Evolution of Banking Institutions

World/ England
–Written records of Banking – ancient Mesopotamia, Egypt, Rome, India (18th century)
–Bank comes from Latin word – Bancas/ Banque - Bench
•Jews of Lombardy – broken bench on bankruptcy
•Macleod – German word – joint stock fund
–2000 BC Babylonians used temples as Banks
–Emergence of Merchant Banks and Knights Templar
–Disruption of Religion led to the destruction of public sense of security of depositing money
in Temple which eventually led to financial makeshifts
Prof Ramchandra Rao – “would trace history of banking in Europe from Middle Ages

•Story of Goldsmith – Medieval Europe

§Use of Gold becomes mainstream
§Difficult to transact
§People/ merchants want a place to keep their money secure, therefore they approach private
vaults of goldsmith
§Claim Cheques/ goldsmith notes – as signed receipts against the large sums of money left
which embodied an undertaking to return the money to the depositor or to the bearer on demand
– led to two developments
1.Early beginning of Issue & Deposit Banking
2.Eventually goldsmith began with the Idea of lending with an interest

Royal Abuse of Banking

•Strength of banking institutions grew at the attention of Monarchs
•Rulers would borrow heavily from the private goldsmith banks to fund wars and support their
lavish lifestyle. For instance – King Philip II of Spain – as a reaction grew the idea of “Current
Account”
India
–Earliest payment instruments were coins – punch marked/ silver or copper
–Ancient India had loan deed forms – rnapatra or rnalekhya –
•Name of the creditor
•Name of the debtor
•Amount of loan
•Interest
•Condition and time of repayment
–Mauryan Period – Adesha – an order of the banker desiring to pay money of a note to third
person – definition of bills of exchange (in spirit)
–Mughal Period – Dastawez
•Payable on demand
•Payable on stipulated time
–Most important – HUNDIS (Sanskrit word – Hund = to collect)
•Oldest surviving form of credit instruments
•Instruments used for collection of Debts
•Bills of exchange (for trade transactions); borrow money; remittance instruments
•Kinds-
1.Darshani Hundi – payable at sight
2.Miadi/ Muddati Hundi – Payable at specified period of time
3.Shah Jog Hundi – Payable by drawee

•England
–Lex Mercatoria – Banking Law
–Post Industrial revolution banking law was largely judge made law - Rulings of Lord
Mansfield are considered most authoritative
–Tonnage Act – raise money for William III – finance war – established Bank of England 1694
– gave monopoly for note issuance but circulation was limited.
–Peel’s Act 1844 – monopoly of issuing notes to Bank of England – gradual extinction of the
right to other banks –this led to growth of deposit banking and Cheque currency.
•
–Britishers
•English Law applied to Europeans
•Respective Law applied to Hindus/ Mohammadens
•Law/ Usage of defendant – when different parties
–Post Independence.
•Imperial Bank – TO- SBI- TO- RBI
•RBI in 1934
•1949 – Banking Companies Act 1949 – Comprehensive and formal structure of banking
regulation in India
•BankNationalisation

Reserve Bank of India

•Central Bank on 01 April 1935 u/RBI Act 1934.

•RBI came from the basis of recommendation of Hilton Young Commission.
•RBI took over the function of currency issue from the Government of India and power of
credit control from the then Imperial Bank of India.
•RBI was nationalised in 1949 following a post war trend towards nationalisation of Central
Bank all over the world. As a centrally administered system it needed to control inflation that
started since 1939 and also embark on a programme to contain economic development and
growth.
•Concerned with organisation of a sound and healthy commercial banking system, ensuring
effective coordination and control over credit through appropriate monetary and credit policies
from time to time. In addition to its core function – also concerns itself with - development of
rural banking; development of money and capital market; promotion of financial institution
•Main functions of the RBI
1.Issuer of Currency in India
a) Responsibility to maintain the internal & external value of the currency.
2.Banker to the Government (Government of India but also to the State Governments)
a) Looks after their current financial transactions.
b) Manages their public debt.
c)Transact banking business on their behalf.
d)Accepts and pays money on behalf of the government.
e) Also carries out exchange remittances.
3.Banker to Banks
a) Commercial banks keep and maintain their accounts with the RBI.
b) They keep deposits and borrow from the RBI
c)In case of difficulties acts as lender of the last resort
4.Regulator and supervisor of the financial system – ensuring public confidence in the system.

National Bank for Agricultural and Rural Development (NABARD)

•1982 – u/ NABARD Act 1981 – Merging of Agricultural Credit Department and Rural
Planning and Credit Cell of the RBI + Agricultural Refinance and Development Cooperation.
•Came up on the recommendations of CRAFICARD (Committee to Review Arrangement for
Constitutional Credit and Rural Development) by RBI.
•CRAFICARD came to the conclusion that –
1.There are massive credit needs for rural development and the need to uplift the weaker
sections to rural areas within a given time horizon, which called for a separate institutional set
up.
2.RBI had onerous responsibilities to discharge with respect to many basic functions of central
banking and therefore not in a position to give undivided attention to operational details of the
emerging complex credit problems
•Apex development bank for supporting and promoting Agricultural and Rural development.
•Preamble – “for providing credit for the promotion of agriculture, small scale industries,
cottage and village industries, handicrafts and other rural crafts and other allied economic
activities in rural areas with a view to promoting integrated rural development and securing
prosperity in rural areas, and for matters connected therewith or incidental thereto.”

1.Planning – dispensation – 1.Assist Government, RBI, 1.Inspection of the RRBs

monitoring of credit for
potentially linked projects
for all districts in the
country.
2.Provides Short term/
medium term/ long term
credit to SCBs & RRBs.
3.Refinance to eligible
institutions - SCBs & RRBs
and other institutions in rural and Cooperative Banks
development efforts. 2.RRBs and cooperative
● banks will have to file
2.Provides facilities for returns and documents to
training and research. NABARD.
● 3.RRBs and cooperative
3.Creates awareness among banks will have to seek
borrowers on ethics of permission from NABARD
payment for opening up of further
branches
EXIM Bank

National Housing Bank (NHB)

SIDBI
Scheduled Banks & Non-Scheduled Banks

Scheduled Banks
1)Banks which have been included in the II schedule of the RBI Act 1934.
2)Banks included in this category should fulfil two conditions –
a) Paid up capital and reserves of an aggregate value of not less than Rs. 5 lakhs.
b) Any activity of the bank will not adversely affect the interests of the depositors
Every scheduled bank enjoys the following facilities from the RBI -
Non-Scheduled Banks
1)Banks not included in the list of scheduled banks.
2)Follow CRR conditions but no compulsion to deposit it with the RBI.
3)Not eligible for having loans from the RBI for day to day activities but u/ emergency
conditions RBI can grant loans.
Regional Rural Banks
National Banking Financial Companies (NBFCs)

NBFCs are categorized

a) type of liabilities into Deposit and Non-Deposit accepting NBFCs
b) non deposit taking NBFCs by their size into systemically important and other non-deposit
holding companies
c)by the kind of activity they conduct.

Within this broad categorization the different types of NBFCs are as follows:
1.Asset Finance Company (AFC)
2.Investment Company (IC)
3.Loan Company (LC)
4.Infrastructure Finance Company (IFC)
5.Systemically Important Core Investment Company (CIC-ND-SI)
6.Infrastructure Debt Fund: Non- Banking Financial Company (IDF-NBFC)
7.Non-Banking Financial Company - Micro Finance Institution (NBFC-MFI)
8.Non-Banking Financial Company – Factors (NBFC-Factors)
9.Mortgage Guarantee Companies (MGC)
NBFC- Non-Operative Financial Holding Company (NOFHC)
Difference between Banking and Money Lending

SOCIAL CONTROL ON BANKS

•1969- Government imposed social control on banks.

•Imposed severe restrictions on –
–the composition of directors;
–internal management;
–administration of banking companies and
–advances by the banks.
• “These were intended to ensure that the bank advances were not confined to large scale
industries and big business houses but also directed in due proportion, to other important
sectors like agriculture, small scale industries and exports.”

Reasons for Nationalisation of Banks

(S.N Gupta, 2018)
1.Concentration of economic power [private industrial houses enjoyed monopoly – one single
director of bank was also director of many other industrial concerns]
2.Regional imbalances [complete neglect of banking business in rural areas]
3.Banks were indulging in anti-social activities & disregarding RBI directions.
4.Inflation & non-availability of funds for planning.
5.Poor service conditions of employees.
6.Lack of protection of interests of depositors.

•1969 – GOI issued an ordinance and nationalised 14 largest commercial banks (each having
the total deposits of not less than Rs. 50 crore or more).
•
•Preamble of the Banking Companies (Acquisition and Transfer of Undertaking) Act, 1970 –
“to control the heights of the economy and to meet progressively and serve better the needs of
development and of the economy in conformity with national policy and objectives and for
matters connected therewith or incidental thereto”
Objectives of Bank Nationalisation (S.N. Gupta, 2018)
1.Removing control over banks by few
2.Providing adequate credit for agriculture, small scale industries and exports.
3.Professionalising bank management
4.Encouraging a new class of entrepreneurs.

•1969 – GOI issued an ordinance and nationalised 14 largest commercial banks (each having
the total deposits of not less than Rs. 50 crore or more).
•
•Preamble of the Banking Companies (Acquisition and Transfer of Undertaking) Act, 1970 –
“to control the heights of the economy and to meet progressively and serve better the needs of
development and of the economy in conformity with national policy and objectives and for
matters connected therewith or incidental thereto”
Objectives of Bank Nationalisation (S.N. Gupta, 2018)
1.Removing control over banks by few
2.Providing adequate credit for agriculture, small scale industries and exports.
3.Professionalising bank management
4.Encouraging a new class of entrepreneurs.

BANKER-CUSTOMER RELATIONSHIP

•Predecessor to the Banking Regulation Act, 1949 is the Banking Companies Act, 1949
–Purpose: to consolidate and amend the law relating to banking companies
–Extends to the whole of India except J&K
–According to Tannan, the need for this was felt because
Abuse of powers by persons controlling banks
Absence of measures for safeguarding the interests of the depositors (of banking companies in
particular)
Partly to the economic interests in general.
–Did not apply to cooperative banks u/ Cooperative Societies Act, 1912.

•Banking Laws (Application to Cooperative Societies) Act, 1965

–An act to amend the RBI Act 1934 and the Banking Companies Act, 1949 for the purpose of
regulating the banking business of certain Cooperative Societies.
–Chapter III talks about amendment to the Banking Companies Act, 1949
Amendment of Long title and preamble
Insertion of Part V – Application of the Act to Cooperative Banks
Whole of India

•Application of the Banking Regulation Act, 1949

Section 2: Application of other laws not barred
The provisions of this Act shall be in addition to, and not, save as hereunder expressly
PROVIDED, in derogation of the [Companies Act,1956 (1 of 1956)], and any other law for the
time being in force.
•Banking Company = S. 5 (c)
"banking company" means any company which transacts the business of banking [in India];
Explanation.--Any company which is engaged in the manufacture of goods or carries on any
trade and which accepts deposits of money from the public merely for the purpose of financing
its business as such manufacturer or trader shall not be deemed to transact the business of
banking within the meaning of this clause;
•Business of Banking is not defined.
•
•But Banking is defined = S. 5(b) "banking" means the accepting, for the purpose of lending
or investment, of deposits of money from the public, repayable on demand or otherwise, and
withdrawal by cheque, draft, order or otherwise;

•Essential Characteristics to be a banking company

–The power to receive deposits from the public which are repayable or refundable as under S.
5 (b) of the BR Act 1949 [banking] & S. 5 (c) [Banking company]
–Though banks are allowed u/ S.6 – Forms of business in which banking companies may
engage.
–The essential characteristic being its ability to receive money as deposits from the customers
and its ability to honour cheques and without this mere power to grant loans would not of itself
render an institution a Banking Company
(Mahalaxmi Bank Ltd. v Registrar of Companies West Bengal
AIR 1961 Cal 666)
–Also held in Rustam Cowasji Cooper v UOI (1970) – Expression “Banking” does not include
other commercial activities of a banking institution.

•Kalipada Sinha v Mahaluxmi Bank Ltd (AIR 1961 Cal 191)

–A company carrying on the business of banking is a ‘banking company’ and it does not make
any difference if it was not carried on for some time.
–The Calcutta HC followed the ruling in Jwala Bank Case.
–
•Jwala Bank Ltd. v Shitla Prasad
–A banking company does not mean that the company must be able to accept deposits of money
from public repayable on demand or otherwise. Banking should be the primary business of the
banking company even if by reason of certain supervening events, the company is not able to
receive deposits.
–U/S.3 of the NI Act, 1881 – “Banker includes any person acting as a banker and any post
office saving’s bank”
–Upendra Kumar v. Don Finance Corp. (2009)
Facts
§The petitioner tried for the offence punishable under Section 138 of the Negotiable
Instruments Act
§the accused borrowed a loan of Rs. 15,000/- and Rs. 6,000/-on from the complainant, agreeing
to repay the same with
§Towards repayment of the said loan, the accused issued the cheque drawn on Mangala Credit
Co-operative
§On presentation, the said cheque was returned with an endorsement of "insufficient funds".
§It is contended on behalf of the petitioner that the cheque is not presented to a bank, but was
presented to a Co-operative Society and as the cheque was not presented to the banker, the
proceedings vitiate.
The court made the following observations -
1.The scope of "Banker" under the Negotiable Instruments Act is so wide and enhanced that it
includes any person acting as a banker.
2.What makes a person a Banker is not what he does with the money of which he obtains the
use by lending it at interest or by investing it, but by the terms upon which he obtains deposits
of money from the banking customers.
3.If it was the intention of the legislature to restrict the meaning of banker as per BR Act, a
specific provision would have been made in the NI Act to define the word "Banker" as any
person regulated by BR Act.
4.Legislature in its wisdom has enhanced the scope of the term "banker" under NI Act.
5.While defining the word "Banker", the language employed in the Section is "includes" which
is meant to embrace business of banking [the definition is inclusive]. Therefore, the scope of
the word "Banker" under Negotiable Instruments Act is vast and stretches beyond the Banking
Regulation Act of 1949.

