RBI flags FEMA breach in overseas guarantees, seeks corporate compliance

RBI directs state-owned banks to ensure corporates admit and pay penalties for violating FEMA rules by securing performance guarantees from overseas financial institutions

The Reserve Bank of India (RBI) has instructed at least two state-owned banks to ensure that their corporate clients acknowledge and pay penalties for violating foreign exchange regulations, according to a report by The Economic Times.

 

The issue pertains to companies securing guarantees from overseas financial institutions, which the central bank deems as a breach of the Foreign Exchange Management Act (FEMA), 1999.  

 

Performance guarantees are commonly sought by firms undertaking large-scale projects, serving as a commitment to fulfill contractual obligations. The transactions under scrutiny involve Indian banks acting as intermediaries, while foreign financial institutions provide the guarantees, the news report said.

 

RBI’s stand on FEMA guidelines  

 

In its notices to the banks, the RBI has reiterated that obtaining performance guarantees from overseas institutions contravenes FEMA Guarantees Regulation 2000. However, this stance appears to be at odds with the RBI’s own 2019 “master direction on external commercial borrowings, trade credits, and structured obligations”, which permits non-resident guarantees under specific conditions, The Economic Times noted.  

 

The 2019 master direction allows a non-resident guarantor to enforce claims against an Indian borrower and repatriate recovered amounts if the liability is settled through inward remittance or specific non-resident accounts. Despite this provision, the RBI, in an October 2023 communication, clarified that such guarantees remain prohibited under FEMA but did not reference the 2019 guidelines.  

 

Legal ambiguity in RBI directive

 

The RBI’s directive has raised legal concerns, as master directions issued by the central bank hold statutory weight. 

 

The news report quoted Harshal Bhuta, partner at PR Bhuta & Co, as saying that the Supreme Court has upheld RBI’s regulations as binding. He pointed out that inconsistencies between FEMA rules and master directions could lead to judicial scrutiny, especially since the ECB master direction permits non-resident guarantees for non-fund-based facilities while FEMA explicitly forbids them.  

 

45 days to regularise transactions

 

To address the issue, the RBI has asked affected corporations to initiate the ‘compounding’ process within 45 days to regularise their guarantees.

 

Industry experts suggest that some companies may resort to offshore guarantees when local banks reach their exposure limits. The Economic Times report said domestic banks could facilitate foreign guarantees for a fee, leveraging their relationships with overseas institutions.