62

Chapter -III

Financial system and
Non-Banking Financial Companies
The Structure and status profile.












63


CHAPTER FOCUS

The present chapter is designed to provide an insight into the Indian
Financial System in its composition, status, evolution, regulatory frame
work, functional arena besides the nexus between the financial system and
economical development. The operational profile, the growth focus, the
dimensions of business volume over the years and also the financial
performance of the NBFCs in India are also given a comprehensive focus to
provide vital background peripheral to the study. An insight has also been
given on recent financial sector reforms and its implications on the non
banking financial institutions.














64

Financial System The Concept and Composition

The financial system facilitates transfer of funds, through financial institutions, financial
markets, financial instruments and services. Financial institutions act as mobilisers and
depositories of savings, and as purveyors of credit or finance. They also provide various
financial services to the community. They act as intermediaries between savers and
investors. All banks and many non-banking institutions also act as intermediaries, and are
called as non-banking financial intermediaries (NBFI). Financial institutions are divided
into the banking and non-banking ones. The distinction between the two has been
highlighted by characterizing the former as creators of credit, and the latter as mere
purveyors of credit.
1
The banking system in India comprises the commercial banks and
co-operative banks. The examples of non-banking financial institutions are Life
Insurance Corporation (LIC), Unit Trust of India (UTI), and Industrial Development
Bank of India (IDBI). Financial markets provide facilities for buying and selling of
financial claims and services. The participants on the demand and supply sides of these
markets are financial institutions, agents, brokers, dealers, borrowers, lenders, savers, and
others who are inter-linked by the laws, contracts, covenants, and communication
networks of the land. Financial markets are sometimes classified as primary (direct) and
secondary (indirect) markets. The primary markets deal in new financial claims or new
securities and, therefore, they are also known as New Issue Markets. On the other hand,
secondary markets deal in securities already issued or existing or outstanding. The
primary markets mobilize savings and they supply fresh or additional capital to business
units. The secondary markets do not contribute directly to the supply of additional
capital; they do so indirectly by rendering securities issued on the primary markets liquid.
Stock markets have both the primary and secondary market segments.

More often financial markets are classified as money markets and capital markets. While
the money market deals in the short-term claims (with a period of maturity of one year or

1
Original source Sayers R.S. Modern Banking, Oxford University Press, Oxford ,1964.

65

less), the capital market does so in the long-term (maturity period above 1 year) claims
2
.
Commercial banks, for example, belong to both. While Treasury Bills Market, Call
Money Market, and Commercial Bills Market are examples of the money market, Stock
Market and Government Bonds Market are examples of the capital market. Financial
asset represent a claim to the payment of a sum of money sometime in future (repayment
of principal) and /or a periodic (regular or not so regular) payment in the form of interest
or dividend. The detailed list of Indian Financial system consisting of Financial
Institutions, Financial Markets, Financial Instruments and Financial Services is as under:

Financial Institutions (intermediaries)

i) Banking: Reserve Bank of India (RBI), Commercial Banks, Co-operative Credit
Societies, Co-operative Banks, Post-office Saving Banks,

ii)Non-Banking: Provident and Pension Funds, Small Savings Organizations, Life
Insurance Corporation (LIC), General Insurance Corporation (GIC), Unit Trust of
India(UTI), Mutual Funds, Investment Trusts, Investment Companies, Finance
Corporations, Nidhis, Chit Funds, Hire-Purchase Finance Companies, Lease Finance
Companies, National Housing Bank (NHB), Housing and Urban Development
Corporation (HUDCO), Housing Development Finance Corporation (HDFC), and other
housing finance companies, Manufacturing companies accepting public deposits, Venture
Capital Funds and National Cooperative Bank of India(NCBI).

Financial Institutions (Special Development)

Industrial Finance Corporation of India (IFCI or IFC), Industrial Credit and Investment
Corporation of India(ICICI), Industrial Development Bank of India(IDBI),Industrial
Reconstruction Bank of India(IRBI),Export and Import Bank of India(EXIM Bank),
National Bank for Agricultural and Rural Development(NABARD), Shipping Credit and
Investment Company of India (SCICI),Tourism Finance Corporation of India
(TFCI),Risk Capital and Technology Finance Corporation (RCTFC),Agricultural Finance

2
Sometimes, the analysts talk of the short-term (maturity period of a year or less), the medium-term
(maturity period of 1, 3 or 5 years), and the long-term (maturity period of more than 3 or 5 years). The
capital market, then, would be said to deal in medium and long-term claims.
66

Consultancy Ltd. (AFC), National Cooperative Development Corporation (NCDC),
Central Warehousing Corporation(CWC),State Warehousing Corporations (SWCs),
Rural Electrification Corporation(REC),National Industrial Development , Corporation
(NIDC), National Small Industries Corporation (NSIC) and Small Industries.


Financial Institutions

i). Regulatory: Reserve Bank of India, Securities and Exchange Board of India (SEBI),
Board for Industrial and Financial, Reconstruction (BIFR), Board for Financial
Supervision, Insurance Regulatory Authority.

ii). Others: Deposit Insurance and Credit Guarantee Corporation (DICGC),Export Credit
and Guarantee Corporation (ECGC), Technical Consultancy Organizations (TCOs),Stock
Holding Corporation of India(SHCI),Credit Rating Information , Services of India
(CRISIL),Discount and Finance House of India(DFHI),Infra-structure Leasing and
Financial Services ,Ltd.(ISLFS), Technology Development and Information Company of
India(TDICI),Merchant Banks, Factoring Companies, Money Lenders, Indigenous
Bankers, Securities Trading Corporation of India(STCI),Primary Dealers, Investment
Information and Credit Rating Agency (ICRA),Depositories and Custodians.


Financial Instruments& Markets

i). Instruments: Equity (ordinary) shares, Preference shares, Industrial debentures or
bonds, Capital gains bonds, Government (gilt-edged) securities or bonds, Relief bonds,
National development bonds, Indira Vikas Patra, Kisan Vikas Patra, National Savings
Scheme, National Savings Certificates, Deposits with banking institutions, Deposits with
companies, Insurance Plans, Units, Participation Certificates, Pass-through certificates,
Certificates of deposits(CDs), Commercial Papers(CPs), Treasury Bills, Commercial
Bills, Call and Notice Money, Hundis, Mortgages, National Savings Annuity Certificates,
Social Security Certificates, Trade Credit, Chits, Inter-corporate deposits, Repos &
Reverse Repos, Stock invest, Global Depository Receipts(GDRs),,Foreign Bonds,
Foreign Currency Convertible Bonds (FCCBs), Eurobonds & Euro notes, Floating Rate
67

Notes(FRNs), Futures, Options, Swaps and other financial derivatives, Zero coupon
bonds, Non-voting shares and Indexed bonds.

ii). Markets: Call Money Market, Treasury Bills Market, Commercial Bills Market,
Government Securities Market, Industrial Securities Market (Stock Market), Foreign
Exchange Market, Over-the-Counter Exchange (OTCE), Discount Market, Market for
Commercial Paper and Certificates of deposits, Mortgage Market, Market for Guarantees,
National Stock Exchange(NSE), Derivatives Markets, Bonds Market and Equities
Market.


Financial Services

Financial Services consists of Hire-purchase and installment credit, Deposit insurance
and other insurance, Financial and performance guarantees, Acceptances, Merchant
banking, Factoring, Credit rating, Credit information, Technical and economic
consultancy, Stock holding, Discounting and Rediscounting, Refinancing, Underwriting,
Leasing, Technology development, Funds transfer, Credit cards, Safe deposit vaults,
Brokerage, Portfolio management, Deposit acceptance, Giving credit, Loan syndicating,
Managing capital issues, Market making, Custodial services and Depository services.

Financial system helps to increase output by moving the economic system towards the
existing production frontier. This is done by transforming a given total amount of wealth
into more productive forms. It induces people to hold fewer saving in the form of
precious metals, real-estate land, consumer durables, and currency and to replace these
assets by bonds, shares, units, etc. It also directly helps to increase the volume and rate
of saving by supplying diversified portfolio of such financial instruments, and by offering
an array of inducements and choices to woo the prospective saver. The growth of
banking habit helps to activate saving and undertake fresh saving. The saving is said to
be institution-elastic i.e., easy access, nearness, better return, and other favorable
features offered by a well-developed financial system lead to increased saving.

