Non Banking Financial Companies
Non-banking finance companies (NBFCs) are a fundamental part of the Indian financial system playing a significant role in nation building and financial inclusion. It plays a complementary role to the banking system in promoting financial inclusion. There are multiple varieties of NBFCs and so the sector demands a well-coordinated response from all stakeholders keeping in mind the differential contextual requirements of different categories of NBFCs.
The Non-Banking Financial Companies (NBFCs) are the financial institutions that offer the banking services, but do not comply with the legal definition of a bank, i.e. it does not hold a bank license. Both banks and NBFCs are financial intermediaries. NBFCs can lend and make investments. Hence, their activities are akin to that of banks. However, there are a few differences between NBFCs and banks:
- NBFC cannot accept demand deposits;
- Banks can maintain demand deposits (savings/current accounts) but NBFCs accept only term deposits;
- Banks form a part of Payment and Settlement Mechanism but NBFCs do not form part of the payment and settlement system and cannot issue cheques drawn on itself;
- Deposit insurance facility of Deposit Insurance and Credit Guarantee Corporation is not available to depositors of NBFCs, unlike in case of banks.
Banks, including co-operative banks, can accept deposits. Non-bank finance companies, which have been issued Certificate of Registration by RBI with a specific licence to accept deposits, are entitled to accept public deposit. Not all NBFCs registered with the Reserve Bank are entitled to accept deposits but only those that hold a deposit accepting Certificate of Registration can accept deposits. The maximum rate of interest an NBFC can offer is 12.5%. The interest may be paid or compounded at rests not shorter than monthly rests. The NBFCs are allowed to accept/renew public deposits for a minimum period of 12 months and maximum period of 60 months. They cannot accept deposits repayable on demand. The NBFCs are effectively under the regulation of the RBI. They need the prior permission of the RBI for changing their names.
As per the RBI Act, 1934 , a NBFC means:- (a) "a financial institution which is a company; (b) a non-banking institution which is a company and which has as its principal business the receiving of deposits, under any scheme or arrangement or in any other manner, or lending in any manner; (c) such other non-banking institution or class of such institutions, as the RBI specifies". The NBFCs are classified on the following basis:
- Liabilities Based Classification
- Asset Based Classification
- Size Based Classification
A NBFC has to be registered with the RBI under the RBI Act, 1934. No Non-banking Financial company can commence or conduct business without obtaining a certificate of registration from the RBI and without having a Net Owned Funds of ₹ Two crore. However, in terms of the powers given to the Bank, to prevent cumbersome dual regulation, certain categories of NBFCs which are regulated by other regulators are exempted from the requirement of registration with RBI. Such NBFCs are following:
- Venture Capital Fund/Merchant Banking companies/Stock broking companies registered with SEBI,
- Insurance Company holding a valid Certificate of Registration issued by IRDA,
- Nidhi companies as notified under Section 620A of the Companies Act, 1956,
- Chit companies as defined in clause (b) of Section 2 of the Chit Funds Act, 1982,
- Housing Finance Companies regulated by National Housing Bank.
Systemically Important NBFCs
The NBFCs whose asset size is of ₹ 500 cr or more as per last audited balance sheet are considered as systemically important NBFCs. They are subject to prudential regulations such as capital adequacy requirements, exposure norms, other reporting requirements etc. The underlying rationale for such classification is that the activities of such NBFCs will have a bearing on the financial stability of the overall economy.
Different Categories of NBFCs registered with RBI
NBFCs are categorized as: a) in terms of the 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:
Asset Finance Company (AFC): An AFC is a company which is a financial institution carrying on as its principal business the financing of physical assets supporting productive/economic activity.
Investment Company (IC): IC means any company which is a financial institution carrying on as its principal business the acquisition of securities.
Loan Company (LC): LC means any company which is a financial institution carrying on as its principal business the providing of finance whether by making loans or advances or otherwise for any activity other than its own but does not include an Asset Finance Company.
Infrastructure Finance Company (IFC): IFC is a non-banking finance company a) which deploys at least 75 per cent of its total assets in infrastructure loans, b) has a minimum Net Owned Funds of ₹ 300 crore, c) has a minimum credit rating of ‘A ‘or equivalent d) and a Capital to Risk Weighted Assets Ratio (CRAR) of 15%. Systemically Important Core Investment Company: It is an NBFC carrying on the business of acquisition of shares and securities which satisfies certain conditions stipulated by the RBI.
Infrastructure Debt Fund Non- Banking Financial Company (IDF-NBFC): IDF-NBFC is a company registered as NBFC to facilitate the flow of long term debt into infrastructure projects. IDF-NBFC raise resources through issue of Rupee or Dollar denominated bonds of minimum 5 year maturity. Only Infrastructure Finance Companies (IFC) can sponsor IDF-NBFCs.