CUSTOMER

•No statutory definition of customer (England and India)

•John Paget – “.to constitute a customer, there must be a recognizable course or habit of dealing
in the nature of regular banking business... It is difficult to reconcile the idea of a single
transaction with that of a customer. The word surely predicates even grammatically some
minimum of custom antithetic to an isolated act.
–Therefore, two conditions –
1.Some recognizable course or habit of dealing between him and the bank and,
2.The transactions were to be in nature of regular banking business.
•Mathew v. Williams, Brown & Co. (1894)
–Some sort of an account
–Initial transaction is not enough
–Continuity/ custom
•Duration theory exploded in Ladbroke v Todd (1914)
– “The relation of banker and customer begins as soon as the first cheque is paid in and accepted
for collection and not merely when it is paid”
–“A person...begins to be a customer of a bank when he goes to the bank with money or cheque
and asks to have an account opened in his name, and the bank accepts the money or a cheque
and is prepared to open an account in the name of that person; it is then and only then that he
is entitled to be called a customer of the bank. It is not necessary that he should have drawn
any money or even that he should be in a position to withdraw money.”

•Commissioner of Taxation v. English Scottish Australian Bank (1920) – Lord Dunedin –

(Duration is not an essence)
“The word customer signifies relation in which duration is not of the essence....... A person
whose money has been accepted by the bank on the footing that the bank undertakes to honour
cheques up to the amount standing to his credit, is, in the view of their Lordships, a customer
of the bank in the sense of the statute irrespective of whether his connection is of long or short”
•Central Bank of India Ltd. v GopinathanNair (1970) Kerala HC
“The term “customer” is not defined in the Act. Broadly speaking, a customer is a person who
has the habit of resorting to the same place or person, to do business. So far as banking
transactions are concerned, he is a person, whose money has been accepted on the footing, that
the banker will honour up to the amount standing to his credit, irrespective of his connection
being of short or long standing.”
•Tannan concludes that –
“A Customer is one who has either a current or a deposit account or, in the absence of it, some
relation with the bank in the ordinary course of business, that can be seen as a banking business

•Savory & Co. v. Lloyds Bank Ltd (1932)

–Plaintiffs were a firm of London stockbrokers.
–Employed two clerks Perkins and Smith.
–Plaintiffs sent out cheques drawn on their bankers Midland Bank Ltd. These were handed
over to Perkins and Smith who stole them and took it to Lloyd’s Bank.
–Plaintiffs subsequently discovered the fraud that followed and sued the clerks and Lloyd’s
Bank to recover the amount of the cheques on the ground of conversion.
–It was held that though Mr. Smith and Mr. Perkins had only one transaction with the Lloyd’s
Bank, they were its customers as a single transaction may constitute a customer of the bank.

•Another requirement is that the dealing must be of a banking nature. This is in contradiction
to the casual services, rendered by a banker, to a person who have opened no account with
him. For instance, if a person occasionally goes to the cashier of the bank and gets cheques
cashed or deposits, valuables or securities for safe custody, or buys a few stamps, he does not
thereby become a customer of the bank as such transactions are not regarded in the nature of
the real banking business.
•Commissioner of Taxation v The English, Scottish, and Australian Bank
“the contrast is not between a habitue and a newcomer, but between a person for whom the
bank performs a casual service e.g. cashing a cheque for a person introduced by one of their
customers and a person who has an account of his own at the bank.”

GENERAL RELATION OF BANKER TO CUSTOMER

•The definition of the relationship between a banker and customer is as elusive as the definition
of the term “customer”
•By far, it has been best captured in Joachimson v. Swiss Bank Corporation
(See page 629 of Tanaan 2010 Commentary)
•The mere opening of a current account by a customer and the banker’s acceptance thereof
involve a contractual relationship by implication.
•As per the old view, a banker was usually thought of as a reliable depository, as was the case
of goldsmiths who were first paid no interest on deposits.
–Debtor and Creditor
–Trustee Relationship
–Agency Relationship
–Bailor - Bailee

Debtor and Creditor

–The relationship between a bank and its customers is the ordinary relation of creditor and
debtor with the superadded obligation arising out of custom of banks to honour customer’s
draft. The position is that once a sum of money is deposited with a bank there remains only a
debt due from the bank to the customer. The money can be used by the bank in every permissible
manner, the bank is really the debtor of the customer to that extent.
(Dharmendrasingh Dolubbic Zala v. State Bank of Saurashtra, 1997).
Sir John Paget – “is primarily that of a debtor and creditor, the respective positions being
determined by the existing state of the account

–Velji Lakhamshi & Co. v. Dr. Banaji (1955)

The Bombay HC has thrown further light on the relation between banker and customer
by holding that the relation between a banker and customer is that of a debtor and
creditor and any amount due by the banker to the customer in that relationship cannot
be claimed by the customer from the bank as a preferential creditor., if the bank is
wound up. If the bank acts as an agent and not as a debtor, then the agency brings about
a fiduciary relationship which lasts until the agency is terminated...
–The generic relationship between a customer and his banker is that of a creditor and his debtor,
but not necessarily in that order.
–Money when paid to a bank ceases altogether to be the money of the principal
–The English Courts have again and again validated that money placed in the custody of a
banker is to all intents and purposes, the money of the banker, for him to do with as he pleases.
He is not answerable to the principal if his investment of depositor’s money runs into the risk.
He is of course answerable for the amount because he has contracted, having received that
money to repay the principal, when demanded or when due.
–Joachimson v. Swiss Bank Corporation
The debt due from a banker to customer and a debt due from an ordinary borrower have
2 distinctions-
ordinary borrower– debtor should find the creditor.
banker-customer – creditor (customer) has to make a demand on the debtor (bank)
Delhi Cloth and General Mills Co. Ltd v. Harnam Singh (1955)
It was held that the banker-customer contract is an exception to the rule that a debtor should
find his creditor. Here the creditor (the customer) has to make a demand on the debtor (banker).
The demand can be made only at that branch where the customer account is kept.

Agency Relationship
A service offered by the bankers to the customer is to collect the customer’s cheques and credit
other instruments such as interest warrants, pension bills etc. in these cases, the relationship
between the parties is that of a principal and an agent.
when a banker buys or sells securities on behalf of his customer; he performs an agency
function.
similarly, when he collects cheques, dividends, bills or promissory notes on his customer’s
behalf, he acts as his agent.

Travancore v. Quillon Bank

An amount was paid into the bank for remittance as a telegraphic transfer to a company
in Bombay. It was held that such money was held by the bank on behalf of the applicant
and as the property of the applicant, apart from the money held as the property of the
bank. The bank received the money in the capacity of a mere agent.
–Official Assignee of Madras representing the Estate of S.N. Firm v. Natesan Pallai (1940)
–Bank of India v. Official Liquidator (1950)
In both cases, similar essence was reflected - Monies held by the bank for effecting a
specific transaction puts the bank receiving such monies in a fiduciary position, and the
relationship then is not that of a debtor and creditor.

Bailor-Bailee
–The legal relationship that arises in case of safe deposit or safe custody is that of bailment.
–The customer who deposits with the bank for safe custody is the bailor and the bank the bailee.
–Bailor for reward - if fees are charged
–Gratuitous bailor – if free!
–Kel United Service Co. v. Johnson’s Claim
In cases where fees are levied, the bank becomes a bailee for reward. Where the bank
accepted the customer’s securities for safe deposit and his instructions to collect
dividends thereon, and collected commission for the service, the banker became bailee
for reward.

•United Commercial Bank v. Hem Chandra Sarkar

“. Bailment is the delivery or the transfer of possession of a chattel with a specific mandate that
requires the identical res either to be returned to the bailor. One important distinction between
agency and bailment s that the bailee does not represent the bailor. He merely exercises with
leave of the bailor, certain powers of the bailor in respect of his property. Secondly, a bailee
has no power to make contracts on behalf of the bailor. Nor can he make the bailor liable for
any act that he by himself in relation to the property bailed...”

BANKER’S RELATIONSHIP AS TRUSTEE

•Bank appointed as receiver

–E.g. by court in a partition suit between members of HUF
•Money for specific purpose
•Money paid to bank with special instructions
1.To retain it until further instructions/ pay to another with no banking account with the bank
and then the bank holding the same pending further instructions from the lodger
2.By customer to banker to sue part of the amount lying in his account be used to meet any bill
of his falling due and then bank accepting such instruction

Security deposit
United Commercial Bank Ltd. v. Okara Grain Buyers Syndicate Ltd. (1968) – money deposited
with the bank for security for the due performance of a contract with a third party, the banker
cannot withhold payment in the absence of any obligation, contractual or fiduciary undertaken
by the banker in favour of such third party.
The banker so accepting a security deposit from a customer has the role of a trustee and become
governed by the provisions of section 81 of the Indian trusts act, 1882.

Ram Ratan Gupta v. Director of Enforcement, Foreign Exchange Regulation

Meaning of the term “lend”
SC – “...to deliver to another a thing for use on condition that the thing lent shall be returned
with or without compensation for the use made of it by the person to whom it was lent”
Subject matter of lending = also be money.
“debt”; a more comprehensive term than loan.
settled law = relationship between a banker and customer for money deposited in the bank is
that of debtor and creditor.

•Shanti Prasad Jain v. Director of Enforcement

“......money deposited in a bank, the relationship that is constituted between the banker and the
customer is one of the debtors and creditor and not trustee and beneficiary. The banker is
entitled to use the monies without being called upon to account for such use, his only liability
being to return the amount in accordance with the terms agreed upon between him and the
customer.”

RBI ACT 1934

•Though it cannot be said precisely when the term ‘central banking’ originated.
•History shows that the two oldest functions of a central bank, viz., those of ‘note issue’ and
‘banker to Government’, were carried out in several countries by either an existing bank or a
new one set up for the purpose, even before such a bank came to be known as the ‘central
bank’.
•These banks, which were called ‘banks of issue’, were doing general banking business as well.

•In course of time, the banks enjoying a monopoly of note issue and the sole right to act as
bankers to Government acquired other functions, such as holding cash reserves of commercial
banks, rediscounting their bills and managing clearing houses.
•A clearer concept of central banking later emerged, and central banking came to be regarded
as a special category of business, quite distinct from commercial banking.
•While some of the ‘central banks’, as they had come to be called, gave up commercial banking
business, some others, notably the Bank of France, carried on, for some years, both types of
business.

•LEGISLATION to set up the Reserve Bank of India was first introduced in January 1927,
though it was only seven years later, in March 1934, that the enactment became an
accomplished fact.
•There is, however, a long history, which has been traced to as far back as 1773, of the efforts
to set up in India a banking institution, with some elements of a central bank.

•Turning to efforts made in India to set up a banking institution with the elements of a central
bank
–Up to as late as 1920, the functions envisaged for the proposed bank were of a mixed type,
reflecting the practices abroad.
–It was only towards the close of the nineteenth century and the beginning of the twentieth that
the term ‘central bank’ came to be used in India in the official despatches.
–It was proposed at that time to amalgamate the three Presidency Banks into one strong
institution
–the central banking functions envisaged for the new institution were not only those of note
issue and banker to Government, as in the earlier proposals, but also the maintenance of the
gold standard, promoting gold circulation as well as measuring and dealing with the
requirements of trade for foreign remittances.
–The new bank was to perform commercial banking functions as well, as the Presidency Banks
had been doing till then.
•The amalgamation of the Presidency Banks took place in 1921.
•The new institution being called the Imperial Bank of India, but it was not entrusted with all
the central banking functions; in particular, currency management remained with Government.
•In the early twenties of this century, central banking came to be treated as a separate class of
business, distinct from commercial banking; it was considered that a single institution could
not suitably perform both types of functions.
•Thus, in 1926, the Hilton Young Commission recommended the setting up of an institution
the Reserve Bank of India, which was to be entrusted with pure central banking functions; it
was to take over from the Imperial Bank such of the central banking functions as that institution
had been performing till then, and the Imperial Bank was to be left free to do only commercial
banking business.
•However, support for the ‘mixed’ type of institution was by no means lacking, among either
non-officials or officials.
•Sir Purshotamdas quoted the example of the Bank of France which was discharging both types
of functions successfully.
•It is stated that Sir James Taylor, the second Governor of the Reserve Bank, had held a view
similar to Sir Purshotamdas’s.
•It is perhaps permissible to conjecture that the support to mixed banking was prompted by the
desire to make the Imperial Bank the country’s central bank.
In the main the controversy on proposals for a central bank related to the questions of ownership
-State versus private ownership and management of such a bank.
•The interesting thing about this controversy, which had an element of shadow boxing about
it, was that both the schools of thought desired ‘independence’ of the bank from Government
control in its day-to-day working.
•It was more a matter of difference of approach with regard to the method of selection of the
Directors of the Governing Board, an element of nomination by Government being present in
all the schemes.
•Even in the proposals where the whole of the capital was to be provided by Government, not
all the Directors were to be nominated by Government: there was provision for an element of
election or selection.
•The consensus among the Indian leaders was against any scheme of selection of the
Directorate by private shareholders.
•Some other arrangements, such as selection by Chambers of Commerce and the Legislature,
were proposed.
•But the active participation of the Legislature in the selection of the Board had its own snags.
•These arrangements were not acceptable to the British Government in India, who preferred to
keep the Legislature out of the scheme and retain residuary powers with the Governor-General.
•In the end, this view prevailed. Anyway, this controversy was responsible for considerable
delay in the establishment of the Bank.
•Another matter on which something should be said at the outset is the concept of ‘State Bank’.
•The account given below shows that the term was used in different senses from time to time.
–For instance, Sir S. Montagu, in his evidence before the Fowler Committee in 1898, stated
that by ‘State Bank’ he did not mean a Government bank, but an Indian national bank doing
the local business of the country and having branches which offered remittance facilities and
which could also be entrusted with the function of note issue.
–In 1913, though Keynes did not define the term ‘State Bank’, he used that expression for his
proposed bank, presumably to convey the responsibility the State was to have in respect of the
functioning of that bank.
–In August 1927, when the Reserve Bank Bill as amended by the Joint Committee came up
before the Legislative Assembly, the term ‘State Bank’ was used in a very loose sense’ by
Members speaking on the Bill. It was used to convey two meanings, viz., (i) a bank wholly
owned by the State and not by shareholders and (ii) a bank to be managed under the complete
control of the State.
•The Finance Member expressed the view that the natural meaning of a ‘State Bank’, according
to him, was a bank under the control of the Government and the Legislature.
•In that sense, the Reserve Bank, as proposed by the Joint Committee, was not a ‘State Bank’,
because while it was to be wholly owned by Government, it was to be completely independent
of the Government and the Legislature.
•The debates in the Legislature on this matter were ‘acrimonious’. They reflected, to no small
extent, the feeling of mistrust and suspicion towards the British rulers.
•However, eventually, anxiety to have in existence a central banking institution led to
compromises in regard to its constitutional features and although what was finally
incorporated in the Reserve Bank law was the principle of a shareholders’ institution,
safeguards were provided to allay the apprehensions of the opponents to the shareholders’
rule, so called.