68

A financial system helps increase the volume of investment also. It becomes possible for
the deficit spending units to undertake more investment, because it would enable them to
command more capital. Without the transfer of purchasing power to an entrepreneur, he
cannot become the entrepreneur.
3
Further, it encourages investment activity by reducing
the cost of finance and risk. This is done by providing insurance services and hedging
opportunities, and by making financial services such as remittance, discounting,
acceptance and guarantees available. Finally, it not only encourages greater investment
but also raises the level of resource allocation efficiency among different investment
channels. It helps to sort out and rank investment projects by sponsoring, encouraging,
and selectively supporting business units or borrowers through more systematic and
expert project appraisal, feasibility studies, monitoring, and by generally keeping a watch
over the executing and management of projects.

In a developing economy persons require an increasing number of alternative ways of
holding wealth. Similarly, individuals and business, private or public, require funds to
finance their activities. These activities may be again consumptive or productive
activities. The activities may require every day working capital for a small firm or the
capital needs of a sophisticated steel project involving an outlay of hundreds of crores of
rupees. Institutionalization of savings and investment process is a logical and rational step
in the economic expansion, development and capital formation process of a highly
industrialized society. Financial intermediation is the process through which the differing
needs of ultimate savers, investors and consumers are reconciled.

Financial system is linked to a reservoir. When the current consumption of householders
and the economic agents are short of their income, the resulting savings flow into the
reservoir. Business whose current expenditure exceeds their income borrows for meeting
their excess expenditure. Without these financial intermediaries the economys savings
and investing transactions would be fragmented. New forms of credit and new types of
financial institutions may increase the volume of capital of firms by facilitating the
mobilization of funds. Financial intermediaries are expected to play a very important role
in the development of large-scale industries in India.

3
Schumpeter, J.A., The Theory of Economic Development, Oxford University Press, London, 1934, p.102
69


The financial intermediaries perform the function of transferring funds from persons with
excess money to persons who require extra funds to fulfill their expenditure or
investment plans. They are responsible for channeling savings to investment and
consumption purposes and without them many of the funds in the economy would remain
idle. Economic growth is thus closely associated with the expansion and increased
sophistication of financial activity. Financial intermediaries such as the commercial
banks and public financial institutions including Life Insurance Corporation have been
transmitting funds from the investors to the industries. But the Non-Banking financial
intermediaries in the private sector have created major impact for innovation during the
last two decades in the post independence era.


Nexus between financial system and economic development

Capital formation is the most important factor of economic growth. The process of capital
formation involves three interdependent activities such as, a) Saving The activity by
which claims to resources set aside and so become available for other purposes. b)
Finance The activity by which claims to resources are either assembled from domestic
saving or obtained from abroad and placed in the hands of investors. c) Investment.the
activity by which resources are actually committed to the production of capital goods.
There are five important distinctions which are important to the functional relation
between savings, capital formation and economic growth that can channel savings to the
most productive types of investment. They are Money and Barter, External and Internal,
Private and Public, Immediate and Intermediate and Security and Venture.

The activities of saving and Investment become extremely diversified and complex
during the process of economic growth and this causes the necessity of Intermediation
between these two important activities. Financial intermediaries play very important
role in a developing economy by performing multifarious activities in development
process. The financial intermediaries transform primary securities into indirect securities
which have low investment costs and are divisible into convenient units. With a
diversified portfolio, they can reduce the risk of investment to the minimum. Financial
70

Intermediaries increase the liquidity of securities by creating claims which are more
liquid than the securities they buy, and issue them to the savers. Thus they canalize more
savings into investment activity. The intermediaries can also facilitate the expansion of
markets through distributive techniques. These activities will be particularly important
for export promotion and marketing of machinery, producer goods, intermediary
products, etc.

The supply of funds depends upon aggregate savings and credit creation by the banking
system, while the need for funds depends upon demand for investment, consumer
durables, housing, and so on. The functions of a financial system are to establish a bridge
between savers and investors and thereby to encourage saving and investment, to provide
finance in anticipation of saving, to enlarge markets over space and time, and to allocate
financial resources efficiently for socially desirable and productive purposes. The
ultimate goal of the financial system is to accelerate the rate of economic development.
Financial markets accelerate development, they themselves, in turn, develop with
economic development. The relationship between economic development and financial
development is thus symbiotic. The efficient financial markets are characterized by the
absence of information-based gain, by correct evaluation of assets, by maximization of
convenience and minimization of transaction costs, and by maximization of marginal
efficiency of capital.


Evolution of Indian financial system

The Indian Financial System was transpired from the traditional Barter system to the
money lenders, the Nidhis and Chit Funds. In the later stages the concept of cooperatives
was started and the same was introduced in India during 1904 by way of Cooperative
Society Act and it paves the way in introduction of cooperative banking institutions in
India.

The commercial banks were started and they occupied the prime role in Indian financial
system. In India Commercial Banks are broadly categorized into Scheduled Commercial
Banks and Unscheduled Commercial Banks. The Scheduled Commercial Banks have
71

been listed under the Second Schedule of the Reserve Bank of India Act, 1934. The
selection measure for listing a bank under the Second Schedule was provided in section
42 (60 of the Reserve Bank of India Act, 1934). The modern Commercial Banks in India
cater to the financial needs of different sectors. The main functions of the commercial
banks comprise, transfer of funds, acceptance of deposits, offering those deposits as loans
for the establishment of industries, purchase of houses, equipments, capital investment
purposes etc. The banks are allowed to act as trustees. On account of the knowledge of
the financial market of India the financial companies are attracted towards them to act as
trustees to take the responsibility of the security for the financial instrument like a
debenture. During 1969 and 1980 some banks were nationalized on public interest and
during later stages the Indian Banking industry has been opened to all and it led to
universal banking practices in the Indian financial system.

The concept of nidhis and chit funds are played key role in Indian financial system and it
worked as bridge between the age old financial practices and the modern banking system.
It is also stated that even today the chit fund industry is playing major role in reaching the
public and it has become a major substitute to the banks where ever the Bank is not able
to reach and cater their needs, such places the chit fund companies and nidhis are in
handy to them.

Non Banking Financial Companies (NBFCs)

According to the Reserve Bank of India Amendment Act 1997 the Non Banking Finance
company was defined as under:-
A financial institution which is a company,
A non banking institution which is a company and whose principal business is to
receiving of deposits under any scheme/arrangement/in any other manner or
lending in any manner and
Other non banking institutions/class of institutions as the RBI may specify.
The directions apply to a NBFC which is defined to include only non-banking institution,
which is any hire-purchase finance, loan or mutual benefit financial company and an
equipment leasing company but excludes an insurance company/stock exchange/stock
72

broking company /merchant banking company. The RBI (Amendment) Act, 1997
defines NBFCS as an Institution or company whose principal business is to accept
deposits under any scheme or arrangement or in any other manner, and to lend in any
manner. As a result of this new definition, a number of loan and investment Companies
registered under the Companies Act by Business houses for the purpose of making
investments in group of companies are now included as NBFCs
4
. The Financial
intermediaries in Indian Financial System are broadly characterized by Public owned,
Monopoly or Oligopoly or Monopolistic market structure and are centralized. The Indian
financial system has another part which comprises a large number of private owned,
decentralized, and relatively small sized financial intermediaries and which makes a more
or less competitive market. Some of them are fund based, and are called (NBFCs) and
some are provide financial services (NBFSCs) Both NBFIs, NBFCs are (1) Loan
companies (LCs) (2) Investment companies or ICs (3) Hire-Purchase finance
companies or HPFCs (4) Lease finance companies or LFCs (5) Housing finance
companies (or) HFCs (6) Mutual Benefit financial companies or MBFCs (7) Residuary
non-banking companies or RNBCs (8) Merchant Banks (9) Venture capital funds (10)
Factors (11) Credit Rating Agencies (12) Depositories and custodial services.