Non-Banking Financial Company : Micro Finance Institution (NBFC-MFI): NBFC-MFI is a non-deposit taking NBFC having not less than 85% of its assets in the nature of qualifying assets with certain conditions.
Non-Banking Financial Company : Factors (NBFC-Factors): NBFC-Factor is a non-deposit taking NBFC engaged in the principal business of factoring. The financial assets in the factoring business should constitute at least 50 percent of its total assets and its income derived from factoring business should not be less than 50 percent of its gross income.
Mortgage Guarantee Companies (MGC) : MGC are financial institutions for which at least 90% of the business turnover is mortgage guarantee business or at least 90% of the gross income is from mortgage guarantee business and net owned fund is ₹ 100 crore.
NBFC- Non-Operative Financial Holding Company (NOFHC): It is a financial institution through which promoter / promoter groups will be permitted to set up a new bank. It’s a wholly-owned Non-Operative Financial Holding Company (NOFHC) which will hold the bank as well as all other financial services companies regulated by RBI or other financial sector regulators.
Importance of the NBFCs
- Despite obvious strains and stresses, the NBFC sector has exhibited remarkable resilience. It has a key role in complementing the banking sector in reaching out to the underserved and unbanked segments of society like the MSMEs sector. The MSMEs are "the cradle of entrepreneurship and innovation" and hence NBFCs have a key role in strengthening of MSMEs. It is also postulated that "the government has a strong focus on promoting entrepreneurship so that India can emerge as a country of job creators instead of being one of job seekers". This focus of government is likely to bear fruit only with the revival of NBFCs.
- Bolstering of the capacity of MSMEs is going to be beneficial for the "Make in India" programme and the revival of manufacturing sector in India which will create more employment opportunities. This will ensure reaping of 'demographic dividend' and prevent it from turning into 'demographic disaster'.
- The Non-performing assets (NPA) problem has seriously hampered the expansion of lending activities of public sector banks. This context has further magnified the importance of NBFCs as they indulge in wide-ranging lending activities.
- Digital lending platforms like peer-to-peer (P2P) lending have become popular in contemporary times. The NBFCs have a key role in this segment also.
- NBFCs have a role to play in strengthening of microfinance in India which is critically important for women empowerment as various self-help groups (SHGs) led by women and catering largely to women have been involved micro-finance.
- Some NBFCs have a role to play in strengthening of infrastructure critically needed for India's economic development. The NBFCs are quite significant for "the core development of infrastructure, transport, employment generation, wealth creation opportunities and financial support for economically weaker sections" among other things.
- A strong urban demand and a boost in the level of credit penetration is expected to drive the growth in the consumer finance segment of NBFCs. However, its growth from the rural sector is likely to be muted.
- India's diversity in terms of geographic expanse, demography, caste and class composition etc. is huge and ensuring financial inclusion for the entire population is a critical challenge. It is also held that "the reach of NBFCs, along with their strong understanding of the market, can help them position themselves as a better alternative to traditional ways of banking". Thus, the NBFCs play a leading role in ensuring financial inclusion.
Powers of RBI over NBFCs
The Reserve Bank has been given the powers under the RBI Act 1934 to register, lay down policy, issue directions, inspect, regulate, supervise and exercise surveillance over NBFCs. The Reserve Bank can penalize NBFCs for violating the provisions of the RBI Act or the directions or orders issued by RBI under RBI Act. The penal action can also result in RBI cancelling the Certificate of Registration issued to the NBFC, or prohibiting them from accepting deposits etc. It is illegal for any financial entity to make a false claim of being regulated by the Reserve Bank to mislead the public to collect deposits. They will be liable for penal action under the Indian Penal Code in such a scenario.
NBFCs Charging High Interest Rates from their Borrowers
The RBI has deregulated interest rates to be charged to borrowers by financial institutions (other than NBFC- Micro Finance Institution). The rate of interest to be charged by the company is governed by the terms and conditions of the loan agreement entered into between the borrower and the NBFCs. However, the NBFCs have to be transparent. The rate of interest and manner of arriving at the rate of interest to different categories of borrowers should be disclosed to the borrower or customer in the application form and communicated explicitly in the sanction letter etc.
Why FDI is needed in the NBFC sector?
The NBFCs always try to depend on innovative alternative strategies for raising funds in order to get higher returns in its business activities. The foreign direct investment (FDI) has emerged as one of the best options for funding in the NBFC sector. However, the NBFCs need to keep two critical variables in mind while exploring funding options:
- Evaluating the mismatch between assets and liabilities and;
- Minimizing the mismatch in assets and liabilities.