PREAMBLE OF THE RBI ACT, 1934

The Preamble of the Reserve Bank of India Act defined the objects of establishing a Reserve
Bank for India
①as the regulation of the issue of bank notes and
②keeping of reserves ‘with a view to securing monetary stability in British India and
③generally to operate the currency and credit system of the country to its advantage’.
•In this, it followed the Preamble of the 1928 Bill. Unlike the earlier Preamble,
•however, it did not envisage ‘the establishment of a gold standard currency for British India’,
for the international monetary situation has undergone great changes in the intervening period,
following Great Britain’s departure from the gold standard in September 1931, and the position
was fluid. The Preamble reflected this, the wording being:
•An Act to constitute a Reserve Bank of India.
•Whereas it is expedient to constitute a Reserve Bank for India to regulate the issue of Bank
notes and keeping of reserves with a view to securing monetary stability in 2[India] and
generally to operate the currency and credit system of the country to its advantage;
•3[AND WHEREAS it is essential to have a modern monetary policy framework to meet the
challenge of an increasingly complex economy;
•AND WHEREAS the primary objective of monetary policy is to maintain price stability while
keeping in mind the objective of growth;
•AND WHEREAS the monetary policy framework in India shall be operated by the Reserve
Bank of India;]
•It is hereby enacted as follows: -
•The Preamble to the Reserve Bank of India Act, 1934 (the Act), under which it was
constituted, specifies its objective as “to regulate the issue of Bank notes and keeping of
reserves with a view to securing monetary stability in India and generally to operate the
currency and credit system of the country to its advantage”. The objectives outlined in the
Preamble hold good even after 75 years.
•A core function of the Reserve Bank in the last 75 years has been the formulation and
implementation of monetary policy with the objectives of maintaining price stability and
ensuring adequate flow of credit to productive sectors of the economy.
•To these was added, in more recent times, the goal of maintaining financial stability. The
objective of maintaining financial stability has spanned its role from external account
management to oversight of banks and non-banking financial institutions as also of money,
government securities and foreign exchange markets.

CHAPTER II – INCORPORATION, CAPITAL, MANAGEMENT, BUSINESS

3. Establishment and incorporation of Reserve Bank.

–the purposes of taking over the management of the currency from the Central Government
and of carrying on the business of banking in accordance with the Act.
–a body corporate having perpetual succession and a common seal and sue and be sued.
6. Offices, branches and agencies.
–establish offices in Bombay, Calcutta, Delhi and Madras
–may establish branches or agencies in any other place in India with the previous sanction of
the Central Government elsewhere.

7. Management.
–Central Government may give such directions to the Bank, after consultation with the
Governor of the Bank, necessary in the public interest.
–a Central Board of Directors
o'general superintendence
direction of the affairs and
business of the Bank shall be entrusted to which may exercise all powers and do all acts and
things which may be exercised or done by the Bank.
–the Governor / the Deputy Governor nominated by him in this behalf, shall also have powers
of general superintendence and direction of the affairs and the business of the Bank.
•9. Local Boards, their constitution and functions.
–constituted for each of the four areas specified in the First Schedule
–shall consist of five members to be appointed by the Central Government - to represent, as far
as possible, territorial and economic interests and the interests of co-operative and indigenous
banks.
– The members of the Local Board shall elect from amongst themselves one person to be the
chairman of the Board.
–Every member shall hold office for a term of 4 years and be eligible for reappointment:
–A Local Board shall advise the Central Board on such matters as may be generally or
specifically referred to it and shall perform such duties as the Central Board may delegate to it

8. Composition of the Central Board, and term of office of Directors.

The Governor and Deputy Governor shall hold office for such term not exceeding five years
as the Central Government may fix when appointing them, and shall be eligible for re-
appointment.
A Director nominated shall hold office for a period of four years and shall be eligible for
reappointment:
Provided that any such Director shall not be appointed for more than two terms, that is,
for a maximum period of eight years either continuously or intermittently.]
A Director (government official) shall hold office during the pleasure of the Central
Government.

CENTRAL BOARD OF DIRECTORS

–The Central Board of Directors is at the top of the Reserve Bank’s organisational structure.
Appointed by the Government under the provisions of the Reserve Bank of India Act, 1934.
–the Central Board has the primary authority and responsibility for the oversight of the Reserve
Bank.
–It delegates specific functions to the Local Boards and various committees.
–The Governor is the Reserve Bank’s chief executive. The Governor supervises and directs the
affairs and business of the RBI.
–The other ten Directors represent different sectors of the economy, such as agriculture,
industry, trade, and professions.
–All these appointments are made for a period of four years.
–The Government also nominates one Government official as a Director representing the
Government, who is usually the Finance Secretary to the Government of India and remains on
the Board ‘during the pleasure of the Central Government’.
–The Governor and Deputy Governors shall devote their whole time to the affairs of the Bank
and shall receive such salaries and allowances as may be determined by the Central Board, with
the approval of the Central Government.
–the Central Board may in the public interest so to do, permit the Governor or Deputy Governor
to undertake, at the request of the Central Government or any State Government, such part-
time honorary work.
–The Central Board has primary authority for the oversight of RBI. It delegates specific
functions through its committees, boards and sub-committees.
Board for Financial Supervision (BFS)
Audit Sub-Committee
Board for Regulation and Supervision of Payment and Settlement Systems (BPSS

•Board for Financial Supervision (BFS)

–Constituted u/regulations formulated by the Central Board u/S.58 RBI Act,
–undertake integrated supervision of different sectors of the financial system [banks, financial
institutions and non-banking financial companies]
–The Reserve Bank Governor - Chairman of the BFS and the Deputy Governors are the ex
officio members.
–One Deputy Governor, usually the Deputy Governor in-charge of banking regulation and
supervision, is nominated as the Vice-Chairperson and four directors from the Reserve Bank’s
Central Board are nominated as members of the Board by the Governor.
–The Board is required to meet normally once a month.
–deliberates on various regulatory and supervisory policy issues (findings of on-site
supervision and off-site surveillance) carried out by the supervisory departments of the Reserve
Bank and gives directions for policy formulation
•Audit Sub-Committee
–The BFS has constituted an Audit Sub-Committee under the BFS Regulations.
– to assist the Board in improving the quality of the statutory audit and internal audit in banks
and financial institutions.
–Deputy Governor in charge of regulation and supervision heads the sub-committee and two
Directors of the Central Board are its members.
•Board for Regulation and Supervision of Payment and Settlement Systems (BPSS)
–The Board provides oversight and direction for policy initiatives on payment and settlement
systems within the country.
–The Reserve Bank Governor - Chairman of the BPSS, while two Deputy Governors, three
Directors of the Central Board and some permanent invitees with domain expertise are its
members.
–lays down policies for regulation and supervision of payment and settlement systems, sets
standards for existing and future systems, authorises such systems, and lays down criteria for
their membership.
10. Disqualifications of Directors and members of Local Boards.
–No person may be a Director or a member of a Local Board who
(a) is a salaried Government
(b) adjudicated an insolvent, or has suspended payment with his creditors, or
(c) is found lunatic or becomes of unsound mind, or
(d) is an officer or employee of any bank, or
(e) is a Director of a banking company or of a co-operative bank.
No two persons - partners of the same mercantile firm, or are Directors of the same private
company,
S.11. Removal from and vacation of office.
–The Central Government may remove from office the Governor, or a Deputy Governor or any
other Director or any member of a Local Board.
–A Director nominated u/S.8 (1) (b)/ (c) shall cease to hold office if without leave from the
Central Board he absents himself from three consecutive meetings of the Board u/S.13.
–Central Government / Central Board shall remove from office any member if such Director
or member becomes subject to any of the disqualifications u/S. 10.
–Director/ member of a Local Board removed or ceasing to hold office, shall not be eligible
for re-appointment either as a Director or as a member of a Local Board until the expiry of the
term for which his appointment was made.
–A Director may resign his office to the [Central Government, and a member of a Local Board
may resign his office to the Central Board, and on the acceptance of the resignation of the office
shall become vacant.
13. Meetings of the Central Board.
–convened by the Governor at least 6 times in each year + at least once in each quarter.
–Any 4 Directors may require the Governor to convene a meeting at any time and the Governor
shall convene a meeting.
– The Governor/ the Deputy Governor authorized by the Governor
vote for him,
shall preside at meetings of the Central Board, and,
in the event of an equality of votes, shall have a second or casting vote.
17. Business which the Bank may transact.
Authorized to carry on several kinds of business namely: -
1. The accepting of money on deposit without interest from and the collection of money for
Central Government, the State Governments, local authorities, banks and any other persons.
2. purchase, sale and rediscount of bills of exchange and promissory notes, drawn on and
payable in India and arising out of bona fide commercial/trade transactions bearing two or more
good signatures, one of which shall be that of a scheduled bank / State co-operative bank/ any
financial institution.
3. The making to local authorities, scheduled banks, State co- operative banks and State
Financial Corporations of loans and advances, repayable on demand or on the expiry of fixed
periods not exceeding ninety days.
4. the custody of monies, securities and other articles of value, and the collection of the
proceeds, whether principal, interest or dividends, of any such securities.
5. the sale and realisation of all property (movable or immovable) which come into the
possession of the Bank in satisfaction of any of its claims.
18A. Validity of loan or advance not to be questioned.
Notwithstanding anything to the contrary contained in any other law for the time being in force,
the validity of any loan or advance granted by the Bank in pursuance of the provisions of this
Act shall not be called in question merely on the ground of non-compliance with the
requirements of such other law as aforesaid or of any resolution, contract, memorandum,
articles of association or other instrument:
Provided, that nothing in this clause shall render valid any loan or advance obtained by any
company or co-operative society where such company or co-operative society is not
empowered by its memorandum to obtain loans or advances;
19. Business which the Bank may not transact.
1) engage in trade or otherwise have a direct interest in any commercial, industrial, or other
undertaking except such interest as it may in any way acquire in the course of the satisfaction
of any of its claims:
Provided that all such interests shall be disposed of at the earliest possible moment;
(2) purchase the shares of any banking company or of any other company, or grant loans upon
the security of any such shares;]
(3) advance money on mortgage of, or otherwise on the security of, immovable property or
documents of title relating thereto, or become the owner of immovable property, except so far
as is necessary for its own business premises and residences for its officers and servants;
4) make loans or advances;
(5) draw or accept bills payable otherwise than on demand;
(6) allow interest on deposits or current accounts.
FUNCTIONS OF THE RESERVE BANK

1)Monetary policy
2) Regulation and supervision of the banking and non-banking financial institutions, including
credit information companies
3)Regulation of money, forex and government securities markets as also certain financial
derivatives
4)Debt and cash management for Central and State Governments
5)Management of foreign exchange reserves
6)Foreign exchange management—current and capital account management
7)Banker to banks
8)Banker to the Central and State Governments
9)Oversight of the payment and settlement systems
10)Currency management
11)Developmental role and Research & statistics
Banker and Debt Manager to the Government

•The Reserve Bank of India Act, 1934 requires the Central Government to entrust the Reserve
Bank with all its money, remittance, exchange and banking transactions in India and the
management of its public debt. The Government also deposits its cash balances with the
Reserve Bank. [S. 20 – Obligation of bank to transact Govt. business & S. 21 – Banks to have
the right to transact Govt. business in India]

•The Reserve Bank may also, by agreement, act as the banker to a State Government. Currently,
the Reserve Bank acts as banker to all the State Governments in India, except Jammu &
Kashmir and Sikkim. It has limited agreements for the management of the public debt of these
two State Governments. [S. 21 A – Bank to Transact Government business of States on
Agreement]

Banker to Banks

Banks are required to maintain a portion of their demand and time liabilities as cash reserves
with the Reserve Bank, thus necessitating a need for maintaining accounts with the Bank.
–S. 42. Cash reserves of scheduled banks to be kept with the Bank
–S. 43. Publication of consolidated statement by the Bank.
•As Banker to Banks, the Reserve Bank focuses on:
–Enabling smooth, swift and seamless clearing and settlement of inter-bank obligations.
–Providing an efficient means of funds transfer for banks.
–Enabling banks to maintain their accounts with the Reserve Bank for statutory reserve
requirements and maintenance of transaction balances.
–Acting as a lender of last resort.

Issuer of Currency

•The Reserve Bank is responsible for the design, production and overall management of the
nation’s currency, with the goal of ensuring an adequate supply of clean and genuine notes.

S. 22. Right to issue bank notes

S. 23. Issue Department
S. 24. Denominations of notes.
S. 25. Form of bank notes.
S. 27. Re-issue of notes.
S. 28. Recovery of notes lost, stolen, mutilated or imperfect.
S. 28A. Issue of special bank notes and special one-rupee notes in certain cases.
Reserve Bank of India (Note Refund) Rules, 2009
Master Circular – Facility for Exchange of Notes and Coins dated July 02, 2018

Monetary Management

•the basic functions of the Reserve Bank of India as enunciated in the Preamble to the RBI Act,
1934 are: “to regulate the issue of Bank notes and keeping of reserves with a view to securing
monetary stability in India and generally to operate the currency and credit system of the
country to its advantage.”
•Thus, the Reserve Bank’s mandate for monetary policy flows from its monetary stability
objective.
•Essentially, monetary policy deals with the use of various policy instruments for influencing
the cost and availability of money in the economy.
Over time, the objectives of monetary policy in India have evolved to include
–maintaining price stability,
–ensuring adequate flow of credit to productive sectors of the economy for supporting
economic growth,
–and achieving financial stability.
•Based on its assessment of macroeconomic and financial conditions, the Reserve Bank takes
the call on the stance of monetary policy and monetary measures.
•Its monetary policy statements reflect the changing circumstances and priorities of the
Reserve Bank and the thrust of policy measures for the future.
•The Governor of the Reserve Bank announces the Monetary Policy in April every year for the
financial year that ends in the following March.
•This is followed by three quarterly reviews in July, October and January. However, depending
on the evolving situation, the Reserve Bank may announce monetary measures at any point of
time.
The Monetary Policy in April and its Second Quarter Review in October consists of two parts:
–Part A provides a review of the macroeconomic and monetary developments and sets the
stance of monetary policy and monetary measures.
–Part B provides a synopsis of the action taken and the status of past policy announcements
together with fresh policy measures. It also deals with important topics, such as, financial
stability, financial markets, interest rates, credit delivery, regulatory norms, financial inclusion
and institutional developments.
Monetary Policy Transmission
–An important factor that determines the effectiveness of monetary policy is its transmission
–a process through which changes in the policy achieve the objectives of controlling inflation
and achieving growth.
–In the implementation of monetary policy, a number of transmission channels have been
identified for influencing real sector activity. These are (a) the quantum channel relating to
money supply and credit; (b) the interest rate channel; (c) the exchange rate channel; and (d)
the asset price channel.
–How these channels function in an economy depends on its stage of development and its
underlying financial structure. For example, in an open economy one would expect the
exchange rate channel to be important; similarly, in an economy where banks are the major
source of finance as against the capital market, credit channel could be a major conduit for
monetary transmission.
–these channels are not mutually exclusive, and there could be considerable feedback and
interaction among them.
Inflation targeting is a monetary policy where the central bank sets a specific inflation rate as
its goal. The central bank does this to make you believe prices will continue rising. It spurs the
economy by making you buy things now before they cost more. [S. 45 ZA]
–The Central Government in consultation with RBI, determine the inflation target in terms of
the Consumer Price Index, once in 5 years.
–Upon determination, notify in the Official Gazette.
•The Consumer Price Index (CPI) is a measure that examines the weighted average of prices
of a basket of consumer goods and services, such as transportation, food and medical care.
–It is calculated by taking price changes for each item in the predetermined basket of goods
and averaging them.
–Changes in the CPI are used to assess price changes associated with the cost of living.
–one of the most frequently used statistics for identifying periods of inflation or deflation.