Classification of NBFCs

Classification of NBFCs as given in the Reserve Bank Amendment Act 1997, 1)
Equipment leasing company (ELC): Carrying on as its Principal Business, the activity of
leasing of equipment. 2) Hire Purchase finance company (HPFC): Carrying hire
purchase transactions (or) financing of such transactions. 3) Housing finance company
(HFC). 4) Investment Company (IC): Carrying the business of acquisition of securities.
5) Loan Company (LC): Financing by making loans and advances. (Does not include
ELC, HPFC, HFC).6) Mutual Benefit companies (MBFC). 7) Residual non-banking
company (RNBC): Company which receives any deposit under any scheme or
arrangement, in one lump sum or in installments by way of contributions or subscriptions
or by sale of units or certificates or other instruments or in any other form according to

4
.Government of India, Report of the Banking Commission, 1972, pp.413-35.
73

definition of NBFC. 8) Miscellaneous non-banking companies (MNBC): Managing,
conducting or supervising as a promoter foreman or agent of any transaction or
arrangement. Ex: conducting any other form of Chit and Kuri which is different from
type of business mentioned above.

After the above classification the Non Banking Financial companies were re-classified
twice, during 1998 it was classified as four types they were 1) Equipment leasing, 2) Hire
Purchase, 3) Investment Company and 4) Loan Companies. During 2006 the NBFCs
were reclassified as three types they are 1) Asset Finance companies (in this both
Equipment Leasing and Hire Purchase companies were merged), 2) Investment
Companies and 3) Loan Companies Apart from those classifications, in order to operate
these NBFCs smoothly certain regulations/directions were issued they are a) Regulations
for deposits for NBFCs accepting deposits, b) Regulations for NBFCs not accepting
deposits and c) Regulations for core investment companies to smooth functioning of their
businesses as well as to give confidence to the participants as well as operators.

In a very broad sense, NBFIs would include even financial institutions like insurance
companies, Life insurance Corporation of India, Unit Trust of India, Industrial Credit and
Investment Corporation of India Ltd., Industrial Finance Corporation of India and
Industrial Reconstruction Corporation of India Ltd., as also State Financial Corporations.
But for the purpose of our present study, the scope of the term is confined to the types of
financial companies enumerated in clause (p) of paragraph 2(1) of the Non-Banking
Financial Companies (Reserve Bank ) Directions, 1966, which mobilize savings of the
community by way of deposits or otherwise and utilize them for the purpose of lending or
investment. Thus the NBFCs that we shall discuss here are hire-purchase finance,
housing finance, investment, loan, miscellaneous financial or mutual benefit financial
companies but excluding insurance, stock exchange or stock broking companies.

Non-banking financial companies (NBFCs) encompass an extremely heterogeneous
group of intermediaries. They differ in various attributes, such as, size, nature of
incorporation and regulation, as well as the basic functionality of financial
intermediation. Notwithstanding their diversity, NBFCs are characterised by their ability
74

to provide niche financial services in the Indian economy. Because of their relative
organisational flexibility leading to a better response mechanism, they are often able to
provide tailor-made services relatively faster than banks and financial institutions.

The non-banking financial companies (NBFCs) flourished in India in the decade of the
1980s against the back drop of a highly regulated banking sector. While the simplified
sanction procedures and low entry barriers encouraged the entry of a host of NBFCs,
factors like flexibility, timeliness in meeting credit needs and low operating cost provided
the NBFCs with an edge over the banking sector.
5
NBFCs proliferated by the early
1990s. This rapid expansion was driven by the scope created by the process of financial
liberalization in fresh avenues of operations in areas, such as, hire purchase, housing,
equipment leasing and investment. The business of asset reconstruction has recently
emerged as a green field within this sector following the passage of the Securitization and
Reconstruction of Financial Assets and Enforcement of Security Interest (SARFAESI)
Act, 2002.

NBFCs are financial intermediaries engaged primarily in the business of accepting
deposits delivering credit. They play an important role in channelising the scarce
financial resources to capital formation. NBFCs supplement the role of banking sector in
meeting the increasing financial needs of the corporate sector, delivering credit to the
unorganised sector &to small local borrowers. All NBFCs are under direct control of RBI
in India. A Non-Banking Financial Company (NBFC) is a company incorporated under
the Companies Act, 1956 and conducting financial business as its principal business. In
contrast, companies incorporated under the same Act but conducting other than Financial
business as their principal business is known as non-banking non-financial Companies.
NBFCs are different from banks in that an NBFC cannot accept demand deposits, issue
checks to customers, or insure deposits through the Deposit Insurance and Credit
Guarantee Corporation (DICGC). In India, the non-banking financial sector comprises a
multiplicity of institutions, which are defined under Section 45I (a) of the Reserve Bank
of India Act, 1934. These are equipment-leasing companies (EL), hire purchase
companies (HP), investment companies, loan companies (LCs), mutual benefit financial

5
.RBI, Report on Trend and Progress of Banking in India, 2007-08.
75

companies (MBFC), miscellaneous non-banking companies (MNBC), housing finance
companies (HFC), insurance companies (IC), stock broking companies (SBC), and
merchant banking companies (MBC). A non-banking company which conducts primarily
financial business and belongs to none of these categories is called a residuary non-
banking company (RNBC).

While most institutions of Indias non-banking financial sector are also found in other
countries financial systems, two of them, MBFCs and MNBCs, better known as Nidhis
and Chit Fund Companies, respectively, are genuinely Indian institutions and rarely
found outside South Asia. Inside India, they are most popular in TamilNadu and Kerala,
from where they have originated. A Nidhi does business only with its equity share
holders. Much like a cooperative bank, a Nidhi accepts deposits and makes loans, which
are mostly secured by jewelry. A chit fund, in Kerala also known as kuri, is a particular
form of a rotating savings and credit association (ROSCA), which is most easily
explained by means of an example. Twenty people, say, agree to contribute a fixed
amount of .1,000 every month . So the group Pools in .20,000 each month as prize
money. Every month an auction is held and in each auction, the bidder who offers the
highest discount is given the prize money 1 minus the discount. For example, when a
member bids .4,000, she/he will be paid .16,000. The discount of .4,000 is equally
shared by all members. In this example, each member thus earns a dividend of .200. The
winner of an auction continues to pay the monthly contribution but is not eligible to bid
in subsequent auctions. According to this system, after 20 months each member will
receive the prize exactly once, at which point the chit fund comes to an end. MNBC or
Chit Fund Company acts as commercial organizer of Chit Funds. Financial
intermediation in chit funds takes place instantly and members contributions do not
appear as deposits on Chit Fund Companies balance sheets. For 2004, the turnover in
registered chit funds is estimated at . 20,000 crore.

NBFCs are essential to a countrys financial system. NBFCs provide services not well
suited for banks. Banks primarily provide payment services and liquidity. Since banks
have to maintain the value of deposits, they tend to have mostly debt-type, as opposed to
equity-type, items on both side of their balance sheet. In contrast, NBFCs can finance
76

riskier borrowers and intermediate equity claims. They thus offer a wider range of risks
to investors, which encourage investment and savings, and create a market for risks.
Second, NBFCs unbundled services that are bundled within a universal bank, and thus
foster competition, which benefits customers. Third, through specialization, NBFCs can
gain informational advantages over banks in their narrowly- defined fields of operation.
Fourth, NBFCs diversify the financial sector, which may alleviate a systemic crisis. Are
the functions performed by NBFCs important for economic growth? Recent research with
cross-country data sets has established that development of the financial sector has the
potential to accelerate economic growth. However, no research on the particular role of
NBFCs in this process has yet been undertaken. Nevertheless, international comparisons
show that economies with lower per capita income tend to have a smaller range of equity-
type claims and a smaller market share of NBFCs relative to banks. An important and
widely-discussed issue in the context of financial institutions is regulation. NBFCs are
particularly important for facilitating storage of value and intermediation of risk.
Moreover, like other financial institutions, they are sensitive to runs and herding
behaviour. If the financial sector does not work smoothly, high transaction costs, lack of
confidence and short-sightedness of economic actors, as well as a culture of corruption
may result.

The objectives of financial sector regulation are protection against systemic risks (like
depositor runs), consumer protection, efficiency enhancement, and social objectives. The
regulations may be structured either institutional or functional level. Under the former,
each financial institution has its own regulatory agency, e.g. one for each category of
NBFC. Under the latter, there are separate agencies for each function of an NBFC, e.g.
one for deposit-taking activities, one for lending, one for market-conduct etc. Indias
legislators have chosen a mix between these two models. RBI regulates ELs, HPs,
Investment Companies, LCs and RNBCs. Similarly, HFCs, ICs, SBCs and MBCs report
to the National Housing Bank, the Insurance Regulation and Development Agency
(IRDA), and the Stock and Exchange Board of India (SEBI), respectively. All these are
instances of institutional regulation. In contrast, Nidhis report to the Department of
Company Affairs (DCA) and Chit Fund Companies to the State Registrar of Chit Funds
77

for their general operations, as well as to RBI for their deposit-taking activities, an
instance of functional regulation.

