank to combine all such subsidiaries into one entity. This is evidenced by the rationale for the scheme of amalgamation between Accelyst Solutions Private Limited (“ASPL”) and Freecharge Payment Technologies Private Limited (“FPTPL”), as set out in the report of the Board of Directors of ASPL[2]. The rationale for the scheme of amalgamation between ASPL and FPTPL is inter alia in furtherance to the compliance to be made by the Axis Bank group, with the RBI approval for ASPL and FPTPL. Accordingly, the acquiring bank should be prepared to ultimately have only one entity that is engaged in the same/ similar business.
4. Employment Agreement with KMPs of the MFI: In an MFI setup, continuance of key employees is an important factor as most customers (borrowers) know these key employees personally. Accordingly, from a business sourcing and continuity perspective, it would be in the acquiring bank’s interest if such KMPs continue with the MFI, post the acquisition.

Conclusion

Given the synergies and benefits for a bank emanating from acquiring MFIs, it is likely that banks may explore such opportunities. While it may seem to be a straightforward M&A strategy for both the financial entities, in light of the discussion above, the legal, regulatory and commercial considerations would need to be dealt with and addressed appropriately in the transaction documents, when assessing such acquisitions. With the assistance of experienced professional advisors, these challenges may be navigated smoothly.        

[1] See: Non-banking Financial Sector: India’s NBFC sector now world’s 3rd largest, next only to USA & UK, ET BFSI (indiatimes.com)

[2] See: https://s.freecharge.in/content/images/shareholderdocs/Annexure-F_Accelyst-Report-adopted-by-Board-of-Directors-of-Accelyst-Solutions-Pvt-Ltd.pdf