CHAPTER IIIF: MONETARY POLICY

45ZB. Constitution of Monetary Policy Committee.

–The Central Government by notification in Official Gazette, constitute Monetary Policy
Committee of the Bank.
–determine the Policy Rate required to achieve the inflation target.
–Decision of the Monetary Policy Committee - binding on the Bank.
–consist of the following Members
a. Governor of the Bank [Chairperson, ex officio]
b. Deputy Governor of the Bank [Member, ex officio]
c. One officer of the Bank - nominated by the Central Board [Member, ex officio]
3 persons appointed by the Central Government [Members]
45ZG. Secretary to Monetary Policy Committee.
Bank shall appoint a Secretary to provide secretariat support to the said Committee, shall
perform such functions and in such manner as may be specified by the regulations made by the
Central Board.

45ZC. Eligibility and Selection of Members appointed by the Central Government.

The Members of the Monetary Policy Committee shall be appointed by the Central
Government from amongst persons of ability, integrity and standing, having knowledge and
experience in the field of economics or banking or finance or monetary policy.

•The Members of the Monetary Policy Committee referred to in shall be appointed by the
Central Government on the recommendations made by Search-cum-Selection Committee
consisting of
(a) Cabinet Secretary—Chairperson;(b) Governor of the Reserve Bank of India/ his
representative (not below the rank of Deputy Governor)—member;(c) Secretary, Department
of Economic Affairs—member;(d) three experts in the field of economics or banking or finance
or Monetary policy to be nominated by the Central Government—members.
Search cum- Selection Committee shall follow procedures as prescribed by the Central
Government.
45ZD. Terms and conditions of appointment of Members of Monetary Policy Committee.

–The Members appointed under S. 45ZB (2) (d) shall hold office for four years and not eligible
for re-appointment.
–The terms and conditions of appointment shall be prescribed by the Central Government and
the remuneration and other allowances payable shall be specified by the \ Central Board.

–A Member may resign at any time before the expiry of his tenure by giving to the Central
Government, a written notice of not less than six weeks, and on the acceptance shall cease to
be a Member

45ZE. Removal of Members of Monetary Policy Committee.

The Central Government may remove from office any Member appointed u/S. 45ZB (2) (d)
–adjudged as an insolvent;
–become physically or mentally incapable
–been convicted of an offence of moral turpitude;
–failed to adequately disclose a material conflict of interest on appointment;
–does not attend three consecutive meetings of Committee without obtaining prior leave; or
–has acquired such financial or other interest as is likely to affect prejudicially his functions as
a Member;
–has acquired any post u/S. 45ZC (1)
–abused his position as to render his continuance in office detrimental to the public interest.
•No Member appointed shall be removed unless he has been given a reasonable opportunity of
being heard in the matter.

45ZF. Vacancies etc., not to invalidate proceedings of Monetary Policy Committee.

–No act or proceeding of the Monetary Policy Committee shall be invalid merely by reason
of—
a.any vacancy/ defect in the constitution of the Monetary Policy Committee
b. any defect in the appointment of a person acting as a Member of the Monetary Policy
Committee
c. any irregularity in the procedure of the Monetary Policy Committee not affecting the merits
of the case.
45ZH. Information for Monetary Policy Committee Members.
–The Bank shall provide all information to the Monetary Policy Committee that may be
relevant to achieve the inflation target (within reasonable time) +
–any Member of the Committee may, at any time, request the Bank for additional information,
including any data, models or analysis.
45ZI. Meetings of Monetary Policy Committee.
–The Bank shall organise at least four meetings in a year.
–The meeting schedule of the Monetary Policy Committee for a year shall be published one
week before the first meeting in that year.
–The meeting schedule may be changed only––(a) by way of a decision taken at a prior meeting
of the Monetary Policy Committee; or (b) if, in the opinion of the Governor, an additional
meeting is required, or a meeting is required to be rescheduled due to administrative exigencies.
–The quorum shall be four Members, at least one of whom shall be the Governor and, in his
absence, the Deputy Governor
–Each Member of the Monetary Policy Committee shall have one vote.
– All questions which come up before any meeting shall be decided by a majority of votes by
the Members present and voting, and in the event of an equality of votes, the Governor shall
have a second or casting vote.
–Each Member of the Monetary Policy Committee shall write a statement specifying the
reasons for voting in favour of, or against the proposed resolution.
– The procedure, conduct, code of confidentiality and any other incidental matter for the
functioning of the Monetary Policy Committee shall be such as may be specified by the
regulations made by the Central Board.
–The proceeding of the Monetary Policy Committee shall be confidential.
45ZJ. Steps to be taken to implement decisions of Monetary Policy Committee.
–The Bank shall publish a document explaining the steps to be taken by it to implement the
decisions of the Monetary Policy Committee, including any changes thereto.
–The particulars to be included in such document and the frequency of publications of such
document shall be such as may be specified by the regulations made by the Central Board.
45ZK. Publication of decisions.
The Bank shall publish, after the conclusion of every meeting of the Monetary Policy
Committee, the resolution adopted by the said Committee;
45ZL. Publication of proceedings of meeting of Monetary Policy Committee.
–The Bank shall publish, on the fourteenth day after every meeting of the Monetary Policy
Committee, the minutes of the proceedings of the meeting which shall include the following,
namely: —
a. The resolution adopted at the meeting of the Monetary Policy Committee;
b. the vote of each member of the Monetary Policy Committee,
c. The statement of each member of the Monetary Policy Committee under sub- section (11)
of section 45ZL on the resolutions adopted in the said meeting.
45ZM. Monetary Policy Report.
The Bank shall, once every six months, publish a document to be called the Monetary Policy
Report, explaining—
other sources of inflation; and
other forecasts of inflation for the period between six to eighteen months from the date of
publication of the document.
The form and contents of the Monetary Policy Report shall be such as may be specified by the
regulations made by the Central Board.
45ZN. Failure to maintain inflation target.
Where the Bank fails to meet the inflation target, it shall set out in a report to the Central
Government––
(a) the reasons for failure to achieve the inflation target;
(b) remedial actions proposed to be
taken by the Bank; and
(c) an estimate of the time-period within which the inflation target
shall be achieved pursuant to timely implementation of proposed remedial actions.
Explanation. —For the purposes of this section, the factors that constitute failure shall be such
as may be notified by the Central Government in the Official Gazette, within three months from
the date of the commencement of Part I of Chapter XII of the Finance Act, 2016.

BASIC CATEGORIES OF LOANS

•A company may need money for a number of reasons. It may need working capital to pay
suppliers, wages or bills; funds for a particular project or transaction, or a one-off sum of money
to solve a financial crisis. Most companies raise finance through a combination of equity
finance and debt finance.
What is debt finance?
–Debt finance consists of raising money by borrowing from a lender, with a promise to repay
the money (usually with interest) at a later date.
–The appropriate method of debt finance will depend on the size and creditworthiness of the
borrower and the amount of money required.
–Debt finance can broadly be divided into two main types:
•Issuing debt securities.
•Taking out a bank loan.
Debt Security
•a financial instrument.
•An issuer of debt securities promises to repay the investors the amount borrowed on or by a
specified date (which is when a debt security is said to "mature"), usually with interest.
•They can usually be easily traded between investors. This feature can make them attractive to
investors.
Debt securities take many forms, for example:
Bonds (including euro bonds and high yield or junk bonds). These usually have a maturity of
one year or more.
Medium term notes. These are debt securities issued under medium term note programmes and
usually have a maturity of up to 30 years.
Commercial paper. These are like bonds but have a maturity of less than one year.
Advantages of debt securities
•Broad investor base.
•Trading
•Covenants
•Interest rates.
•Security over assets.
•Disclosure.
Broad investor base
Ø an issuer can usually access a much wider group of potential investors than a syndicated
loan.
Ø Depending on demand at the time, this may mean the issuer can pay a more competitive
price for borrowing than with a bank loan.
Trading
Ø They transferable instruments (often listed on a stock exchange) that can be traded in the
international capital markets.
Ø An investor can lend money to the issuer but needn't be bound to wait until the maturity date
for his repayment because the debt securities can be sold if the investor needs to realise his
investment. This may give an issuer access to willing lenders when a bank loan might not be
possible or desirable.
Covenants.
Ø the terms and conditions of issues of debt securities generally contain far fewer and less
stringent covenants than in a syndicated loan.
Interest rates.
Ø Debt securities usually have more flexible interest rate options for a borrower as debt
securities can be fixed rate, floating rate, zero coupon and so on.
Ø Syndicated loans usually only have a floating rate of interest.
Security over assets.
Ø Debt securities are frequently unsecured, whereas traditionally loans are secured.
•Disclosure
Ø in a debt securities issue, information about the issuer is usually limited to information that
is publicly available.
Ø in a syndicated loan, the lending banks conduct very thorough due diligence on the company.
This will mean the borrower disclosing much less information to the lender in a bond issue
than for a loan.
Bank loans
•A company may get a loan from a single bank (a bilateral loan) or a group of banks (a
syndicated loan).
•Bank loans are tailored to the borrower's particular needs and so take many forms, for
example:
–Overdraft (the amount borrowed is repayable on demand).
–Term loan (the loan is repayable by the end of a set time period).
–Revolving facility (the borrower can re-borrow amounts it has already repaid).
–Other miscellaneous forms

KINDS OF LOANS SYNDICATED LOAN AGREEMENTS

•Definition: A structure whereby a large number of banks lend funds for a long period of time
to a single borrower.
•Basic features:
–The lending entities come from a whole number of different jurisdictions;
– The loan is made in a number of currencies; and
–Banks are lending any currencies that the borrower wants to borrow (= the currency may have
nothing to do with the country of the bank).
•Legal issues: The international syndicated loan appears to be:
– a number of separate loans,
– made by individual banks to the same borrower,
–which are subject to the same terms and conditions, and
–each lender possesses rights to interest and principal from the borrower.

THE SYNDICATION PROCESS

•Borrower solicits bids from arrangers.

•Banks outline their syndication strategy and qualifications

•Borrower will grant a “mandate” to the Lead Manager

•Lead Manager forms “managing group” and prepares documents

•Documents are distributed in Draft form to banks indicating a clear interest to join syndication.

•Once agreed, SLA is formally signed.

•Fulfilment of conditions precedent by the borrower

•Certification of compliance by lead manager/ agent bank

•Syndicate transfers amount to the account held with agent bank.

•Agent Bank disburses the money to the borrower.

Elaborating the flowchart:

1)At the centre of the syndications process is a major international bank which will act as the
lead bank or ‘lead manager’.
2)The lead manager initiates the process by approaching potential borrowers.
3)A firm proposal of finance is usually contained in a ‘term sheet’ or ‘offer document’, on the
basis of which the borrower will grand a ‘mandate’ to the lead manager to organise a group of
banks which will form the lending syndicate.
4)After obtaining a mandate, the lead manager would usually form a small group of banks (the
‘managing group’) who will agree in principle to lend most, if not all of the funds required by
the borrower.
5)The lead manager prepares legal documents and the ‘information memorandum’.
6)Once the borrower and the syndicate have agreed on the form of the SLA, the document will
be formally signed.
7)For the disbursement of fund to happen, however, the borrower must satisfy to certain
conditions – ‘conditions precedent’.
8)Once the conditions have been satisfied, a bank designated as the ‘agent bank’ (it may be the
lead manager but not always) will certify to the syndicate that the conditions have been satisfied
– ‘certification of compliance’.
9)The syndicated banks will then transfer the amounts they agreed to lend to an account held
by the agent bank.
The Agent Bank will then transfer to the borrower the aggregate amount.

Advantages of a syndicated loan

•Flexibility as to amount borrowed.
•Flexibility as to amount repaid.
•Currency.
•Publicity.
•Renegotiation of terms.
•Size of borrower.
Flexibility as to amount borrowed
• A syndicated loan can be tailored to allow the borrower to draw down funds when needed, so
can be useful as a contingency fund.
•In an issue of debt securities, the issuer usually receives the full subscription price (and will
be liable for interest payments on the full amount) on the issue date.
•not an ideal source of finance if the amount of money needed is uncertain or for contingencies.

Flexibility as to amount repaid

•Repayments for a syndicated loan can be in instalments or, if the loan is made on a revolving
basis, the borrower can repay and redraw money when required.
•Issues of debt securities usually provide for one payment on maturity (a "bullet repayment")
as well as regular interest payments (although some can be repaid in instalments).

