Due Diligence Regarding Guarantees from NRIs by Resident Indians

The Reserve Bank of India (RBI) has issued a new circular emphasizing the prohibition of unauthorized guarantees from non-residents in favour of Indian residents. The circular, directed to Authorized Dealer (AD) Category-I banks, reinforces compliance with the Foreign Exchange Management Act, 1999 (FEMA) and specifically addresses instances of Standby Letters of Credit (SBLCs) and performance guarantees issued by non-residents on behalf of Indian resident.

Key Points of the New RBI Directive

1. AD Category-I Banks’ Compliance Responsibility: The RBI has tasked AD Category-I banks authorized to deal in foreign exchange with verifying that all guarantee contracts involving Indian residents comply with FEMA guidelines. These banks are also required to inform their clients about these restrictions, ensuring they are aware of FEMA’s broad prohibition on obtaining guarantees from non-residents without explicit RBI approval.
2. Legal Basis and Broader Scope of Regulation: The RBI’s authority to enforce this prohibition comes under Sections 6(3)(j), 10(4), and 11(1) of FEMA, 1999. The Guarantee Regulations within FEMA state that, unless specifically allowed, no person in India may provide or obtain a guarantee for transactions with non-residents. Under these rules, even corporate entities registered in India cannot avail of credit enhancements like guarantees from international financial institutions or joint venture partners without prior RBI approval. This reflects FEMA’s stringent approach to regulating capital account transactions and preventing unauthorized cross-border financial arrangements.
3. Clarification on Capital Account Transactions: The RBI has reiterated that guarantees fall under “capital account transactions,” which are tightly controlled and only permitted with specific RBI approval.

By enforcing these guidelines, the RBI seeks to maintain regulatory oversight over foreign exchange transactions and protect the integrity of India’s financial system.