Foreign exchange compliance on NRNR deposits: using them as effective loan security without RBI permission was treated as contravention, with penalty reduced.

Treating non-resident account deposits as the effective security for loans to a resident borrower, without creating independent primary security and without RBI permission, was found to breach the foreign exchange framework and RBI directions because it indirectly conferred foreign exchange consideration on the non-resident depositors. The bank's argument that the deposits were only collateral was rejected on the facts. The penalty was examined on its circumstances and then reduced to Rs. 15 lakhs, but the finding of contravention was sustained and the appeal failed on merits.

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Issues: (i) Whether the appellant bank violated the foreign exchange law and RBI directions by treating NRNR deposits as primary security for loans granted to a resident borrower. (ii) Whether the penalty imposed on the bank required interference.

Issue (i): Whether the appellant bank violated the foreign exchange law and RBI directions by treating NRNR deposits as primary security for loans granted to a resident borrower.

Analysis: The deposits in the non-resident account were not treated as mere collateral. The loans were granted against those deposits without creation of any independent primary security out of the loan proceeds. On the facts, this created an indirect foreign exchange consideration in favour of the non-resident depositors without RBI permission and was inconsistent with the conditions attached to such lending under the governing foreign exchange regime.

Conclusion: The bank was held to have contravened the applicable foreign exchange provisions and RBI directions.

Issue (ii): Whether the penalty imposed on the bank required interference.

Analysis: The bank's defence that the deposits were only collateral security was rejected because the transaction was found to be contrary to the required regulatory framework. However, the appellate authority considered the quantum of penalty on the facts and circumstances of the case and exercised limited interference.

Conclusion: The penalty was reduced to Rs. 15 lakhs.

Final Conclusion: The appeal failed on merits, and the finding of contravention was sustained, but the monetary penalty was moderated.

Ratio Decidendi: Deposits in a non-resident account cannot be treated as collateral in substance when they are used as the effective security for lending without compliance with the RBI conditions, and such arrangement may amount to a contravention of the foreign exchange law.

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