Currency
• Some syndicated loans allow a borrower to switch the loan from one currency to another for
successive interest periods.
•In an issue of debt securities, the issuer will usually borrow in the currency specified when the
debt securities are issued (although "swaps" can be entered to allow the currency to be
swapped)
Publicity
•Syndicated loans are private transactions between the borrower and a syndicate of banks.
•The details of an issue of debt securities will become public if the debt securities are listed on
a stock exchange.
Renegotiation of terms.
•With a syndicated loan, it is usually possible to negotiate with the syndicate of lenders if the
borrower finds itself in financial difficulties.
•With an issue of debt securities, it is unlikely that the issuer will even know the identity of the
investors. There are also likely to be too many investors to renegotiate the terms and conditions.
Size of borrower.
•Issuers of debt securities generally need to be established companies with a good credit rating
because investors will be more willing to invest in a company with a good credit history and
reputation.
•If the issuer is not of sufficient size and creditworthiness to be acceptable to the debt securities
markets, it will not be able to issue debt securities and will probably have to rely on loans from
banks
Term Sheet/ Offer Document
1.Usually contains the amount that will be borrowed, the interest rate, the duration, the currency
and the terms and conditions that apply to the SL.
2.They can be legally binding, unless appropriate clauses are inserted
3.Usually a ‘subject to contract’ clause. Such a clause should generally be sufficient to prevent
legal obligations from arising until a formal contract i.e. SLA has been signed by the parties.
4.In the absence of such a clause, the question whether a term sheet / offer document can be
legally binding will depend on the intention of the parties and the surrounding circumstances.
5.If intention to create legal obligations is effectively excluded by appropriate clauses, there is
no legal commitment on the part of the lead manager to provide the finance to the borrower
even after the mandate is granted.
6.*As a good market practice = once a mandate is granted, the lead manager would usually
consider itself obliged to organise a syndicate and obtain the finance for the borrower.

The London Interbank Market

Information Memorandum (IM)

1.Contains information
a. concerning the financial and business position of the borrower.
b. Details about the loan
2.Generally prepared for borrowers who are new to the international syndicated loan market or
who are not so frequent borrowers.
3.Syndicate participants may rely at least partially on the information provided while making
the decision i.e. to join the syndicate or not.
4.Inaccuracies or Misleading information in the IM makes it a potential source of liability for
the lead manager
a. Under Common law of tort,
a. Negligence
b. Fraudulent Misrepresentation
b. Under provisions of Misrepresentation Act, 1967 (in UK)
a.S.2 (1)
b. One can escape liability if they can prove that he had reasonable grounds for believing that
the representation was genuine.

1.The borrower who provides the details will also be potentially liable for any defect.
2.Remedies against the borrower is usually contained in the SLA itself = express clause –
inaccuracy/ misleading information in the IM will constitute an event of default on the part of
the borrower (thus, giving rise to immediate right in the syndicate to call default and demand
repayment of all outstanding amounts i.e. accelerate the loan prior to the date of maturity).
3.In order to reduce the potential liability of the lead manager, two techniques have been
adopted –
a. Disclaimer notices in the IM
Objective of a disclaimer – elimination of any reliance being placed on the lead manager by
the syndicate wrt. the accuracy of the contents in the IM.
b. Contractual clauses in the loan agreement i.e. SLA

Effectiveness of Disclaimer Clauses u/ English Law

–If misrepresentation is fraudulent, court is unlikely to give effect to such exemption.
–Depended on the precise words and content.
–May be hit by the Unfair Contract Terms Act 1977 (UCTA) unless they satisfy a test of
reasonableness.
•Potential provision = S.2 applies to contractual terms +notices not having contractual force.
•Conflict of law rules application will have to be looked into.
–Factors affecting reasonableness –
•Sophistication of the recipients of the IM
•Access of legal and financial resources
•Ability of the bank to make such independent evaluation
•*in practice – IM are not relied on by banks to a great degree
*on contrary – Time limitation to make independent evaluation

THE LEAD MANAGER (DUTIES)

•In practice, a lead manager would also assume the role of the agent bank in the SLA after
signing of the formal legal documents.
•Agent bank for the syndicate!
•Express clauses – agent bank does not act as an agent on behalf of the borrower.
Contractual Duties as AGENT BANK
–Certification of compliance
Ü Examination of a variety of documents – capacity and authorisations.
Ü May involve matters relating to foreign law.
Ü Therefore, empowered to take action on the basis of legal opinions.
Ü Clauses exempting agent banks liability for any action taken or not taken on the basis of such
legal opinion or advice.
–Paying Agent
Ü Clawback clause – demand repayment from the borrower of any funds which the agent bank
does not receive from the syndicate
Ü Liability to lend of each bank is neither a joint liability of the syndicate nor a liability of the
agent bank.
Ü Insolvency of the agent bank
–Monitoring Loan Covenants
Ü Absence of clauses – common law may impose a duty of due diligence on the bank
–Duty to Act on Occurrence of Default
–Fiduciary

STRUCTURE AND CONTENTS OF a SYNDICATED LOAN AGREEMENT (SLA)

The bulk of provisions under SLA can be grouped under the following headings
•Conditions Precedent
•Representation and Warranties
•Financial Arrangements
•Covenants
•Default
•Choice of Law and Jurisdiction

Conditions Precedent
•To be satisfied by the borrower before the obligation of the lending banks to disburse fund is
triggered.
•These ensure that the loan agreement is valid and enforceable legal agreement and the
borrower has the power and all necessary authorisations to enter into the agreement.
•Usually provides various documents – constitution, powers, legal opinions from lawyers,
internal authorizations, etc.
•Legal nature (whether promissory conditions or contingent conditions) – depends on the
construction in the SLA [refer pg. 69]
•Tranches – conditions precedent – prior to each drawdown.
•Revolving facility – conditions precedent – applicable to each such re-borrowing
Representation & Warranties (R&W)
•Substratum of facts based on which the syndicate makes the loan facility available to the
borrower.
•R & W fall into two groups
Group 1
o Identical to conditions precedent
o Legal Status and capacity to enter into loan agreement.
o All internal and external authorisations.
o SLA will not violate constitutional documents or any laws in the home state of the borrower.
o If untrue/inaccurate-
a. Terminate the loan and demand immediate repayment (accelerate the loan).
b. If the inaccuracy is of such a nature that the agreement turns out to be null and void –
damages under English Law for fraudulent or negligent misrepresentations.

Group 2
a. Financial and business position of the borrowing entity.
b. Warrant and represent the accuracy of all financial statements submitted by the borrower to
the syndicate banks
c. No pending litigation/judicial proceeding that may have adverse effect on the financial or
business condition.
d. No a defaulter in any other loan/financing agreement.
e. Has title to the assets on the balance sheet.
•Tranches – R&W to be repeated in each drawdown.
•Revolving Facility – R&W to be repeated in each re-borrowing.
•Where the SLA is valid and legally enforceable, the consequence of a breach of one of the
R&W gives the syndicate to terminate the SLA with immediate effect and demand repayment.
In practice, its breach is made an event of default

Financial Arrangements
•Currency of loan & currency of repayment.
–Single currency/ multi-currency
–Provision to deal with currency fluctuations – a right to require repayment of the excess.
–Express provision: currency of borrowing = currency of repayment
•Statement of purpose and use of proceeds of the loan
–Specific clause stating the purpose for which the loan is made and the use to which the
proceeds are to be utilised.
–If SLA is governed by English Law - beneficial – avoids illegality of the loan transaction
“Neither the agent bank nor the other members of the syndicate shall be bound to enquire as to
the use of the proceeds of the loan and that they shall not be able to be responsible for the
application of the proceeds of the loan”
*BUT the syndicate shall not be able to rely on this clause to enforce the loan agreement if the
syndicate were in fact aware that the loan proceeds were to be used for some unlawful purpose.
•Prepayment
–Gives the borrower the power to prepay
–Subject to a premium
•Funding mechanism in the international market
–LIBOR payable
–Euro Market disaster clause – to tackle inefficiency of deposits in a given currency or other
economic problems that hinders fixation of an interest. Drafted in the widest possible manner.
An alternative to lend in another currency.
•Interest payments and withholding tax
–Make payments of interest without withholding.
–Tax issues
•Funding and increased costs
–Borrowers usually required to make additional payments in the event that the cost of the
syndicate bank in funding the loan becomes financially more onerous due to regulatory
requirement in the home state of the syndicate.
Standard Covenants

Financial Covenants
–Borrower maintains a level of financial performance to ensure that it will be able to meet its
payment obligations when it becomes due.
–This covenant embodies such levels of financial performance.
–Considered to be very vital. They function as early warning signals if the borrower might fail
to meet the payment obligations.
•Debt to Equity Ratio
•Minimum Net Worth Ratio
•Current Ratio
•Minimum Working capital
•Debt service Ratio
Financial Information Covenants
–Drafted widely sometimes
–Publicly available information + reasonably needed to monitor the performance of the
borrower
Asset Disposal Covenants
–Aim is to ensure proper and adequate financial performance by the corporate entity – thus,
giving rise to this covenant which controls substantial disposal of revenue generating assets.
–Regulates both asset quality and quantity.
–It will usually provide that the borrower/ it’s subsidiaries will not dispose of assets which
exceed a certain specified amount ‘except in the ordinary course of business’
–It may also control on the amounts of dividends which may be distributed by the borrower.
Merger Control Covenants
–Clauses such as this prohibits the borrower from ‘merging’ with another corporate entity
without the consent of the syndicate banks.
–The commercial purpose of the clause seems to be an attempt to preserve the legal identity of
the borrowing entity.
–It is important to note that the meaning of the word ‘merger’ may be an issue. There is an
interplay of the proper law of the agreement and the legal nature of the transaction in question.
Pari Passu Covenant
•Under this, the borrower warrants that its obligations under the SLA will rank equally with
the rights of the borrower’s other unsecured creditors.
•Primary objective – to ensure that the borrower has not conferred priority to any other
unsecured creditor at the time of the SLA
•Potential dodgy area – interaction between the governing law of the SLA (i.e. English Law)
and law of the jurisdiction governing the bankruptcy or insolvency.
Negative Pledge Covenant
•Under this, the borrower cannot give security over its assets to subsequent lenders.
•Rationale – in most systems of law secured assets are not available to the unsecured creditors
in the event of liquidation or bankruptcy of the borrower, thus in order to save the interests of
the syndicate as unsecured creditors, such a clause is essential.
•Furthermore, on a commercial front it prevents the borrower from obtaining financing by
giving security over assets where its financial performance has gone down to a level from
where it cannot obtain funds from lenders on unsecured basis.
•It is important to take note that this clause will be subject to some exceptions –
–If drafted wide – it could cause a breach of the covenant even when the syndicate does not
have any actual objection to the creation of the security interest.
–If drafter narrow –commercial transactions that do not create a security interest but have
similar commercial effect may spill out from the scope.
•Applicable law
o A complicated situation – interaction of the law applicable to the SLA and the law creating
security interest
o What is the meaning of “security interest” in the negative pledge covenant? – English Conflict
of law rules!
What is the legal nature and effect of the transaction wrt. The assets ?
§Fixed Assets – lex situs
§Ambulatory Assets – law of the flag
§Intangible Assets – lex situs/ proper law of the document creating the security interest.
•Ways to enforce negative pledge covenant
● Equal security
● Same security
● Injunction
● Automatic security

Default & Cross Default

•Default clauses in an SLA seek to define the various events on the occurrence of which
syndicate will have an unqualified right to accelerate the loan and call for repayment of loan
outstanding prior to maturity.
In practice – the remedy of calling default is the ULTIMATE SANCTION! – why?
–This is because, calling of default by one of the syndicates will result in all other syndicates
calling default on the basis of cross default clauses.
–Hence, banks try to bargain with the borrower for some remedial action.
“Events of default clause is like a lynchpin which supports the network of rights and liabilities
contained in the SLA. All covenants, representations and warranties should be locked into the
default mechanisms so as to give the syndicate banks a right to accelerate on the occurrence of
a breach of covenant/ R&W of the loan agreement”.
3 principal occurrences in respect of which an event of default should occur
–Failure to pay interest or principal repayment when they fall due.
–Non-compliance with any covenant of the loan agreement
–Breach of any R&W
Cross default clause
gives syndicate a right to call default in the event that any other lender acquires a right
under his/her loan agreement to accelerate the loan
A very important and powerful clause in the SLA
①Links every borrowing in the International Syndicated Loan Market – breach of any
covenant in any SLA, trickles to give right to each and every one of the borrower’s SLA is
capable of being accelerated.
②Cross default is not just triggered at mere acceleration of a loan, it is when any borrowings
“become capable of being declared due prior to its stated date of payment”. Thus, even if
lenders in a given SLA, do not take any action on the breach of the covenant, it still gives power
to other lenders in other SLAs a right to call default.
–In practice – such broad construction is usually objected, and banks do not accelerate the
loans.
[REMEMBER – CALLING DEFAULT IS THE ULTIMATE SANCTION – “THE LAST
RESORT!!!”]
Sharing Clauses
•The obligation of each member of the syndicate to the borrower is expressly stated to be
several and not joint.
•Thus, when a particular bank fails to make available its portion of the loan, the other syndicate
banks are not relieved from their respective obligations and also are not required to make up
for the difference.
•Also, each bank may separately enforce its rights to the borrower. However, one should
consider the power given to the lead manager given by the syndicate to call default on their
behalf – [construction of the SLA is to be considered]
Sharing clause is an exception to this concept of independency and severability of the lenders.
–Sharing clause requires that all payments of interest and/or principal paid by the borrower
should be paid only to the agent bank and not to each individual member of the syndicate.
–Requires the agent bank to re-distribute the payments to the members of the syndicate pro-
rata in accordance with each member’s loan to the borrower.
–If any member of the syndicate is repaid wholly/ partially by the borrower in respect of the
loan outstanding, such member is required to share such receipt with other members of the
syndicate on pro-rata basis.
Suppose a member set off their rights –
•Usually another clause is provided wherein in the event that a syndicate member sets off a
deposit of the borrower against a member’s loan outstanding’s, such syndicate member is
required to share the deposit pro rata with other members of the syndicate
Practical approach – a clause permitting the member of the syndicate to set off such deposit for
the benefit of all members of the syndicate

NATURE AND SCOPE OF A GOVERNING LAW

•International finance involves the application of many systems of law.