There has been an exponential growth in digital marketplace lending space. So, there is a growing realization that banks are becoming inadequate for meeting the ever-increasing loan requirements for individuals and small business communities. By the year 2021, world lending business in India is expected to cross $290 billion. The ecosystem of digital lending like peer-to-peer (P2P) lending platforms are gradually becoming important. Such platforms are likely to perform an important role in financial inclusion. The NBFCs finance infrastructure, MSMEs, microfinance sector, digital lending platforms etc. The conventional NBFCs have not been able to compete with banks because of lower rate of interest. Hence, this NBFC is a capital-starved segment. The government and the RBI should formulate an appropriate funding framework for the NBFCs which should be inclusive of a suitable FDI policy for this sector.
Changes in FDI rules for NBFC sector in 2017
There has been a spurt of enthusiasm on the part of foreign investors in India’s NBFC sector in the aftermath of economic liberalization in 1991. The FDI rules have been changing for NBFC sector from time to time. Earlier under FDI policy 2016, FDI under automatic route was permitted in only 18 specified NBFC activities subject to prescribed minimum capitalization norms. Now as per the changed FDI policy 2017, under section 47 of the Foreign Exchange Management Act, 100 percent FDI through automatic route is permitted for NBFCs. Further, minimum capitalization norms as stipulated under FDI policy 2016 for foreign investment in NBFCs are no more applicable. It has been suitably modified under the FDI policy 2017 as the financial regulators stipulate their own set of capitalization norms. The regulatory procedures for NBFCs are complex. The RBI has now simplified the compliance procedures of various steps through online mode in case of foreign funding in case of NBFCs.
Residuary Non-Banking Companies (RNBCs)
Residuary Non-Banking Company is a unique class of NBFC which is a company and has as its principal business the receiving of deposits, under any scheme or arrangement or in any other manner and not being Investment, Asset Financing, Loan Company. These companies are required to maintain investments as per directions of RBI, in addition to liquid assets. The functioning of these companies is different from those of NBFCs in terms of method of mobilization of deposits and requirement of deployment of depositors' funds as per Directions.
Can NBFCs accept deposits from NRIs?
As per the rule effective from April 24, 2004, NBFCs cannot accept deposits from NRIs except deposits by debit to NRO account of NRI provided some other criteria are fulfilled.
Regulatory Architecture of the NBFCs
Generally the NBFCs are under the regulation of the Reserve Bank of India (RBI). There are various inter-linked regulatory problems in the regulatory mechanism for NBFCs. The NBFCs have been operating under certain regulatory constraints and so they are disadvantaged vis-à-vis banks. As far as the asset side is concerned, there has been a regulatory convergence between banks and NBFCs. However, there is a lack of regulatory convergence between banks and NBFCs on the liability side. The critical regulatory shortcomings need to be ironed out so that NBFCs attain their full potential and become very efficient.
The Nachiket Mor Committee (2014) has argued for convergence of certain regulatory aspects between banks and non-banking financial companies (NBFCs) based on the principle of neutrality in line with the Usha Thorat Committee recommendations. It had argued that wide number of NBFC categories add to the complexity in the entire regulatory architecture. Further, it stressed that such complexity led “to scope for arbitrage” apart from putting obstacle in the path of robust evolution of the NBFCs. It also opined that there is a need to shift from entity-based regulation of NBFCs to activity-based regulation of NBFCs. Other recommendations of the Nachiket Mor Committee (2014) regarding NBFCs:
- It called for increasing the borrowing limits for an individual, income limits of borrowers, and disbursement amount for NBFC- microfinance institutions (NBFC-MFIs). The RBI has implemented this recommendation which is expected to give a boost to the microfinance industry.
- It suggested that the priority sector lending norms and the lender of last resort facility should not be made applicable to NBFCs.
- NBFCs should adopt core banking systems so as to enable better off-site supervision.
- The wholesale funding constraints faced by the NBFCs should be addressed in a systematic manner with the involvement of institutions like the RBI, SEBI, NABARD, NHB, SIDBI etc. and other related steps.
- There is a need to abandon the statutory liquidity requirement (SLR) for the NBFCs.
Usha Thorat Committee (2011) recommendations on the NBFCs:
- NBFCs are to be classified under two categories: Exempted NBFC (based on asset size) and registered NBFCs.
- All registered NBFCs should maintain high quality liquid assets.
- Statutory Liquid Ratio (SLR) requirement for deposit taking NBFCs should continue.
- It argued for raising the provisioning for standard assets regarding the NBFCs.
- The classification of loans to NPA should be brought in line with that of banks for all registered NBFCs. It means that the criteria of 90 days should be followed for deciding NPAs in NBFCs like that of banks. It was supposed to be implemented in a phased manner.
Terms of regulation of NBFCs by the RBI
Although, the non-banking financial companies do not hold the bank license and are restricted to take any public deposits their operations are covered under the banking regulations and are regulated by the Reserve Bank of India.
- The Reserve Bank of India (RBI) issued an ombudsman scheme for non-banking finance companies (NBFCs), offering a grievance redressal mechanism for their customers.
