Expert speak: Offshore Guarantees for Loans to Resident Indians: Navigating Legal and Regulatory Challenges
Introduction
Offshore guarantees have become increasingly relevant within India’s financial ecosystem, not just as credit enhancement tools for corporate borrowers, but also as enabling instruments to direct funding toward underserved sectors. The most widely adopted route is the ‘structure obligation route’ set out in Paragraph 19 of the Reserve Bank of India Master Direction on External Commercial Borrowings, Trade Credits and Structured Obligations 2018 (“ECB Master Direction“, as amended from time to time).
The ‘structured obligation route’ permits eligible non-resident entities to guarantee domestic, rupee-denominated credit facilities, availed by Indian borrowers from Indian lenders, subject to conditions specified in the ECB Master Direction. In recent years, this route has also been considered by philanthropic and developmental institutions to provide guarantees in favour of lenders that target financially excluded segments, such as MSMEs, clean energy borrowers, or women entrepreneurs.
However, while this route has gained popularity among institutions seeking to expand credit access, it has also generated certain regulatory friction. The interaction between the ECB Master Directions and the more restrictive FEMA (Guarantees) Regulations, 2000 (“Guarantees Regulations“, as amended from time to time) has given rise to interpretational uncertainties. Recent informal guidance issued by the Reserve Bank of India (“RBI“) to certain banks has further blurred the permissibility of these structures.
This article examines the regulatory framework and the concerns arising in relation thereto.
Legal Framework
Under the Foreign Exchange Management Act, 1999 (“FEMA“), guarantees are capital account transactions and are therefore subject to regulation. The Guarantee Regulations prohibits Indian residents from availing guarantees from non-residents for domestic rupee loans, unless specifically permitted. In contrast, Paragraph 19 of the ECB Master Directions offers an express carve-out. It permits eligible non-resident entities to issue guarantees in favour of domestic, rupee-denominated credit facilities (both fund-based and non-fund-based) extended by Indian lenders to Indian borrowers. This is subject to, inter alia, the following key conditions:
- if invoked, the non-resident guarantor must discharge its liability through permissible channels such as inward remittance or balances in NRE/FCNR(B) accounts; and
- general permission is available to the Indian borrower to reimburse the guarantor using permissible FEMA-compliant routes, post invocation.
Structuring Practice and Market Adoption
The structure obligation route is frequently used by multi-national companies to guarantee loans of their Indian affiliates. These guarantees often help Indian entities access better pricing, longer tenors, or relaxed collateral requirements.
A more innovative application of Paragraph 19 has emerged in the development finance and philanthropic space. Non-profit institutions, donor-funded platforms, and DFIs have increasingly provided portfolio guarantees, structured as first-loss or capped-risk arrangements, in favour of Indian financial institutions that extend loans to priority sectors. These guarantees are intended to de-risk lending to segments that may otherwise fall outside standard underwriting practices. For instance, a non-resident guarantor may commit to cover up to 15% of losses on a ₹100 crore loan portfolio targeting low-income or underserved borrowers.
Legal Position and Risk Perception Among Stakeholders
Despite the clear regulatory carve-out under Paragraph 19, a degree of inconsistency has emerged in how these guarantees are treated by different banks and regulators. Most stakeholders and banks take the view that Paragraph 19 is a valid exception to the Guarantee Regulations, provided that such guarantees are compliant with the ECB Master Direction, involve no capital account transaction at inception, and conform to FEMA requirements upon invocation. However, recent regulatory communications from the RBI have cast certain doubts among stakeholders on the permissibility of these structures, particularly under Paragraph 19 of the ECB Master Direction.
Additionally, a concern is raised by some stakeholders that if such guarantees are issued by non-residents at a ‘portfolio-level’, then it may resemble ‘synthetic securitisation’. Under the RBI Securitisation of Standard Assets Directions, 2021 (“Securitisation Directions“), synthetic securitisation is defined as the transfer of credit risk through guarantees or derivatives without the transfer of the underlying assets. Such securitisation is prohibited for regulated entities with the aim to prevent off-balance-sheet risk creation and regulatory arbitrage.
At first glance, a capped portfolio guarantee could appear to mimic such a structure as it involves credit risk mitigation without an actual transfer of loans. However, these important distinctions may be considered:
- these guarantees do not involve tranching or capital market distribution;
- the loans remain on the balance sheet of the originator, there is no capital relief; and
- no synthetic instruments or swaps are used — the structure is a straightforward guarantee.
Further support for this distinction comes from RBI’s Guidelines on Default Loss Guarantees (DLG) in digital lending, issued in 2023. These guidelines clarify that guarantees up to 5% of a loan book will not be treated as synthetic securitisation. While the DLG Guidelines apply specifically to digital lending arrangements, the underlying logic can be imported to the non-resident portfolio guarantees.
Moreover, the Securitisation Directions themselves include an important carve-out: they exclude use of instruments permitted to lenders for hedging under the current regulatory instructions. Paragraph 19 clearly constitutes such a regulatory instruction. Therefore, when a portfolio guarantee is structured within its bounds, it should ideally not be considered in violation of securitisation restrictions.
Recent Regulatory Signals and Market Response
In late 2023, certain AD banks reportedly received informal guidance from the RBI expressing concern over certain offshore guarantees. In some cases, banks were advised to seek compounding for past transactions. The messaging has been indirect with no formal circular or notification being issued withdrawing or amending Paragraph 19. The impact of the said informal communication has created a paradox: on one hand, the ECB Master Directions clearly permit offshore guarantees in domestic credit transactions; on the other, informal interpretations seem to revert to a blanket reading of the Guarantee Regulations without taking into account the specific exemption under Paragraph 19. This lack of harmonisation between RBI’s own instruments has created a risk-averse environment amongst the stakeholders engaged in this space.
Conclusion
Offshore guarantees, particularly those structured under Paragraph 19 of the ECB Master Directions, offer immense potential to support India’s financial and developmental objectives. Yet, the current regulatory ambiguity, is undermining this potential. Paragraph 19 offers a carefully designed route for cross-border risk sharing without compromising FEMA’s core objectives. Its continued viability depends on clear, consistent, and harmonised interpretation. A formal clarification from the RBI would go a long way in restoring confidence, encouraging responsible innovation, and ensuring that developmental capital continues to find its way to those who need it most.
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