•The potential applicability of numerous legal systems introduces a system of uncertainty with
regard to validity, enforceability and interpretation of legal documents which give effect to the
transaction + the rights and liabilities of the parties.
•Solution = choice of law clause
Seeks to control:
1.Validity, enforceability and interpretation of all the legal documents evidencing and
constituting the transaction.
2.Legal rights and obligations of the various parties
The extent to which other systems of law will affect the transaction
International finance involves the potential applicability of many systems of law. The potential
application of different systems of law introduces a significant element of uncertainty. On the
one hand, there’s uncertainty as to the intrinsic validity, enforceability, and interpretation of
legal documents which constitute or give effect to an international transaction; on the other
hand, there’s uncertainty as to the rights and liabilities of parties to such a transaction. To
reduce the uncertainty to a minimum, an attempt is made to apply one system of law to the
transaction and to exclude as far as possible the applicability of other legal systems. This is the
role of the ‘choice of law’ clause in a contract.

•“Proper law of the contract”: a system of law by which the party intended the contract to be
governed, or where their intention is neither expressed nor to be inferred from the
circumstances, the system of law with which the transaction has it closest and most real
connection. Dicey and Morris (the conflict of Laws).
•In the absence of such a clause, the international financing transaction may be subject to:
–̈ The law of the place where the legal documents are signed;
–̈ The law of the place where a borrower (syndicated loan)/ issuer (bond issue) is incorporated
or deemed to be resident;
–̈ The law of the country in which any dispute is subsequently litigated

•Choice of Law: Legal and commercial factors

Freedom of choice under the prospective proper law.
–Certainty and result predictability under legal documents.
–Conceptual sophistication of the system.
–Language.
–Forum of potential litigation
–Familiarity.
Aspects controlled by the proper law
Formation of the contract.
Interpretation and effect of the contract.
Validity of the contract.
Performance of the contract.
Limitations
Corporate Capacity
Mergers and acquisitions
Creation of security interests
 PROJECT FINANCE

•Project finance is the funding (financing) of long-term infrastructure, industrial projects, and
public services using a non-recourse or limited recourse financial structure.
•The debt and equity used to finance the project are paid back from the cash flow generated by
the project

•In simple words, project finance means structured financing of a specific economic entity SPV
[Special Purpose Vehicle] also called as the project company created by sponsors using equity
or mezzanine debt and for which lenders consider cash flows as being the primary source of
loan reimbursement, whereas assets represent collateral.
•Most authors agree that it does not depend upon the soundness of credit worthiness of the
sponsors (i.e. the parties proposing the business idea to launch the project).
•Approval does not depend on the value of the assets of the sponsors who are willing to make
available as collateral.
•Rather, it is basically a function of the project’s ability to repay the debt contracted and
remunerate the capital invested at a rate consistent with the degree of risk inherent in the
venture concerned.
•Project finance debt can be non-recourse or limited recourse to the project sponsor.
•Non-recourse project finance –
–Predicated completely on the merits of the project rather than the credit of the project sponsor.
–Since, it is non-recourse, the project sponsor has no direct legal obligation to repay the project
debt.
–Ability of the project sponsor to produce revenue from the operation is the foundation of a
project financing, the contracts form the framework for project viability and control allocation
of risks. Contracts that represent the obligation to make a payment to the project company on
the delivery of some product or service are very important because these contracts govern cash
flows.
•Limited recourse project finance –
–Indicates limited obligations and responsibilities of the project sponsor.
–Gravity of the recourse is dependent upon the unique risks in the project + the markets
approach to handle the same.
•Historically, project finance was used in oil extraction and power production sectors.
•Initially it involved parties in the private sector and over the years it has been increasingly
used to finance projects in which public sector plays an important role.
Private sector participation in realising public works is known as PPP (public-private
partnership). The role of the public administration is usually based on a concession agreement
that provides various alternatives
 STAGES OF IMPLEMENTATION FOR A PROJECT

GESTATION STAGE
1.essentially comprises of the development of the project concept, preliminary study of the basis
and feasibility of the project.
2.the importance of the stage is that it provides the foundation for the project.
3.The critical aspect of this stage is that of research and development of the project concept
and feasibility which culminates in the decision to develop the project.

DEVELOPMENT STAGE
1.Commences from the time the decision to implement the project has been taken and the
project has evolved from the gestation stage.
2.In this stage, the activities would constitute the framework for the implementation of the
project, ranging from the incorporation of the project company to financial closure.
3.One of the main decisions at this stage is to determine the project development vehicle and
structure of the project implementation.
4.Also involves commencement of negotiation to formulate and create lenders consortium. The
process of negotiation, finalisation and execution of the entire documentation required for a
particular project should ideally be as follows –
–Executing agreements with the Govt.
–Concluding Agreements with various Equity Participants
–Executing Agreements with various contractors.
–Executing agreements with lenders.
CONSTRUCTION STAGE
1.Involves implementation of the construction within the schedule.
2.Time is a crucial factor. Any delay with directly affects costs and consequently the financing
of the project.
3.This stage demands a high degree of monitoring by the government agencies, lenders as well
as project companies under the terms of the concession agreement and construction contract.
4.This stage concludes upon the acceptance of the completed infrastructure facility by the
project company after all the relevant testing procedures have been cleared.
OPERATION AND MAINTENANCE STAGE
1.Commences once the facility has been established.
2.This is the phase where all the financial projections of the project with respect to the market
are tested and realised.
3.Apart from operation and maintenance of the project, other crucial activities involve levying
and collection of tariffs from the consumers/users of the facility.
4.There is also periodic inspection for the growth of the facility and respective repayment of
debts and other returns to the various financial investors.
TERMINATION AND TRANSFER STAGE
1.Comparatively one of the most difficult stages in the project.
2.The main activity at this stage is the process of handing over the facility by the project
company to the government.
3.The concession agreement usually provides detailed procedures for such transfer.
4.Strength of documentation is important as they should ensure adequate protection of interests
of the parties so that there is sufficient incentive for them to perform their respective obligations
till the end of the project.
THE VARIOUS PARTIES ARE

1.Project Sponsor
2.Project Company
3.Borrowing Entity
4.Commercial Lender
5.International Agencies
6.Bilateral Agencies
7.Rating Agency
8.Supplier
9.Output Purchaser
10.Contractor
11.Operator
12.Financial Advisor
13.Technical Consultants
14.Project Finance Lawyers
15.Local Lawyers
16.Host Government

•The main protagonist in the origination of a project is almost always either a host government
or a private sponsor, and both will, normally, have key roles.
•Governments are key players in encouraging the development of projects to meet the core
needs of their communities within the infrastructure sector particularly in less developed
countries, while private sponsors are more likely to demonstrate their initiative where there is
an opportunity to utilize or exploit resources, as in, for example, the mining sector. There are,
of course, overlaps and exceptions.
4 Stages –
Stage I – Project Origination
Stage II – Financing the Projects
Stage III – Constructing the Project
Stage IV – Operating the Project

STAGE I
PROJECT ORIGINATION

•HOST GOVERNMENT
–The reluctance or inability of host governments to increase their borrowing, together with
emerging political will to involve the private sector (including foreign investors), therefore
underlie very visible efforts to find ways to involve private capital and private initiative in the
promotion of public interest objectives, such as the development of infrastructure.
–Host government will have at least some of the following objectives, to involve the private
sector in project development.
1.Minimizing Costs
2.Risk Transfer
3.Demanding a safe, efficiently run project
4.Attracting new capital
5.Technology development and training
6.Competitive advantage
Minimizing Costs –
a. Private participation in the development of infrastructure and other projects can lower overall
costs.
b. For example, effectively structured and transparent bidding procedures in respect of projects
being proposed by host governments are designed to heighten competition among private
sector sponsors and suppliers, thereby encouraging efficiency with a view to lowering overall
costs.
Risk Transfer
a. Host governments will generally, seek to transfer the risk of infrastructure development from
the public sector to the private sector. 
(1) no liability for the project;
(2) retaining control
over the project; and
(3) limiting the government’s undertakings and retaining flexibility.
b. It will seek to insulate itself from responsibility for the design, construction, development,
testing, and commissioning of any project.
fundamentally, it will not wish to be liable to any third parties for cost overruns or accidents in
relation thereto.
Demanding a safe, efficiently run project
a.A host government will demand that the project be completed to the government’s
specifications as quickly as possible and seek adequate safeguards and assurances that the
project will be operated in accordance with good industry practice and in line with the public’s
interests.
b. Terms relating to, for example, health and safety, the environment, and employment may be
set out explicitly in contractual arrangements between a host government and private sponsors,
but it is more likely that existing laws, rules, and regulations will govern these matters.

Attracting new capital

a. major goal of all governments to attract new capital investment to their territories from
beyond their borders.
b. Followed by creation of new jobs and infrastructure related directly to the relevant project,
knock-on benefits are likely to be achieved with potential industrial development in related
sectors.
c.For instance, the off-take product of a mining project may be processed at a related project
site in the vicinity of the mine. Moreover, it is to be hoped that any project will result in a
trickle-down effect involving increased spending in, for example, the shops and bars of local
communities.
Technology development and training
a. Host governments will expect the development of major projects in a variety of sectors to
promote innovation, introduction of technology and the creation of a skilled, well-trained body
of professionals and personnel.
b. To advance these objectives, the government may require minimum levels of domestic
procurement and employment as conditions of tenders, licences, and/or permits.
Competitive advantage
Will help to generate a more reliable, efficient, and cost-effective industrial sector. Such
developments may enhance a country’s overall competitive position and
promote economic growth and social development.

Starting A Bidding Process

Where a host government wishes to procure the development of a project by a private sponsor,
it is likely to publish a request for proposals soliciting bids on particular terms.
Ideally, those terms will be sufficiently detailed and fixed to:
(1) ease comparison of bids; and
(2) to encourage competition and thereby push down prices,
force bidders to compete with transparent pricing structures.
Once a preferred bidder has been selected, there may be further bilateral negotiations between
the host government and the private sponsors to refine the relevant terms.
ADVISORS AND CONSULTANTS
–Before the terms to be set out in a request for proposals are determined (or a project is
otherwise developed), a substantial amount of research and development work is always
required.
–Major international projects are typically researched and developed as concepts long before
their financing is arranged or construction begins.
–Consultants, who should bring independent and specialist expertise to a project, may be
required to:
(1) establish where a resource, such as a mineral deposit, exists and whether it exists in
quantities to justify its exploitation;
(2) consider the viability of exploiting a resource or developing a product or service
from a cost and other logistics perspective;
(3) develop ideas to facilitate the exploitation of a resource or the development of a
product or service;
(4) measure the demand for a particular resource, product, or service;
(5) evaluate the potential to finance the relevant project and, where relevant, help to
structure such financing;
(6) advise on the best practice in respect of project insurance and assist arrangement
thereof; and
(7) provide legal advice in relation to legal aspects of each of the matters described
above and the project in general.
APPROACHING LEGAL ISSUES IN A PROJECT FINANCE TRANSACTION

1.Project finance transactions entail lenders extending a large amount of credit to a newly
formed, thinly capitalized company whose principal assets at the time of closing are not
physical but rather merely contracts, licenses, and ambitious plans. Hence the focus on prudent
legal analysis.
2.Unless a project financing reaches financial close, there are no ‘winners. However, even after
the finance documents are signed, the complex relationships among the parties must be
sustained through economic, political, and legal change.
3.No matter how comprehensive the legal documentation, virtually every project encounters
some form of technical or commercial problem over its life that leads to legal difficulties.
4.Sometimes that difficulty arises because two parties have a legitimate disagreement over the
meaning or effect of a few of the words contained within the mountain of documents governing
their relationships. In other cases, issues that had not been contemplated at the time of financial
close arise with a consequent absence of guidance in the documents as to how to resolve them.
1.Ever-shifting market standards, and the absence of agreed-form project documentation,
contribute to the extremely varied nature of project finance transactions.
2.Project finance lawyers must patiently consider the technical, political, and legal risks of each
individual project in order to enable parties to reach agreement on how contentious issues
should be treated.
3.This process requires familiarity with varied disciplines of law, ranging from civil procedure,
contracts, property, trusts, torts, equity, and conflicts of laws, and with a range of financial
instruments, such as commercial bank loans, capital markets instruments, multilateral, and
domestic government-funded loans, guarantees from export credit agencies, and Islamic
Sharia-compliant instruments.
1.There are a range of threshold legal issues and tasks, common to virtually all projects, which
must be addressed if the project finance lawyer is to accomplish his or her role effectively.
2.Among these are:
– (1) identifying the overall legal risks associated with a project;
– (2) assessing the laws and regulations of the host states and of the courts and other institutions
that implement them;
– (3) addressing environmental and social considerations;
– (4) choosing the governing law for the finance and project documents;
– (5) drafting and negotiating complex credit agreements; and
– (6) developing security packages across a range of jurisdictions.
OVERALL RISK ASSESSMENT:
1.Projects inevitably face risk. The ultimate assessment in any project is whether the risk profile
of the deal, taken as a whole, is ‘bankable’. It is a judgment formed by lenders, sponsors, and
their advisers every time a deal closes.
2.An essential aspect of the project finance lawyer’s role in helping the parties reach a
‘bankability’ assessment involves reviewing the project, and in particular its underlying
documentation, in order to identify its potential and fundamental risks and to determine if, and
how appropriately, those risks have been allocated among the parties.
3.In carrying out this diligence effort, a project finance lawyer must liaise with a myriad of
advisers. The project finance lawyer will work closely with local lawyers in a broad range of
relevant jurisdictions and is often responsible for producing a comprehensive due diligence
report that pulls together the key risk assessment and evaluations of each adviser and highlights
the potential issues from a documentation perspective.
ASSESSING THE HOST COUNTRY
Among the legal issues arising under the domestic law of the host state that need to be assessed
are:
(1) corporate governance;(2) industrial regulation;(3) environmental, land use, and other
permitting; (4) taxation;(5) customs and immigration law;(6) reliability of local laws and
courts/changes in law.

Corporate governance
If a project company is organized under local law, which is frequently a requirement of host
governments, investors and lenders will need to assess the governance flexibility afforded to
them by that law. Of key relevance to investors is to ensure that the ability of the company to
distribute profits to shareholders is not unduly constrained by corporate law and local
accounting practices. Among the other issues to be considered are whether shareholders benefit
from limitations on their individual liability for the obligations of the project company, whether
the rights of minority shareholders will be respected, and whether agreed voting, share transfer
restrictions, or pre-emption rights, and the like, set out in an agreement among the shareholders
will be given effect under local law. It will also be important to the investors that their appointed
directors retain the right to direct the company and its management on key issues. This is of
particular concern where international investors are in joint venture with local investors or an
entity affiliated with the host government. 


