RBI Directives on Foreign Exchange Laws and Overseas Guarantees
The Reserve Bank of India (RBI) has issued directives to certain state-owned banks regarding the breach of foreign exchange laws by their corporate clients. These clients have been asked to pay a penalty and acknowledge the breach if they have obtained guarantees from overseas banks.
Performance Guarantees and FEMA Guidelines
- Companies often secure performance guarantees from banks to undertake large projects, serving as assurances to fulfill contractual obligations.
- RBI has identified violations involving banks in India acting as advisors, while offshore financial institutions serve as guarantors.
- The Foreign Exchange Management Act (FEMA), 1999 prohibits guarantees from offshore financial institutions under the FEMA Guarantees Regulation 2000.
- However, RBI’s 2019 master direction allows certain transactions related to non-resident guarantees for domestic facilities.
Legal and Regulatory Perspectives
- The Supreme Court considers RBI directions, including master directions, as statutory regulations.
- There is potential for conflict between FEMA regulations and RBI master directions, especially regarding non-resident guarantees.
- Judicial forums may need to address these conflicts, as noted by Harshal Bhuta, a partner at PR Bhuta & Co.
RBI's Call to Action
- Corporates are instructed to regularize guarantees through compounding proceedings within 45 days of notification.
Industry Practices and Reasons for Overseas Guarantees
- Local companies may obtain guarantees from overseas banks due to local banks reaching exposure limits.
- Suspicions of bogus guarantees might have prompted recent RBI actions, although this remains unconfirmed.
Alternative Arrangements and Impact
- Under FEMA notification 3R, non-residents can issue guarantees for securitizing rupee facilities, indirectly resulting in contingent liabilities.
- Suhas Bendre suggests that allowing local companies to use overseas guarantees could have no net impact on forex flows.