To achieve the objectives of efficiency enhancement and protection against systemic
risks, regulation has to be neutral. This means that institutions providing the same or
similar services should be subject to identical regulatory requirements. Regulatory
neutrality fosters efficiency-enhancing competition between institutions as each service
will be provided by the institution which can provide it at the lowest cost. Deviations
from regulatory neutrality, on the other hand, likely cause efficiency losses. Suppose that
two institutions can provide a particular service at the same cost under regulatory
neutrality but that, for no apparent reason, one of the two institutions is regulated less
strictly. If regulatory requirements are costly to firms, that institution obtains a regulatory
comparative advantage and will drive the more regulated one out of the market, an
example of regulatory arbitrage. Moreover, if differences in regulatory requirements are
big, less regulated institutions may drive out more efficient ones. In this worst case, the
outcome will be both inefficient and fragile, as institutions which meet the lowest among
all regulatory standards dominate the market.

Much of the history of NBFCs in India over the last fifty years can serve as a case study
of non-neutral regulation and consequent regulatory arbitrage. Before 1997, RBIs
supervision of NBFCs was limited to prescription of prudential norms and thus the
structure of NBFCs. assets. No requirements were in place regarding minimum capital,
amount and term structure of deposits, and interest rates on deposits and loans. At the
same time the banking sector was heavily regulated through excessive statutory liquidity
requirements, directed lending initiatives, and interest rate caps. NBFCs, which were not
subject to any of these rules, thus enjoyed a substantial regulatory comparative advantage
for several bank-type activities, most notably lending and deposit taking. Consequently,
between 1981 and 1996, the number of NBFCs grew more than seven-fold and the share
of non-bank deposits 4 increased from 3.1 to 10.6 per cent. Several companies were
extremely leveraged and deposits-to-Net owned funds (NOF) ratios in excess of 40 not
uncommon. Numerous bankruptcies of NBFCs in the early 1990.s prompted RBI to take
action. The measures sanctioned in 1997, most notably minimum NOF and a maximum
78

deposits-to-NOF ratio of 1.5 and 4 (depending on the companys rating), brought NBFC
standards closer to those of the banking sector. Subsequently the number of registered
NBFCs shrank by seventy per cent between 1997 and 2003. Nevertheless, NBFCs
continue to enjoy regulatory privileges. The 1997 provisions were not applied uniformly
across NBFCs. In particular, Nidhis as well as RNBCs were exempt from maximum
deposits-to-NOF ratios and, partly, from interest rate ceilings. As it stands, substantial
deviations from regulatory neutrality and resulting inefficiencies continue to be common
features of the NBFC sector. While the regulatory measures implemented over the last
ten years are steps into the right direction, regulators still have to go long ways to create
an environment in which banking and non-banking financial institutions compete on even
grounds.


Evolution of Non-Banking Financial Companies

India soon after independence launched on a programme of rapid industrialization which
needed long term investment in capital assets. Industries which were essential and
required huge investments were setup by the Government of India in the public sector.
The government also extended guarantees whenever loan was obtained by the public
sector industries from the foreign agencies. Public financial institutions were established
for instance, the Industrial Development Bank of India and the statutory Finance
Corporations. The development banks have been providing large and medium industrial
concerns direct finance assistance and small and medium industrial concerns through the
State Financial Institutions. These corporations issue bonds and debentures and also
accept deposits from the public. But the private sector had to rely mostly on the
commercial banks which were also not grown to such a scale as to provide corporate
funds required by the promoters. Traditionally banks have been financing manufacturing
activity by providing working capital. With the shortage of financial resources against
expanding activities the companies were mostly depending on credit deals. Capital goods
such as machinery, equipment etc., were imported on deferred payment terms.

With the inadequacy of the financial institutions and the services provided by them
companies were set up in the private sector under the Companies Act whose main
79

business was to do non-banking financial business. To set up a non-banking financial
company is a very attractive proposition. There is no gestation period. The capital
investment in equity is also not huge as in the case of manufacturing companies. In most
of the companies the equity was built up on long term by successful operation. The
advantages of securing additional assets through non-banking financial companies came
to be realised in the seventies. Acquisition of equipment and capital assets through
leasing was favoured to overcome the disabilities arising out of the MRTP Act which
prescribed asset qualification for declaration of an undertaking as a giant. The MRTP Act
declared any undertaking having .100 crore assets as disclosed in the balance sheet as an
MRTP company. As assets secured on lease are owned by the lessor company and not by
the lessee and are not also in theory transferable to the lessee the leased equipment or
assets did not form the constituent of gross block of the borrowing manufacturing
company. Many industrial groups or manufacturing companies set up non banking
financial companies as associate finance companies. There are no special advantages
derived under the MRTP Act now as the concept of MRTP company has lost its
significance when the pre-entry sanctions under that Act were removed.

The non banking financial sector in India has recorded marked growth in the recent
years, in terms of the number of Non-banking financial companies (NBFCs), their
deposits and so on. Keeping in view the growing importance of NBFCs, the banking laws
(misce- llaneous provisions) act, 1963 was introduced to regulate them. To enable the
regulatory authorities to frame suitable policy measures, several committees have been
appointed from time to time to conduct an in depth study of these institutions and make
suitable recommendations for their healthy growth, within the given regulatory frame
work. The suggestions/recommendations made, by them in the context of the
contemporary financial scenario, formed the basis of the formulation of policy measures
by the regulatory authorities/Reserve Bank of India (RBI). The committees that deserve
specific mention in this regard are the:Bhabatosh Datta study group (1971), J ames Raj
study Group (1975), Chakravarthy Committee (1985), Vaghul committee (1987),
Narasimham Committee on Financial systems (1991) and Shah committee 1992)). The
Shah committee, as a follow-up to the Narasimham committee, was the first to suggest a
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comprehensive regulatory framework for NBFCs. While, in principle, endorsing the Shah
Committees frame work of regulations for NBFCs, the RBI had implemented a number
of its recommendations and incorporated them in the RBI Directions that regulate and
supervise the working and operations of such companies. The Khanna Group, 1996, had
suggested a supervisory framework for NBFCs. In pursuance of its recommendations, the
RBI Act was amended in J anuary 1997. As a further follow-up, the RBI Acceptance of
public deposits directions, the RBI NBFCs Prudential norms directions and the RBI
NBFCs auditors report directions were modified /issued in J anuary 1998. The RBI
acceptance of public deposits directions were modified in December 1998, as
recommended by the Vasudev Task Force Group.


Development of Regulatory Frame Work for NBFCs

The regulatory frame work for NBFCs had been in existence since 1963 under the
provisions of Chapter III B of the Reserve Bank of India Act and the Directions issued.
The regulation of the deposit acceptance activities of the Non-Banking Finance
Companies (NBFCs) was initiated in the sixties with a view to safeguard depositors
interests and to ensure that the NBFCs function on healthy lines. Accordingly, in 1963, a
new Chapter III B was inserted in the Reserve Bank of India Act, 1934 to effectively
supervise, control and regulate the deposit acceptance activities of these institutions. The
Bhabatosh Datta Study Group (1971) set up to examine the role and operations of
NBFCs. Recommended that NBFCs should be classified into approved and non-
approved categories and the regulation should be centered primarily on the approved
(i.e. those which satisfy certain additional requirements such as adequate amount of
capital, reserves, liquid assets, etc.) NBFCs. Subsequently, the regulatory frame work
suggested by the J ames Raj Study Group (1974) aimed at keeping the magnitude of
deposits accepted by NBFCs within reasonable limits and ensuring that they were in
conformity with the objectives of monetary and credit policy.