Industrial regulation
For most projects, the analysis of the regulatory environment encompasses two inquiries: (i)
what rights are granted to, and what obligations are imposed on, the project company; and (ii)
what risk is there that the regulatory regime will change over time to the detriment of the project
company or its investors and lenders. Where the regulatory regime is established as a matter of
statutory law, project finance lawyers must review the relevant legislation and regulations
carefully, in close consultation with local lawyers. Where those laws are comprehensive and
clear, certainty as to the scope of the regulatory regime can be achieved, but there will remain
the risk that the regime may evolve over time; it is an accepted prerogative of sovereign states
to change their domestic laws.
In circumstances where there is an absence of regulation of general application, or where there
is significant uncertainty as to the stability of the regulatory regime, it may be appropriate for
the host state to enter into direct undertakings with the project company and, in some cases, its
principal investors, to set out specific investor protections. The scope of these will vary
significantly depending on the extent of investor and lender concern as to the reliability of the
host state’s investment regime.

Permitting
The construction and operation of a project generally requires the project company to secure a
broad range of permits and consents. The subject matter of these range from environmental and
social considerations, to land use, to health and safety. The analysis of the risk arising from the
need to secure permits turns, in the first instance, on identifying the consents that will be
required and ensuring that they have been issued or will be issued in the ordinary course without
undue expense, delay, or conditionality. The risk of permit revocation is also important, as well
as a determination as to whether a secured lender, or its transferee, would be entitled to the
benefit of the permits. In many instances, the granting authority will wish to retain discretion
to assess the identity and competence of the transferee.

Taxation
Virtually all projects are subject to some form of taxation, and the tax regime will generally
have a significant impact on the project’s economics. Most sponsors assess their return on
investment on an after-tax basis, and thus consider clarity and certainty of the tax regime to be
a key consideration.

Customs and immigration law

Whenever goods or individuals cross a border, they become subject to the laws of both the
country they are leaving and the country they are entering. For projects, the concern is generally
focused on the ability of the project to import into the host state key goods and equipment and
to employ qualified expatriate managers, engineers, and labour.

Reliability of local law and courts

Countries with well-developed laws and an established and independent judiciary are often
more attractive jurisdictions for investment than countries with little clarity as to their laws or
certainty as to their application.
Legal certainty will be of concern to all parties, but lenders will focus particular concern on
whether local law recognizes the rights of secured creditors and whether their claims will be
respected were the project company to become insolvent. Not all countries have express
insolvency regimes, and the ones that do vary significantly as to the rights and preferences that
they afford to secured lenders.

ENVIRONMENTAL AND SOCIAL CONSIDERATIONS

1.The construction and operation of a project invariably have environmental and social impacts
on the locality of the project. Managing these impacts may help assure the long-term
acceptance of the project by affected parties.
2.Lenders will generally require, at a minimum, to comply with all environmental and social
laws and regulations binding on it. They will also likely require the development of, and
compliance with, an agreed environmental and social risk management plan.
3.This is both to insulate the project company, and the lenders, from legal risk, but also to
preserve the lenders’ reputation as responsible parties. Even in the absence of environmental
legislation in a particular jurisdiction, national or multinational credit institutions financing a
project may require compliance with World Bank or similar standards.

GOVERNING LAW CONSIDERATIONS

–Contracts are often quite clear in describing the terms of a transaction, but the manner in
which contracts will be interpreted or enforced may differ significantly from those terms.
–The relevant considerations involve an analysis of:
(i)the choice of law to govern the contracts;
(ii)(ii) the enforceability of contracts under that law; and
(iii)(iii) the choice of forum for disputes arising from the transaction, including whether
judgments or awards from that forum will be enforced in each relevant jurisdiction.
Choice of law
The knowledge that the transaction is governed by the law of a familiar jurisdiction can be a
source of significant comfort to investors and lenders. Choice of law questions inevitably arise
in the context of negotiating finance documents and frequently involve an election between
English law and New York law.

Enforceability
Not all contracts are enforceable in accordance with their terms. There may be mandatory
provisions of law that override the terms of the contract. Many countries have civil or similar
codes whose provisions will apply to a contract not- withstanding its terms. Legal uncertainty
may be pronounced when the country in which the project is located has no tradition of reported
case law (making it more difficult to establish how the rules are applied by the domestic courts
in practice) or where domestic law prohibits fundamental aspects of the transaction (for
instance, Sharia’a principles preventing the enforcement of interest payments).

Forum
The selection of a forum for any disputes heard in connection with the project has important
implications such as: (1) Will the forum be neutral in its decision-making? (2) What law will
the chosen forum apply, and will the outcome differ as a result? (3) Which evidential or
procedural rules will apply in the forum? (4) Will judgments or awards be enforced in the home
jurisdiction of the borrower or the other project parties?
One important factor, when considering the choice of forum, is whether the dispute should be
litigated or arbitrated. There are advantages to using the courts, particularly in jurisdictions
such as England and New York, where long histories of case law precedent, established
procedural laws, and unbiased judicial oversight provide comfort for sponsors and lenders that
their claims will be duly upheld. In many jurisdictions, courts can compel parties to disclose
facts or documents and may be able to order interim relief, such as an injunction.
Further, as arbitration is a product of contract, only parties that have consented to arbitration
through the contract can be compelled to proceed in that forum. Litigation may thus be
necessary in a multi-party dispute in order to join an interested party that is not a party to the
original contract. On the other hand, the speed and privacy of an arbitral process is a benefit,
and a specially designated arbitrator may be better equipped to address complex technical
issues than a more generalist judge. The parties may view an arbitral forum in a neutral foreign
venue as providing certainty of an efficient and reasonable result. Moreover, an arbitral award
may, in some cases, be more likely to be recognized and enforced in the relevant party’s home
jurisdiction without review on the merits than a foreign court judgment.

STAGE II
FINANCING THE PROJECT

EQUITY FINANCING
–Even where debt is secured on the terms of a project financing, the debt lenders usually require
that a substantial proportion of the overall project cost, usually in the region of 20 per cent or
more, is funded by way of equity investment.
–Equity may be contributed by way of share capital investment in the project company or, more
frequently, it is provided via shareholder loans to the project company.
DEBT FINANCING
–A variety of commercial banks, export credit agencies, insurance companies, pension funds,
and other finance entities may participate in a project financing through public or private debt
placements.
–The identity of the lenders to a particular project will depend on a variety of factors
extent of any existing commercial relations between a particular sponsor and bank,
o the political and/or economic/social developmental importance of the relevant project,
its location, and its commercial risks.
–In a project financing, different types of lenders may have different objectives or, at least,
different priorities.
ALTERNATIVE FINANCING
•additional debt financing for a project may be obtained in the bond market.
•The motivations of bondholders are likely to be, effectively, indistinguishable from
commercial banks and financings involving them will be structured as such.
•The Islamic finance market is also becoming increasingly popular as a source of project
finance - typically, used
as a substitute for debt financing.
STAGE III
CONSTRUCTING THE PROJECT

CONSTRUCTION CONTRACTOR
–designs and builds the project, often on the basis of a ‘turnkey’ fixed-price contract.
–The construction contract is generally awarded on the basis of a competitive tendering
process, where pricing is likely to be the key consideration.
–The objective of the contractor will be to complete the construction of the project at a cost
that allows it to preserve its anticipated profit margin.
–The contractor is usually liable for delay damages for late completion and may earn an early
completion bonus to the extent that the project is completed ahead of schedule. Contractors are
also called upon to pay damages if the project does not pass certain performance tests.
–The construction contractor generally enters into subcontracts for equipment procurement,
civil works, and design and engineering services pursuant to which it seeks to pass on many of
the risks it is asked to assume under the construction contract entered into with the project
company.
# Infrastructure needs of a project are likely to include the following:
I. Access needs - accessing the site for construction and operation of the project
II.Power and water needs
III.Housing and other social development requirements
ONGOING ROLES
–Various advisers and consultants assisting both the project company and its lenders will be
involved with monitoring the progress of construction in the context of compliance with the
transaction documentation.
–Expenditure, equity investment, technical specifications, environmental standards, insurance
matters, and legal compliance are all likely to be under high levels of supervision through the
construction phase.

STAGE IV
OPERATING THE PROJECT

There is likely to be a timing overlap between the completion of construction and the
commencement of the operational phase of any project.
OPERATOR
–Manufacturing and other facilities are complex. Their operation and maintenance often
require significant skills that a single purpose project company may not have within its own
workforce or intellectual property resources.
–In such circumstances, an independent contractor is often charged with operating and
maintaining the project for an extended term.
–In some cases, separate arrangements, often with an affiliated entity (where a sponsor has
industry expertise within its group of companies), will be made to manage ordinary day-to-day
operations.
–To supplement this, major equipment maintenance may be contracted out to an experienced
equipment vendor under the terms of a technical support agreement.
OPERATION AND MAINTENANCE GUARANTOR
–Operator is often, either the project company or an affiliate of the project company on the
basis that there is relevant expertise.
–Neither the project company when acting as the operator of a project nor a separate operating
company is likely to be an entity of substance.
–Lenders will therefore seek additional comfort from an entity of substance, often the senior
company within the group or another group company with an acceptable long-term credit
rating, in the form of a guarantee of the operator’s obligations under the operation and
maintenance agreement.
SUPPLIERS
–critical in providing an assured source of feedstock, fuel, and other raw materials to the
project.
–These inputs are crucial to the ability of the project to produce its product and generate
revenues with which to repay the project’s debt financing.
–To provide assurance of supply, the project company may enter into long-term supply and
transportation arrangements (mutually beneficial as the supplier thereby also secures an assured
market for its resource).
–A supplier may be asked to provide warranties of supply and price over a long period, which
could expose it to substantial risks.
ONGOING ROLES
– As in the construction of a project, various advisers and consultants assisting both the project
company and its lenders will be involved with monitoring the ongoing performance of the
operational project regarding compliance with the documentation.
–Financial covenants, technical specifications, environmental standards, insurance matters, and
legal compliance are all likely to be under high levels of supervision throughout the operations
phase, although per-haps less than during the construction phase as the inputs and outputs of
any mature project should be relatively stable.

OVERVIEW OF PROJECT DOCUMENTATION

Contracts are king in project finance.

•This is because non-recourse and limited recourse project finance are based on the
predictability provided by the contract structure, project sponsors are interested in the risk
allocation and other contract terms.
•The types of documents that may be necessary in a non-recourse or limited recourse project
financing
1.Organizational documents
2.Agreements with the government of the host country
3.Real property agreements
4.Construction documents
5.Technology documents
6.Operation and maintenance documents
7.Fuel supply documents
8.Utility documents
9.Off take revenue agreements
10.Transportation documents
11.Financing documents
JOHN DEWAR – International Project Finance: Law and Practice
A significant number of commercial contracts may be required to facilitate a project. These can
broadly be classified into:
(1) the principal project agreements, such as the concession agreement, the con- struction
contract, the operation and maintenance contract, and the project off-take contract;
(2) the secondary project agreements, such as power and water connection agreements with
the local utility, shared facilities agreements (perhaps with other projects or ventures affiliated
with the sponsors), and subsidiary feed- stock agreements with local suppliers; and
(3) project subcontracts (such as a long-term turbine maintenance contract, which a turbine
supplier may enter into with the project’s operation and maintenance contractor).
•Across the globe there is a respect towards the idea that private parties have a right to bind
themselves in a written contract.
Some typical “key aspects” in these documents are as follows –
1.Governing law – some jurisdiction prevents application of certain laws on public policy or
nationalistic grounds.
2.Forum – clear intention of the parties and considerations to address.
3.Contract Formation – requirements vary from country to country; therefore, local
requirements should be paid attention to.
4.Formalities – fulfilment of procedural and substantive safeguards and other formalities
related to contracts.
1.Enforceability of Risk Allocation and Remedies
•At the outset, the aim of risk allocation is to meet market standards of finance ability, or
‘bankability’. The agree-
ments embodying the risk allocation should be assessed as a whole, with a view to:
(a)providing that significant risks are allocated to those parties that are best able and most
motivated to assume them; and
(b)(b) reducing the residual risks in the project to a level that the sponsors and lenders can
prudently manage
2. Currency Issues.
3. Government Action
4. Term of the contract – largely consideration is towards local laws.
5. Language of the contract – written as well as interpretation – important to select one
language for certainty, clarity and uniformity. Translations can be challenging in diluting the
essence of the contractual terms.
•If the project documents are unacceptable for use in project financing, requiring amendments
before lending any funds to the project company is common for the lenders.
•Thus, besides negotiation of the documents that protect the interests of the project sponsors,
they must also negotiate the documents in a way that shall satisfy the requirements of the
lending community.
•However, in most cases the lenders are not selected before contract finalisation – one approach
to this dilemma is “financial cooperation clause” in project contracts.

PRINCIPAL LOAN FINANCE DOCUMENTATION

•Project financings are document-heavy transactions due to the elaborate risk allocation and
mitigation measures they engender.
•A complex financing generates copious amounts of documentation addressing the project’s
construction and operation, the financing that supports it, and the security that in turn underpins
the financing.