- An officer at the RBI not below the rank of general manager will be appointed by the regulator as the ombudsman with territorial jurisdiction being specified by the central bank.
- Any customer or person can file a compliant with the ombudsman on various grounds like non-payment or inordinate delay in payment of interest, non-repayment of deposits, lack of transparency in loan agreement et.
- The NBFC shall, unless it has preferred an appeal, within one month of the award by the complainant, comply with the award and intimate compliance to the complainant and the ombudsman.
- The Ombudsman will be required to send a report to the RBI governor annually on 30 June containing general review of the activities of his office during the preceding financial year.
Conditions under which NBFCs can accept public deposits:
The non-banking companies, registered with the Reserve Bank of India can accept the public deposits and must comply with the following regulations as stated under the Non-Banking Financial Companies Acceptance of Public Deposits Directions, issued by RBI. These are:
- The NBFCs are allowed to take the public deposits for a minimum period of 12 months and the maximum period of 60 months.
- These companies are not allowed to accept deposits, which are repayable on demand.
- The NBFCs cannot offer the interest rate higher than the ceiling rate as prescribed by RBI from time to time.
- The companies cannot offer any gifts, incentives, or any other benefit to the depositors.
- The deposits are not insured.
- The NBFCs must have minimum investment grade credit rating.
- The RBI gives no guarantee of the repayment of deposits by the NBFCs.
Reasons for the growth of the NBFCs in India
- The banks are unable to fulfil the ever-growing credit demands of all segments of India’s population especially small businesses.
- The NBFCs have “unique value proposition”. They try to “leverage alternative and tech-driven credit appraisal methodologies” to analyse the creditworthiness of potential borrowers. This unique and differentiated approach makes it easy for them to meet the loan requirements of individuals and businesses which have been conventionally underserved by banks.
- The introduction of e-KYC and digital loan agreements has made borrowing very smooth. The NBFC lenders offer the right financial product to consumers and small businesses. The realistic use of technology to further augment business processes has an additional benefit that it helps in keeping extraneous business costs down leading to credit disbursement at highly competitive interest rates.
- The regional reach of the NBFCs in India is wide and deep with a dedicated customer base. This presents enormous business opportunities for them. Many high-tech NBFCs have started investing in analytics and AI capabilities to connect to their customers in a highly technocratic way to serve their credit needs better. This magnifies the scope of profitability for these NBFCs.
- The demands from infrastructure and microfinance sectors are huge. This is another reason for the growth of the NBFCs.
An ASSOCHAM report has highlighted the following contributory factors responsible for the growth of the NBFCs:
- Latent credit demand;
- Increased Consumption;
- Distribution reach and sectors where traditional banks do not lead;
- Digital disruption, especially for micro, small and medium enterprises (MSMEs) and small and medium enterprises (SMEs);
- Stress on public sector units (PSUs).
Adverse Challenges faced by the NBFCs
- Borrowing Cost: They face magnified borrowing cost which is consequently passed on to their borrowers in the form of higher interest on loans. It leads to the problem of non-payment of loans.
- The problem of non-payment of loans has led to accumulation of NPAs.
- Higher borrowing cost= Higher cost of funds for borrowers=low credit rating=low profit margins.
- Capital Adequacy norms: There are serious issues with raising capital by the NBFCs. It leads to reduction of profit margins. It has a consequent adverse impact on ability to attract private equity investment. Hence, there are increasing challenges for meeting the stipulated capital adequacy norms.
- There are challenges associated with regulation of the NBFC sector.
- They also do not enjoy much popular trust like banks.
- Credit risk and collection problems also pose challenges for the NBFCs.
- There are concerns associated with the commercial paper market which logically increases funding challenges for NBFCs.
- The NBFCs are largely dependent on competitors, banks and capital markets for raising funds impacting their potential for sustainable growth.
- There is a lack of flexibility in classification of loans by the NBFCs.
The creation of a sound NBFC ecosystem can catalyse economic development of the country. There has been a critical emergence of the NBFCs as financial intermediaries of enormous significance especially for “the small-scale and retail sectors, in under-served areas and unbanked sectors”. The NBFCs business model has low operating cost and so they have great potential for serving vulnerable sections of the society. Hence, they have to be regulated in an efficient way to further bolster their inclusionary potential. The landscape of the NBFCs is evolving significantly with innovative business models. Hence, the regulations governing NBFCs must evolve with the changing contextual requirements of the sector. An appropriate framework for the same must maintain a fine balance between under-regulation and over-regulation. Hence, the RBI has undertaken a slew of reforms as far as the regulation for the NBFCs are concerned. There has been a streamlining of regulations for NBFCs that are not systemically important. At the same time, the quality of systemically important NBFCs has been bolstered so that they can attain the best global standards.