The provisions of Chapter III B of the RBI Act, 1934, however, conferred very limited
powers on the Reserve Bank. The legislative intent was aimed at moderating the deposit
mobilization of NBFCs and thereby to providing indirect protection to depositors by
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linking the quantum of deposit acceptance to Net Owned Fund. Thus, the directions were
restricted to the liability-side of the balance sheet, and too, solely to deposit acceptance
activities. It did not extend to the asset-side of the balance sheets of NBFCs.
Subsequently, several experts/working groups which examined the functioning of NBFCs
were unanimous about the inadequacy of the legislative frame work and reiterated the
need for enhancing the extant frame work. The Chakravarthy Committee, in its Report
submitted in 1985, recommended for the introduction of a system of licensing for NBFCs
in order to protect the interests of depositors. Thereafter, the Narasimham Committee
(1991) outlined a frame work for streamlining the functioning of NBFCs. The
Narasimham committee was of the view that, keeping in mind the growing importance of
NBFCs in the financial intermediation process and their resource to borrowing,
regulatory frame work to govern these institutions should be specified. Such frame work
should include, in addition to the existing requirements of gearing and liquidity ratios,
norms relating to capital adequacy, debt-equity ratio, credit concentration ratio,
adherence to sound accounting practices, uniform disclosure requirements and asset
valuation. Further, the committee argued that the supervision of these institutions should
come within the purview of the proposed agency to be set up for this purpose under the
aegis of the Reserve Bank of India. The introduction of suitable legislation was deemed
as essential not only for ensuring sound and healthy functioning of NBFCs, but also for
safeguarding the interests of depositors.


Recommendations of the Shah Committee

In the light of these developments, the Reserve Bank appointed a working group on
financial companies in 1992 under the chairman ship of Dr. A.C.Shah to make an in-
depth study of the role of NBFCs and to suggest regulatory and control measures to
ensure healthy growth of these companies. The working group, in its report submitted in
September 1992, made wide-ranging recommendations for ensuring the functioning of
NBFCs on sound lines. The Reserve Bank thereafter initiated a series of measures,
including (i) the widening of the definition of regulated deposits to include inter-
corporate deposits, deposits from shareholders and directors and the borrowings by issue
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of debentures secured by immovable property, (ii) the introduction of a scheme of
registration of NBFCs having net owned fund of .50 lakh and above, (iii) the issuance of
guidelines on prudential norms so as to regulate the asset side of the balance sheet of
NBFCs. These measures relating to the registration and prudential norms could not be
given statutory backing at that time since the provisions of the Reserve Bank of India
Act, 1934, did not confer it with adequate powers to make them mandatory.

In J anuary 1997, an ordinance was issued by the Government effecting comprehensive
changes in the provisions of the RBI Act, 1934. This was subsequently replaced by the
Reserve Bank of India (Amendment) Act in March 1997. The salient features of the
amended provisions, based on the recommendations of the Shah Committee, pertain to
the entry point norm of . 25 lakh as minimum NOF, compulsory registration with the
RBI, maintenance of certain percentage of liquid assets in the form of unencumbered
approved securities, creation of reserve fund and transfer thereto every year an amount
not less than 20 per cent of net profit, determination of policy and issuing of directions by
the Bank on prudential norms, prohibition of NBFCs from accepting deposits and filing
of winding-up petitions for violation of directions. The company law board was
empowered to direct a defaulting NBFC to repay any deposits. Stringent penal provisions
were also included empowering the Reserve Bank to impose, interalia, and pecuniary
penalty for violation of the provisions of RBI Act.

Exercising the powers derived under the amended Act and in the light of the experience
in monitoring of the activities of NBFCs, a new set of regulatory measures was
announced by the Reserve Bank in J anuary 1998. As a result, the entire gamut of
regulation and supervision over the activities of NBFCs was redefined, both in terms of
the trust as well as the forces. Consequently, NBFCs were classified into three categories
for purposes of regulation, viz, (i) those accepting public deposits, (ii) those which do not
accept public deposits but are engaged in the financial business, and (iii) core investment
companies which hold at least 90 per cent of their assets as investments in the securities
of their group/holding/subsidiary companies. While NBFCs accepting public deposits
will be subject to the entire gamut of regulations, those not accepting public deposits
would be regulated in a limited manner. Therefore, the regulatory attention was focused
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primarily on NBFCs accepting public deposits. In respect of new NBFCs (which are
incorporated on or after April 20, 1999 and which seek registration with the Reserve
Bank), the minimum NOF has been raised to .2 crore.

Consequent on the amendment to RBI Act, the liquidity requirement for the NBFCs was
enhanced. Accordingly, loan and investment companies, which were earlier maintaining
liquid assets at 5.0 per cent were directed to maintain 7.5 per cent and 10.0 per cent of
their deposits in Government and other approved securities, effective J anuary 1 and April
1 , 1998, respectively. For other NBFCs, the percentage of assets to be maintained by
them as statutory reserves was increased to 12.5 per cent and 15.0 per cent of their
deposits respectively, to be effective from the above mentioned dates. Besides, with a
view to ensuring that NBFCs can have recourse to such liquid assets in times of
emergency, the custody of these assets with designated commercial banks was also
prescribed. Keeping in mind the risk profile of NBFCs, the capital adequacy ratio was
also raised in a phased manner to 10.0 per cent and 12.0 per cent by end-March 1998 and
1999, respectively.


Regulations over NBFCs accepting Public Deposits

The regulatory attention has been utilized to enable intensified surveillance of NBFCs
accepting public deposits. The Reserve Bank issued directions relating to acceptance of
public deposits prescribing, (a) the quantum of public deposits (b) the period of deposits
which should not be less than 12 months and should not exceed 60 months, (c) the rate of
interest payable on such deposits subject to a ceiling of 16 per cent, (d) the brokerage fees
and other expenses amounting to a maximum of 2 per cent and 0.5 per cent of the
deposits, respectively, and, (e) the contents of the application forms as well as the
advertisement for soliciting deposits.

The companies which accept public deposits are required to comply with all the
prudential norms on income recognition, asset classification, accounting standards,
provisioning for bad debts, capital adequacy, credit/investment concentration norms, etc.
The capital adequacy ratio has been fixed at 12 per cent and above, in accordance with
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the eligibility criteria for accepting public deposits. The credit and investment
concentration norms have been fixed at 15 per cent and 25 per cent of the owned funds,
depending on whether the exposure is to a single borrower to a borrower group, while the
totality of loans and investment has been subject to a ceiling of 25 per cent and 40 per
cent of the owned fund, respectively, depending on whether the exposure is to a single
party or to an industry group.


Regulations over NBFCs not accepting public deposits

The NBFCs not accepting public deposits would be regulated in a limited manner. Such
companies have been exempted from the regulations on interest rates, period as well as
the ceiling on quantum of borrowings. The ceiling on the aforesaid factors for NBFCs
accepting public deposits is expected to act as a benchmark for NBFCs not accepting
public deposits. However, prudential norms having a bearing on the disclosure of true
and fair picture of their financial health have been made applicable to ensure
transparency in the financial statements to these companies, excepting those relating to
capital adequacy and credit concentration norms.


Chit Fund Companies

Operations of chit funds companies are governed under the Chit Fund Act, 1982, which is
administered by State Governments. However, their deposit taking activities are regulated
by the Reserve Bank and they are allowed to accept a miniscule amount of deposits, i.e. ,
up to 25 per cent of their NOF from the public and up to 15 per cent from their share
holders. The concerns regarding the protection of depositors interests are further
minimized to a great extent as the chit fund companies usually accept deposits from their
chit subscribers. MNBCs were prohibited with effect from August 18, 2009 from
accepting deposits from public except from the shareholders, which was subjected to the
conditions specified in the MNBC (RBI) Directions 1977. Any deposit accepted and held
by the MNBCs other than from its shareholders as on date shall be repaid on maturity and
shall not be eligible for renewal.

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Differences between NBFCs and Banks

The difference between banks and NBFCs is mainly in the nature of the liabilities of the
two and, to some extent, in the structure of their assets. While the liabilities of
commercial banks usually consist of demand and time deposits, those of NBFCs do not
ordinarily include demand deposits, the mutual benefit financial companies, commonly
known as Nidhis, being notable exceptions. Since demand deposits which are withdrawal
by cheque are considered to be a component of money, it is the degree of money ness of
the liabilities of the two types of institutions which constitutes a major difference
between the two. From the point of view of assets held, it may be said that commercial
banks hold a wide variety ranging from short-term and medium-term to long term credits
and they also use various credit instruments like overdrafts, cash credits, bills, etc. On the
other hand, the assets of NBFCs are more specialized. For instance, hire purchase finance
companies confine their operations mainly to the financing of transport operations and
consumer credit while housing finance companies make loans for housing purpose. It
may, however, be stated that the difference in the nature of assets held by commercial
banks on the one hand and those held by NBFCs on the other does not clearly demarcate
the respective fields of the two because commercial banks are also, of late, making
advances in fields like transport and consumer credit, which were earlier considered as
out of their purview.