THE CREDIT AGREEMENT

•Principal legal document - records the express terms agreed by the borrower and lender to
govern their contractual relationship.
•Lender will lend/agree to lend a sum of money to the borrower in return for the borrower’s
promise to repay that sum either on demand or at the agreed time, usually with interest.
•This foundation will be supplemented by protective and administrative provisions, such as
representations and warranties, covenants, events of default, agency mechanics, and dispute
resolution clauses, among others.
•Market practice and the desire on the part of arrangers and originating lenders to syndicate or
sell down all or part of the loan will often dictate the form, if not the substance, of the credit
agreement.
§In a multi-sourced financing where a number of lenders are advancing different tranches of
debt, it has become customary for the provisions that are common to the various debt tranches
to be set out in a ‘common terms agreement’.
§This allows the commercial and operational features unique to each debt tranche to be set out
in a more streamlined agreement, which incorporates the common terms by reference.
§This approach saves time and cost in avoiding multiple bilateral negotiations over
substantially similar provisions, ensures lender parity, at least to the extent of the common
terms.
Purpose clause
–set out the purpose for which loans advanced under the agreement are to be applied.
–Lenders will want to ensure that the borrower does not divert the borrowings away from the
project and to demonstrate compliance with their lending eligibility criteria.
–In most cases, actual misuse will trigger an event of default.
–Furthermore, the purpose clause evidences the intention of the parties in advancing the money,
which helps protect the lender on the borrower’s insolvency if the money has either not yet
been applied or has been misapplied.
Conditions precedent
–Commitment to lend the agreed sums of money to the borrower, subject to the conditions
specified in the agreement itself.
–usually be two sets of conditions precedent:
those which are common to all debt tranches and are therefore set out in the common term’s
agreement; and
o those which are specific to a particular debt tranche and are therefore set out in the individual
loan agreement applicable to that tranche.
Drawdown of loans
oIf the conditions precedent has been met; the project company will be entitled to request loans
to be advanced to it by delivering written requests in accordance with the procedures set out in
the credit agreement.
o Lenders always require a minimum period of notice to raise the funds in the interbank market.
This notice period is negotiated but will largely be driven by the customary practice of the
relevant interbank market.
Repayments
o the repayment profile of a project finance loan will usually reflect the revenue generating
characteristics of the relevant sector;
o Repayments will usually be made to the lenders’ agent for distribution to the lenders, usually
on a pro rata basis.
Prepayments
–Most credit agreements will expressly permit the borrower to repay all or part of the loan
early.
–Prepayment can be either mandatory, upon the occurrence of certain prescribed events (for
example, illegality, change of control, or damage to the plant), or at the borrower’s volition.
o Voluntary prepayment will usually be conditional on the borrower giving the lenders a
minimum amount of notice and prepayment being made at the end of an interest period.
–Some lenders occasionally request a prepayment fee or premium on the basis that they have
incurred costs and agreed margins on the expectation of a return over a longer period.
•There are a number of events, most of them outside of the direct control of the borrower, which
will, upon their occurrence, trigger an obligation enjoining the borrower to mandatorily prepay
the outstanding loans. Such as -
1.Illegality
2.Change of control
3.Deterioration of the borrower’s credit rating
4.Failure to meet prescribed financial ratios
•There are a number of events, most of them outside of the direct control of the borrower, which
will, upon their occurrence, trigger an obligation enjoining the borrower to mandatorily prepay
the outstanding loans. Such as -
1.Illegality
2.Change of control
3.Deterioration of the borrower’s credit rating
4.Failure to meet prescribed financial ratios

Interest
–Most credit agreements will charge interest on the loans advanced to the borrower, either on
a floating or a fixed rate basis.
–Floating rate lending is based on the notion that lenders fund their loan participations through
short-term deposits in the interbank market for each interest period at an interbank rate
–A failure to pay interest when due will trigger a payment default but also cause a higher,
default rate to apply
Representations and warranties
–A lot of time is spent negotiating representations and warranties, which in project financings,
are extensive and are repeated often.
–The set of representations and warranties will typically be based on market standard forms
such as the LMA leveraged form, with additional representations added to reflect the policy
requirements of certain lenders.
–Borrowers will seek to restrict the scope of representations and warranties, particularly by
using materiality or knowledge qualifications in respect of commercial warranties.
Events of Default
ACCOUNTS AGREEMENT

•Since a true project financing is non-recourse to the sponsor’s balance sheet, with cash flows
from the project’s assets and operations being the only source of debt service and repayment.
•the project accounts and the cash flow will be jealously guarded by the creditors via elaborate,
and occasionally onerous, restrictions regulating the flow of cash and its allocation.
•The lenders will insist on having access to virtually all available cash flow in the forward years
of the project and will use the
•The creditors will exert control through a ‘waterfall’ of accounts.
•Funds initially go into
1.The receipt or revenue account at the top and
2. then cascade through the operating account,
3.The debt service account (for the payment of principal and interest) and various reserve
accounts (generally including a debt service reserve account (DSRA), into which a reserve for
future debt service payments, often calculated on the basis of six months’ debt service, will be
set aside).
4. at the bottom of the waterfall is an account from which dividend distributions will be
permitted to be paid to the shareholders of the project company.
The cascade defines the priority of uses for the project’s cash flow, which will take on
significance when actual revenue falls below operating cost requirements
•The project company is typically permitted to
–withdraw funds from the operating account solely to cover approved operating expenses,
–from the reserve accounts to fund specified costs, and
– from the project company’s distributions account to fund distributions to its shareholders, so
long as the conditions for withdrawal set out in the credit agreement have been satisfied.
The lenders will generally have security over the accounts and the balances contained
within them, and they will often seek the right to assert broader control over the use of
the funds held in the accounts upon the occurrence of a default or other adverse
conditions.
•The waterfall and other accounts operating mechanics + provisions governing the relationship
between the account bank, the other finance parties, and the project company, will be detailed
in the common term’s agreement or in a stand- alone accounts agreement.
•The latter is likely to be more appropriate where the account bank is not also lending to the
project and prefers not to be a party to the common term’s agreement or where a different
governing law applies to the accounts.
•The account agreement will also be useful in disapplying certain rights that the account bank
enjoys, either under the normal banker-customer relationship, or pursuant to its normal bank
mandates.
The key provisions in the account’s agreement will address the following:
–Acknowledgment of security:
The accounts agreement will generally be used as the means by which the project
company gives notice of the security created over the project accounts
–No other accounts:
The project company is usually prevented from establishing any other accounts beyond
those prescribed in the account’s agreement without the prior written consent of the
lenders.
–Instructing party:
The borrower usually retain full access to the project accounts prior to the occurrence
of an event of default and the account bank will usually be entitled, without further
verification, to allow the project company to operate the project accounts in accordance
with the provisions of the accounts agreement until such time as it is notified by the
finance parties that an account blocking event has occurred.

•Waterfalls:
The principal demarcation as to the application of account balances (and therefore the
applicable ‘waterfall’ structure) will be informed by whether the use occurs during the
construction phase or operations phase; and/or before or during the occurrence of a default.
Each such phase will normally have a specific priority waterfall

Distribution and dividend restrictions:

The accounts provisions usually restrict the project company’s ability to make dividend
payments or distributions of any kind unless the prescribed preconditions have been satisfied,
which include, for example, there are no outstanding defaults;
Access to books and records and confidentiality:
To enable the finance parties to police the accounts, the project company will authorise the
account bank to give access to the books and records held by it on the accounts to the finance
parties and authorise the account bank to waive any general duty of confidentiality that it may
owe to the project company.

INTERCREDITOR AGREEMENTS

•the inter- creditor agreement is a compact among creditors, the raison d’être of which is the
orderly re-prioritization of creditors who would, without more, rank equally at law.
•Thus, at the core of an intercreditor agreement will be found provisions providing for
–the contractual subordination to the senior debt of all other debt tranches and
–the application of the proceeds of the enforcement of the project security so that the claims of
the senior creditors are discharged ahead of the claims of the other finance parties.
•Secured creditors are not affected by the pari passu principle and the assets that constitute the
collateral are not part of the insolvent estate and are therefore not available to the unsecured
creditors or to the liquidator.
•As amongst the secured parties, the general proposition under English law is that they should
be free to allocate the assets contractually as they see fit, as an incident of their proprietary
rights to the security, subject only to the terms of that security.
•The role of the modern intercreditor agreement has grown beyond this primary function to
encompass many other mechanics, largely because it is one of the few documents to which each
present and future project finance party is or will be a party.
•The modern intercreditor agreement will therefore also
①seek to subordinate certain classes of debt,
②outline payment priorities both before and after a project has gone into default,
③oblige creditors to turn over payments received, or recoveries made out of turn,
④regulate the ability to take, and set forth procedures governing the taking of enforcement
action against the borrower or its assets, and
5) The voting rights of the various creditor constituencies.
Drafting and negotiation considerations
•Negotiations around the intercreditor agreement do not directly concern the borrower although
it will often insist on being a party to the intercreditor agreement in order to prevent
amendments to the agreed voting thresholds and to certain defined terms without its consent.
•During the negotiation process,
–the most senior creditors usually generate the first draft of the intercreditor agreement, which
will be reviewed and commented upon by the subordinated creditors.
–The intercreditor agreement is not usually finalized until the full complement of finance
documents has been largely settled.
–Only then can the draftsman really know what to prescribe for.
–However, for complex financings, it is advisable, and indeed increasingly common, to agree
a summary of the key intercede- tor features—the intercreditor principles—as part of the term
sheet negotiations to ensure that the main commercial aspects of the intercreditor relationships
are negotiated.
•Given the inherent conflict of interest with senior creditors, subordinated lenders often retain
separate counsel (or a separate legal team at the firm appointed to act as common lenders’
counsel) to advise them on inter-creditor matters.
• In any event, subordinated creditors should ensure that, as much as is possible, the
intercreditor agreement contains protective provisions which, in a distressed scenario, will both
preserve value and allow the subordinated creditors some influence in a restructuring situation.
•Needless to say, the ability of the subordinated creditors to negotiate a robust inter-creditor
arrangement will depend on their relative negotiating strength.
•As more and more sponsors and lenders in varying and wide-ranging sec- tors have turned to
project finance, structuring has become increasingly complex and intercreditor agreements
have had to adapt to this complexity.
•The project finance practitioner will rarely, however, see the multi-tiered structures prevalent
in the acquisition finance market.
•A typical project finance intercreditor arrangement might involve the following classes of
creditors.
–Senior Creditor
–Subordinated creditors
•Senior creditors
–typically, be the broadest creditor class.
–will usually, but not invariably, be third party debt providers and hedge providers, as well as
the account banks and agents under the project finance documents.
–include all moneys advanced under the original senior facility agreements but also permitted
supplemental, additional, or replacement senior debt.
–Also, the affiliated senior creditor will usually only have the right to vote in respect of
decisions requiring unanimity or which are capable of directly and adversely affecting its rights
in its capacity as a senior creditor
•Subordinated creditors
–Ranking immediately below the senior creditors and above the equity providers is the more
junior class of creditor
–variously called the mezzanine or junior creditor, depending more on the features of their
financing than their rights under the intercreditor agreement.
–In project financing, the subordination of these creditors is only relative to the senior creditors;
they will still rank ahead of the unsecured creditors and equity providers.
–Affiliated subordinated creditors will usually not be entitled to vote on any decision under the
intercreditor agreement.
•The more complex a project’s finance plan, the more complex its intercreditor agreement will
be.
•Intercreditor restrictions
1.generally restrict the right of any particular lender to accelerate its debt, enforce security,
initiate bankruptcy or insolvency proceedings or take other independent action that may
prejudice the project, without the agreement of at least a designated percentage of the senior
creditors.
2.Following an event of default, a particular lender may be restrained from exercising remedies
for a specified period in order to afford other more senior lenders the opportunity to cure the
default or to exercise their own remedies.
3.also contain provisions relating to the sharing of the proceeds derived from the enforcement
of security.
1.The rights of subordinated creditors will generally be further restricted.
a. will usually only be entitled to receive debt service payments on a subordinated basis in
accordance with the project revenue cash waterfall set out in the finance documents.
b. The rights of subordinated lenders to accelerate and take other enforcement action against
the borrower will usually be subject to a ‘standstill period’ during which the senior creditors
are given free rein to decide how to proceed.
I. Commonly seen are durations of sixty to ninety days for payment defaults, ninety to 120 days
for breach of financial covenants
ii.120 to 180 days for all other defaults.
•Subordinated creditor value protections
1.The senior lenders will invariably restrict the subordinated creditors’ ability to take any action
that could interfere with the senior lenders’ ability to take enforcement action.
2.However, the subordinated creditors and equity parties will be particularly interested in
influencing the ability of the senior creditors to initiate enforcement action or alter the template
on the basis of which the financing was closed.
3.The senior creditors will be receptive to such influence only if it improves prospects for new
investment or assures the senior creditors of a better chance of recovery than is otherwise
available through enforcing security.
1.The following provisions in an intercreditor agreement are designed to pre- serve value at the
subordinated levels:
a. Restrictions on amendments to senior documents: The senior lenders will require the
subordinated lenders’ consent to amend or give any waiver or consent under any senior finance.
b. Option to purchase: Subordinated creditors will often be granted an option to purchase the
senior debt in full at par after a senior default.
c. Subordinate exclusive security: Where subordinated creditors have exclusive security, they
would usually expect to have the ability to enforce that security at any time
d. Narrow standstill: Subordinated creditors will typically be subject to a ‘stand- still’
obligation preventing them from taking enforcement action for a fixed period whilst the senior
creditors consider their options. Subordinated credit- tors will focus on keeping the standstill
period as short as possible and may seek exemptions from it if the senior creditors commence
an enforcement action against the project company.
•Voting rights and structures
1.Often the most complexity in a project finance intercreditor agreement is found within the
voting framework.
2.It is advisable to adopt a formulaic structure based on the type of decision required to be
made and the voting threshold needed to pass the relevant decision.
3.There are a number of voting structures, which creditors may adopt.
4.To determine the appropriate voting arrangement for a particular project,
a.one needs to assess the size of each debt tranche as this obviously has a direct effect on the
proportionate voting strength of each lender group.
b. Other considerations which need to be taken into account include whether there are
differences in the maturity of the various tranches of debt, whether the financing incorporates
debt with both fixed and floating interest rates, and involves risk policy providers who are
likely to seek to control the votes of the lenders benefiting from their risk cover.
•Common voting structures include: 

(1) One dollar, one vote:
each lender’s voting power will be directly proportionate to its monetary exposure and votes
will be determined by the percentage of all commitments or outstanding’s. This approach is
popular for its user- friendliness and fairness. 

(2) Block voting:
a) lenders within a particular debt tranche are assigned a vote equal to the amount of the debt
in the tranche as a group but, within each tranche of debt will vote on the basis of their
individual exposure.
b) Under this structure, passing a measure requires the vote of a majority of the lenders in each
of the various debt tranches, thus requiring a high degree of consensus among the lending group
as agreement will be necessary both within each tranche and also across all tranches. This
system may delay decision making.
Golden vote:
a) A variant to the exposure vote system is to require the consent of particular lenders within
the group over and above the absolute voting thresh- olds.
b) Thus, a minority group could exercise a disproportionately greater decision-making power
than would otherwise be possible under other structures.
c)Moreover, determining which lenders should hold a golden vote and when the golden vote
should apply is often challenging.
d)Each lending group and each lender will tend to view itself as deserving of special
recognition, given their particular market or political position and many will likely resist
conceding the special treatment afforded to a co-lender/lending group.
e) The golden vote is also commonly employed by governments in particular strategic
industries.
• (4) Consultation:
a) Occasionally, the borrower will push for inclusion of a consultation period before a vote can
be taken, particularly with respect to taking enforcement action.
The usefulness of this device is doubtful as most reputable lenders will, in any event, only take
enforcement action as a last resort and consultation will occur as a natural part of the
deliberations leading to such action