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The Government has, pursuant to gazette notification no. 2652 dated November 8, 2016, ceased to recognise Rs.500 and Rs.1000 rupee denominated bank notes (“Specified Bank Notes” or “SBNs”) as legal tender with effect from November 9, 2016, with an intention to eradicate terrorism, smuggling and circulation of counterfeit notes. This step, aimed at treating the black money menace plaguing the country for years, may already be having some hard hitting ramifications on the less organised/unorganised business and financial sectors of the country.

There are a large number of micro finance companies in India, catering to the financing needs of rural and semi-urban Indian population. Customers, typically individuals (women, daily wage workers, farmers), small traders and retailers, coming from rural areas and fringes of urban areas mainly operate on a cash basis due to informal and trifling nature of the amounts involved in such transactions. Loan instalments from some such customers are usually collected on a weekly and sometimes on daily basis. Demonetization of SBNs has halted, albeit temporarily, business transactions which are now running on a daily credit basis, and more importantly has led to a domino effect on employees/daily wage workers and other customers of non-banking financial companies-micro financial institutions (“NBFC-MFIs”) whose livelihood is based on cash payments. Such customers, more often than not, fall in the category of small farmers and unskilled labour who do not have bank accounts and/or sufficient means to either exchange existing SBNs in their possession into notes of acceptable denomination, or make a transition to cashless means of finance. Failure to do so is adversely affecting their daily businesses/lives which in turn is affecting the timely repayment of loans taken by them from NBFC-MFIs.

NBFC-MFIs have already started experiencing loan defaults since the demonetisation, which may lead to temporary increase in non-performing assets. This chain reaction may not only adversely affect the overall asset quality of NBFC-MFIs but will eventually trickle down to banks and other financial institutions and may subsequently, affect the Indian economy as a whole. NBFC-MFIs generally rely on borrowing from banks for further lending. Due to limited capital, significant defaults from customers can not only cripple the business of NBFC-MFIs by limiting their liquid resources but also force them to withhold any further loan disbursements to survive.

Pursuant to various circulars issued in November 2016, exchange of SBNs over the counter have been restricted to Rs.2,000/- with effect from November 18, 2016 and can be done only once per person. Further, cash withdrawals from bank accounts over bank counters, have been restricted to an overall limit of Rs.24,000/- per week till November 24, 2016. RBI vide its circular dated November 10, 2016 has further clarified that the above limit on withdrawals are not applicable to cash withdrawals from a bank account by (i) one bank from another bank; (b) post offices; (c) money changers operating at international airports; and (iv) operators of white label automated teller machines (“ATMs”), without specifying whether these limits were applicable only to saving accounts or any other bank accounts. Subsequently, vide circular dated November 14, 2016, and November 21, 2016, the RBI clarified that a maximum sum of Rs.50,000/- per week may be withdrawn from current/overdraft (excluding personal overdraft accounts) and cash accounts which have been operational for the last 3 months or more. As stated above, NBFC-MFIs generally lend to smaller customers by borrowing from banks. Therefore, placing a limit on withdrawal by NBFC-MFIs will severely restrict them from withdrawing funds from their own current accounts for onward lending to their customers.

Suggestions/Way out

According to a December, 2015 Reserve Bank of India report titled “Report of the Committee on Medium-term Path on Financial Inclusion”, the number of branches per 1,00,000 of population in rural and semi-urban areas is less than half of that in urban and metropolitan areas.

The presence of ATMs is also very low in rural areas. However, NBFC-MFIs have a very strong reach in rural areas and semi-urban areas where banks have a considerably lower penetration. Therefore, with a view to mitigate the hardship and financial crunch currently being faced by NBFC-MFIs and the rural and semi-urban community, the government / RBI may consider the following :

  1. Exchange of SBNs :- The Government may take advantage of the extensive infrastructure and reach that NBFC-MFIs have in rural and semi-urban areas by allowing them to be eligible to exchange SBNs against valid compliance documents and by putting in place other checks and balances.
  2. Acceptance of SBNs :- NBFC-MFIs may be allowed to act as facilitators and collect repayment of loans from their customers through SBNs until December 30, 2016 while complying with all other control and KYC requirements stipulated by the RBI in this regard. This would help reduce cases of unintentional defaults in loans and also ensure that the overall asset quality of the NBFC-MFI sector does not get eroded.
  3. Enhance the withdrawal limits :- In order to provide necessary operational flexibility and at the same time being mindful of the growing business needs, the Government/ RBI may consider relaxing the daily / weekly withdrawal limits for companies involved in the micro-financing sector.
While the decision to demonetize SBNs in order to curb anti-national activities, is a welcome move, one may consider adopting the above measures in order to try and smoothen the transition and ease the plight of the informal cash-driven sectors.

* This article is authored by Anjan Dasgupta, Partner, and Roochi Loona, Associate. These are personal views of the authors, and do not reflect the views of HSA Advocates.

HSA Advocates (HSA) has consistently been recognised amongst one of India’s leading full service legal advisors to corporates, financial institutions, PE and VC funds, governments and public sector enterprises. Drawing strength from the collective experience of its people, the exceptional diversity of its profiles and deep sector understanding, at HSA each and every lawyer invests in servicing clients with utmost sincerity, keeping the client’s interest paramount. With offices in New Delhi, Mumbai, Kolkata and Bengaluru, HSA Advocates’ credentials are a testimony of its ability to attract the best and brightest talent and the firm’s belief in nurturing teams with the requisite skills, in particular cultivating sector-specific expertise.

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