Many activities and functions of NBFCs are similar to those of banks. The distinction
between them has become considerably blurred. It is true that NBFCs, unlike banks, are
still not a part of payments mechanism. They cannot create money but in many other
respects, they are substitution and complementary with banks.

NBFCs are doing functions akin to that of banks; however there are a few differences:

(i) An NBFC cannot accept demand deposits;

(ii) An NBFC is not a part of the payment and settlement system and as such an
NBFC cannot issue cheque drawn on itself; and

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(iii) Deposit insurance facility of Deposit Insurance and Credit Guarantee
Corporation is not available for NBFC depositors unlike in case of banks.


CurrentScenarioofNBFCs

Global credit crisis followed by increase in interest rates in October and November 2008
resulted in widespread crisis of confidence. Chain of events after the collapse of Lehman
Brothers is still fresh in the minds of investors. Non-Banking Finance Companies
(NBFCs) in India were severely impacted due to economic slowdown coupled with fall in
demand for financing as several businesses deferred their expansion plan. Stock prices of
NBFCs crashed on the back of rising non-performing assets and several companies
closed their operations. International NBFCs still continue to close down or sell their
back end operations in India.

The positive news however is that, this crisis has forced NBFCs to improve their
operations and strategies. Industry experts opine that they are much more mature today
than they were during the last decade. Timely intervention of RBI helped reduce the
negative effect of credit crunch on banks and NBFCs. In fact, aggressive strategies
helped LIC Housing Finance to grab new customers (including customers of other banks)
and increase its market share in national mortgage market. Surprisingly it was able to
maintain its profitability in 2009 (around 37%). HDFC, the largest NBFC in India,
however experienced a slowdown in customer growth due to stiff competition, especially
from LIC Housing Finance and tight monetary conditions. Other NBFCs that were stable
during this period of credit crunch are Infrastructure Development Finance Company
(IDFC) Power Finance Corporation (PFC) and Rural Electrification Corporation (REC).
Growth prospects are strong for these companies given the acute shortage of power in the
country and expected increase in demand for infrastructure projects. The segment which
was hit hardest was Vehicle Financing. Companies financing new vehicle purchases
experienced a drastic reduction in new customer numbers. Fortunately, since vehicle
finance is asset-based business, their asset quality did not suffer as against other
consumer financing businesses. Contrary to this, Shri ram Transport Finance, the only
NBFC which deals in second-hand vehicle financing was able to maintain its growth
87

primarily due to its business model which does not entirely depends on health of the auto
industry.

There are thousands of market players in the NBFCS sector. About 41,000 NBFCS were
there during 1997. The majority of the NBFCS are private limited companies and rest
being public limited companies. The number of NBFCS which regularly report or submit
returns to the RBI/NHB is quite small in relation to the total number of companies at
work. The important reasons for the growth of non banking finance companies are a)
they provide tailor made services to the clients; b) there has been a comprehensive
regulation of NBFCS; c) customers have been attracted to them by their higher level of
customer-orientation, lesser ore/post sanction requirements, simplicity and speed of their
services; d) the monetary and credit policies have created an unsatisfied fringe of
borrowers, i.e. the borrowers out side the purview of banks. The NBFCS have catered to
the needs of this section of borrowers; e) the relatively higher interest rates offered by
them on deposits have attracted a large number of small savers towards them.


The Resources of NBFCs

The resources of NBFCS are derived from deposits (regulated and exempted), and
ne net owned funds.

Deposits means, any money received by a non-banking company by way of a
deposit or loan or in any other form.(apart from usual deposits, i.e. interoperate
loans, borrowing by Pvt.limited NBFCS from their shareholders.

Regulated deposit means, a deposit which is subject to certain ceiling and other
restrictions imposed by regulatory measures. It includes (a) nonconvertible
debentures (b) deposits received by companies from their shareholders(c) deposits
guaranteed by directors (d) fixed deposits etc. received from the
public.(e)interoperate deposits.

Exempted deposits signify those types of deposits/borrowings which are outside
the scope of the regulatory measures. It includes (a) borrowings from banks and
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specified financial institutions.(b)money received from central/state/foreign
governments.(c)security deposits. (d) Advances received against orders (e)
convertible debentures.

And net-owned funds means the aggregate of paid up capital and free reserves.



Role of NBFCs

NBFCs like banks and other financial institutions act as intermediaries between the
ultimate savers and the ultimate borrowers. The rationale of their existence derives from
the fact that in an economy there are surplus units which save and deficit units which are
in need of such savings and a mechanism is needed to bring the two together. Surplus
units (savers) can lend to the deficit units (borrowers) directly. This, however, is normally
inconvenient to both the savers and borrowers and is certainly not the most efficient
means of flow of funds between the units. With the mediation of financial institutions,
there is a reduction in the degree of risks involved and there is also a more efficient
utilization of the resources in the economy. Financial intermediaries can provide a more
economical service because of the economies of scale, their professional expertise and
their ability to spread the risk over a large number of units. Thus, their operations give to
the saver the combined benefits of higher return, lower risk and liquidity. The borrowers
on the other hand also get a wider choice on account of intermediation of financial
institutions. It may be of relevance to note that while the loans granted by commercial
banks are, by and large, for industrial, commercial and agricultural purposes, those
granted by NBFCs are generally for transport, trading, acquisition of durable consumer
goods, purchase and repair of houses or just for plain consumption. Since their activities
are not controlled by monetary authorities to the same extent as those of commercial
banks, the credit extended by NBFCs may not necessarily be in consonance with national
objectives and priorities. The major function of financial intermediaries is to transfer the
savings of surplus units to deficit units; hence, they can play a useful role in the economy
of the country. To the extent that they help in monetizing the economy and transferring
unproductive financial assets into productive assets, they contribute to the countrys
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economic development. In fact, the nature and diversity of financial institutions
themselves have become measures of economic development of a country. The Reserve
Bank of India expert committees identified the need of non banking financial companies
in the following areas:

Development of sectors like transport and infrastructure
Substantial employment generation
Help and increase wealth creation
Broad base economic development
Irreplaceable supplement to bank credit in rural segments
Major thrust on semi-urban, rural Areas and first time buyers/users
To finance economically weaker sections.
Huge contribution to the state exchequer.


Regulation of NBFCs

While NBFCs have been rendering many useful services, several advances, unhealthy
features of their working also have been observed. At present all NBFCs except HFCs
are regulated by the RBI. With enactment of RBI (Amendment) act 1997, all of them
with net owned funds of .25Lakhs and above have to register with the RBI now. The
BFS with the help of department of supervision of the RBI began supervising NBFCs
from J uly 1995. HFCs are regulated by NHB. The major regulatory provisions are:-

(i) The minimum net worth funds of 25 Lakh and the NBFC should achieve
the minimum net worth norm in 3 years or extended 3years more at the
discretion of RBI.
(ii) NBFCs have to maintain 10%and15% of their deposits in liquid assets.
(iii) They have to create reserve fund and transfer not less than 20% of their
net deposits to it every year.
(iv) The RBI directs them on issues of disclosures, prudential norms, credit,
investments etc.
(v) Nomination facility is available to depositors of these companies.
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(vi) Unincorporated bodies engaged in financial activity cannot accept deposits
from the public from April, 1997.
(vii) They have to achieve a minimum capital adequacy norm of 8% by March,
1996.
(viii) They have to obtain a minimum credit rating from any one of 3 credit
rating agencies.
(ix) A ceiling of 15% interest on deposits has been prescribed for MBFCs or
Nidhis.
(x) The interest rate ceiling on deposits as also the ceiling on quantum of
deposits for NBFCs (other than Nidhis) have removed, subject to
compliance with the RBI directions and guidelines.

With a view to protecting the interests of depositors, the regulatory attention was mostly
focused on NBFCs accepting public deposits (NBFS-D) until recently. Over the last few
years however, this regulatory framework has undergone a significant change, with
increasingly more attention now being paid to non-deposit taking NBFCs (NBFCs-ND)
as well. This change was necessitated mainly on account of a significant increase in both
the number and balance sheet size of NBFCs-ND segment which gave rise to systemic
concerns to address this issue. NBFCs-ND with asset size of .100 crore and above was
classified as systemically important NBFCs (NBFCs-ND-SI) and are subjected to
limited regulations. The changing regulatory policy also recognized that those
activities of NBFCs which are asset creating must be given special consideration.
Accordingly in December 2006, a reclassification of NBFCs was effected. In terms of
the new classification, companies financing real/physical assets for productive/economic
activity are classified as asset finance companies (AFC), subject to the fulfillment of
certain norms. The prudential norms for AFCs vary from the norms for other NBFCs.
The revised NBFC classification now comprises of AFCs, loan companies (LCs) and
investment companies (ICs) instead of equipment leasing, hire purchase, loan companies
and investment companies earlier.



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Figure -3.1
Regulatory Focus in Respect of NBFCs in India
Type of NBFC Name of the Regulatory Authority
Equipment Leasing Companies [EL] Reserve Bank of India
Hire Purchase Finance Companies [HP] Reserve Bank of India
Loan Companies Reserve Bank of India
Investment Companies Reserve Bank of India
Residuary Non-Banking Companies Reserve Bank of India
Miscellaneous Non-Banking Companies
(Chit Fund)
Reserve Bank of India* and Registrars of Chits
of the concerned States
Mutual Benefit Finance Companies
(Nidhis and Potential Nidhis)
Department of Company Affairs of GOI
Micro financial companies Department of Company Affairs of GOI
Housing Finance Companies National Housing Bank
Insurance Companies
Insurance Regulatory and Development
Authority
Stock Broking Companies Securities and Exchange Board of India
Merchant Banking Companies Securities and Exchange Board of India
Source: Report on Trend and Progress of Banking in India, RBI, Mumbai various issues

Protection of Depositors Interest: With a view to protecting the interests of the
depositors further, the Reserve Bank initiated steps for creating a charge on the SLR
securities in favour of the depositors. Accordingly, NBFCs accepting/holding public
deposits were advised in J anuary 2007 to create floating charge on the statutory liquid
assets in favour of their depositors, through the mechanism of Trust Deed. The charge
is required to be registered with the Registrar of Companies and the information in this
regard is required to be furnished to the Trustees and the Reserve Bank. Furthermore,
92

with a view to containing the systemic risk relating to NBFCs-D, measures were initiated
to ensure that only finally sound NBFCs accept deposits. It was, therefore, prescribed in
J une 2008 that NBFCs having net owned funds (NOF) of less than ` 200 lakh may freeze
their deposits at the level than held by them. Asset Finance companies(AFC) having
minimum investment grade credit rating and CRAR of 12 per cent may bring down
public deposits to a level that is 1.5 times their NOF, while all other companies may bring
down their public deposits to a lever equal to their NOF by March 31 2009.

Transparency in Operations of the NBFCs: Along with measures for enhancing the
financial strength of NBFCs, initiatives to inculcate fair corporate governance practices
and good treatment of customers were also undertaken. The Reserve Bank issued
guidelines on Fair Practices Code for NBFCs in September 2006; NBFCs were advised to
invariably furnish a copy of the loan agreement along with a copy each of all enclosures
quoted in the loan agreement to all borrowers at the time of sanction/ disbursement of
loans. Deposit taking NBFCs with deposits of `20 Crore and above and NBFCs-ND-SI
have been advised to frame internal guidelines on corporate governance which should
include, inter alia, constitution audit committee, nomination committee and risk
management committee, among others. Certain disclosure and transparency practices
have also been specified for them. NBFCs have been advised to lay down appropriate
internal principles and procedures for determining interest rates and processing and other
charges, even though interest rates are not regulated by the Reserve Bank. In order to
ensure that only NBFCs which are actually engaged in the business of NBFI hold
Certificate of Registration (COR), it has been decided that all NBFCs should obtain and
submit an annual certificate from their statutory auditors to the effect that they continue
to undertake the business of NBFI to be eligible for holding of COR.

To strengthen their financial viability, NBFCs were permitted in December 2006 to
undertake fee based business to augment their income, subject to certain norms. The
diversification business that may be permitted include, marketing and distribution of
mutual fund products as agents of mutual funds and issuing co branded credit cards with
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scheduled commercial banks, without risk sharing, with prior approval of the Reserve
Bank, for an initial period of two years and a review thereafter.

Foreign Direct Investment (FDI) in NBFC sector: In view of the interest evinced in FDI
participation in the NBFC sector, regulatory measures have also been undertaken in
respect of foreign direct investment (FDI) in the NBFCs sector, FDI under automatic
route is permitted in respect of 18 NBFC activities, subject to prescribed minimum
capitalization norms. While allowing FDI in NBFCs, the Reserve Bank takes into
consideration fit and proper criteria of directors, information about the overseas regulator
of the companies bringing the FDI into India and inter-regulatory views. Bank is
monitoring minimum capitalization norms as regards FDI with a view to ensuring that
NBFC activities are limited to permissible activities.

Monitoring of Frauds in NBFCs: In March 2008 all deposit taking NBFCs (including
RNBCs) were advised that the extant instructions with regard to monitoring of frauds
were revised and as such cases of negligence and cash shortages and irregularities in
foreign exchange transactions were to be reported as fraud if transactions were to be
reported as fraud if the intention to cheat/ defraud was suspected/proved. However, in
cases were fraudulent intention was not suspected/ proved at the time of detection but
involve cash shortages of more than ten thousand rupees and cases where cash shortages
more than five thousand rupees were detected by management/auditor/inspecting officer
and not reported on the occurrence by the persons handling cash, then such cases may
also be treated as fraud and reported accordingly.

Prevention of Money Laundering Act, 2002 Obligation of NBFCs: It was reiterated in
August 2008 that NBFCs, as a part of transaction monitoring mechanism, are required to
put in place an appropriate software application to throw alerts when the transactions are
inconsistent with risk categorization and updated profile of customers. In the case of
NBFCs, where all the branches are not yet fully computerized, the Principal Officer of
the NBFC should cull out the transaction details from branches which are not
computerized and suitably arrange to feed the data into an electronic file with the help of
the editable electronic utilities of cash transaction report (CTR) and suspicious
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transaction reports (STR) as have been made available by Financial Intelligence Unit-
India (FIU-IND) on their website. It was further clarified that cash transaction reporting
by branches/offices of NBFCs to their Principal Officer should invariably be submitted
on a monthly basis and the Principal Officer, in turn, should ensure to submit CTR for
every month to FIU-IND within the prescribed time schedule.

Facility of Liquidity Support for NBFCs: On October 15, 2008 the Reserve Bank
announced, purely as temporary measure, that banks may avail of additional liquidity
support exclusively for the purpose of meeting the liquidity requirements of mutual funds
(MFs) to the extent of up to 0.5 per cent of their NDTL. Further, it was decided, on a
purely temporary and ad hoc basis, subject to review, to extend this facility and allow
banks to avail liquidity support under the LAF through relaxation in the maintenance of
SLR to the extent of up to 1.5 per cent of their NDTL. This relaxation in SLR is to be
used exclusively for the purpose of meeting the funding requirements of NBFCs and
MFs. Banks can apportion the total accommodation allowed above between MFs and
NBFCs flexibly as per their business needs.

Policy Initiatives for NBFCs-ND-SI: The number, product variety and size of
NBFCs-ND-SI have witnessed substantial growth in recent years and as a result the
operations of these companies have increasingly assumed systemic implications. As a
response to these developments, the minimal regulatory regime that existed for these
companies has been transformed into limited regulatory regime by the Reserve Bank.
In line with the growing focus on NBFCs-ND-SI in recent years, certain important policy
initiatives were undertaken in 2007-08.

Supervisory Framework

Various entry-level norms for new and existing NBFCs have been laid down. Among the
various measures introduced was compulsory registration of NBFCs engaged in financial
intermediation, prescription of minimum level of Net Owned Funds (NOF), maintenance
of certain percentage of liquid assets, creation of reserve fund and transfer thereto every
year a certain percentage of profits to reserve fund. The regulations also provide for
95

measures like credit rating for deposits, capital adequacy, income recognition, asset
classification, compulsory credit rating provision for bad and doubtful debts, exposure
norms and other measures to keep a check on their financial solvency and financial
reporting. While the regulatory framework has been dovetailed primarily towards NBFCs
accepting/holding public deposits, the supervisory mechanism for NBFCs is based on
three criteria, viz., (a) the size of the NBFC, (b) the type of activity performed, and (c) the
acceptance or otherwise of public deposits. Towards this end, a four-pronged supervisory
setup consisting of on-site examination, off-site surveillance, exception reporting by
NBFCs' statutory auditors and market intelligence system has been instituted.






















96

Figure-3.2
Non-Banking Financial Companies - Principal Business
Non-Banking Financial
Companies
Principal Business
Non-Banking Financial Company In terms of the Section 45-I(f) of the RBI Act, 1934 as amended in
1997, their principal business is that of a financial institution as
defined in Section 45 I(c) or that of receiving deposits under any
scheme or lending in any manner.
Equipment leasing company (EL) Equipment leasing or financing of such activity.
Hire purchase finance company
(HP)
Hire purchase transaction or financing of such transactions.
Investment company (IC) Acquisition of securities and trading in such securities to earn a
profit.
Loan company (LC) Providing finance by making loans or advances, or otherwise for any
activity other than its own; excludes EL/HP/HFCs.
Mutual benefit financial company
(MBFC) i.e. Nidhi Company
Means any company which is notified by the Central Government
under Section 620A of the Companies Act 1956 (1 of 1956).
Miscellaneous non-banking
company (MNBC) i.e. Chit Fund
Company
Managing, conducting or supervising as a promoter, foreman or
agent of any transaction or arrangement by which the company
enters into an agreement with a specified number of subscribers that
every one of them shall subscribe a certain sum in installments over
a definite period and that every one of such subscribers shall in turn,
as determined by lot or by auction or by tender or in such manner as
may be provided for in the agreement, be entitled to the prize
amount.
Residuary non-banking company
(RNBC)
Company which receives deposits under any scheme or arrangement,
by whatever name called, in one lump-sum or in installments by way
of contributions or subscriptions or by sale of units or certificates or
other instruments, or in any manner. These companies are NBFCs
but do not belong to any of the categories as stated above.
Non-banking non-financial
company (NBNFC)
Means an industrial concern as defined in the Industrial
Development Bank of India Act, 1964, or a company whose
principal activity is agricultural operations or trading in goods and
services or construction/sale of real estate and which is not classified
as financial or miscellaneous or residuary non- banking company.
Housing finance company (HFC) The financing of the acquisition or construction of houses including
the acquisition or development of plots of land. These companies are
supervised by the National Housing Bank.
Source: Report on Trend and Progress of Banking in India, RBI, Mumbai, 2006-07.
97


Unincorporated Bodies: After the RBI (Amendment) Act, 1997, they cannot receive
deposits except from relatives as specified in Section 45-S of RBI Act, if such bodies are
engaged, wholly or partly in any of the activities specified in clause (c) of Section 45-I of
the Act, ibid or principal business is that of receiving deposits or lending. Miscellaneous
non-banking companies covered by the Miscellaneous Non-Banking Companies (Reserve
Bank) Directions, 1973 are of two types they are, (a) Those conducting prize chits,
benefit/ savings schemes, lucky draws, etc; (b) Those conducting conventional or
customary chit funds where under the foremen companies enter into agreements with a
specified number of subscribers that every one of them shall subscribe a certain sum in
installments over a definite period and that every one of such subscriber shall in his turn,
as determined by lot or by auction or by tender or in such other manner as may be
provided for in the agreements, be entitled to the prize amount. This prize amount is
arrived at by deduction from out of the total amount subscribed at each installment by all
subscribers, (i) the commission charged by the company service charges as a promoter or
a foreman or an agent and (ii) discount, i.e, any sum which a subscriber agrees to forego,
from out of the total subscriptions of each installment in consideration of the balance
being paid to therm.

Companies conducting the conventional types of chits or those conducting any other form
of chits/kuris or executing any other business similar to this type of business are
comparatively of a recent origin. And of late there has been a mushroom growth of such
companies which are doing brisk business in several parts of the country, especially in
big cities like Ahmedabad, Bangalore, Bombay, Calcutta and Delhi. They have also
established branches in various States. These companies float schemes for collecting
money from the public. The modus operandi of such schemes is that the company acts
as the foreman or promoter and collects subscriptions in one lump sum or by monthly
installments spread over a specified period from the subscribers to the schemes.
Periodically, the numbers allotted to members holding the tickets or units are put to a
draw and the member holding the lucky ticket gets the prize either in cash or in the form
of an article of utility, such as a motor car, scooter, etc. Once a person gets the prize, he is
98

very often not required to pay further installments and his name is deleted from further
draws. The schemes usually provide for the return of subscriptions paid by the members
with or without an additional sum by way of bonus or premium at the end of the
stipulated period in case they do not get any prize. The principal items of income of these
companies are interest earned on loans given to the subscribers against the security of the
subscriptions paid or on an unsecured basis as also loans to other parties, service charges
and membership fees collected from the subscribers at the time of admission to the
membership of the schemes. The major heads of expenditure are prizes given in
accordance with the rules and regulations of the schemes, advertisements and publicity
expenses and remuneration and other perquisites to the directors.


Miscellaneous Non-Banking Companies (MNBCs)

MNBCs are mainly engaged in the Chit Fund business. The term 'deposit' as defined
under Section 45 I (bb) of the Reserve Bank of India Act, 1934 does not include
subscription to Chit Funds. The Chit Fund companies have been exempted from all the
core provisions of Chapter IIIB of the RBI Act including registration. In terms of
Miscellaneous Non-Banking Companies (RBI) Directions, the companies can accept
deposits up to 25 per cent and 15 per cent of the NOF from public and shareholders,
respectively, for a period of 6 months to 36 months, but cannot accept deposits repayable
on demand/notice.

A study group on Miscellaneous Non-Banking companies (RBI) during 1997 headed by
Dr. Bhabatosh Dutta reviewed the role of various non banking financial institutions it
observed that the chit funds were not efficient as saving or lending institutions and they
encouraged consumption spending and in some cases hoarding of scarce commodities. As
elimination of chit funds would leave credit gap they should be regulated by appropriate
legislation to ensure safeguarding the interests of the members. In 1974 a study group
headed by Dr.J .S.Raj observed that prize chits or benefit schemes do not serve any social
purpose, on the contrary they are prejudicial to public interest also adversely affecting the
efficiency of fiscal and monetary policy. The study group therefore recommended the
total ban of the conduct of Prize Chits. In 1978 the Prize Chits and Money Circulation
99

Schemes (Banning) Act 1978 was enacted. As a follow up of the recommendations of
the Raj Committee a set of directions were issued by the Reserve Bank called the
Miscellaneous non banking(Reserve Bank) Directions, 1977 regulating the working of
the conventional chits.

The Miscellaneous Non-Banking Companies (Reserve Bank ) Directions, 1977 came into
force with effect from the 1
st
J uly, 1977. These directions shall apply to every financial
institution which is a company and which carries on in any place in the State of J ammu
and Kashmir, any of the following types of business and to every financial institution
which is a company and which carries on, in any place in India, any of the mentioned
types of business referred to collecting whether as a promoter, foreman, agent or in any
other capacity, monies in one lump sum or in installments by way of contribution, or
subscription or by sale of units, certificates or other instruments or in any other manner or
as membership fees or admission fees or service charges to or in respect of any savings,
mutual benefit, thrift, or any other scheme or arrangement by whatever name called, and
utilizing the monies so collected or any part thereof or the income accruing from
investment or other use of such monies for all or any of the following purposes:

a. Giving or awarding periodically or otherwise to a specified number of subscribers
as determined by lot, draw or in any other manner, prizes or gifts in cash or in
kind, whether or not the recipient of the prize or gift is under a liability to make
any further payment in respect of such scheme or arrangement.

b. Refunding to the subscribers or such of them as have not won any prize or gift,
the whole or part of the subscriptions, contributions, or other monies collected,
with or without any bonus, premium, interest or other advantage, howsoever
called, on the termination of the scheme or arrangement or, on or after the expiry
of the period stipulated therein.

Managing, conducting or supervising as a promoter, foreman or agent of any transaction
or arrangement by which the company, enters into an agreement with a specified number
of subscribers that every one of them shall subscribe a certain sum in installments over a
100

definite period and that every one of such subscribers shall, in his turn as determined by
lot or by auction or by tender or in such other manner as may be provided for in the
arrangement be entitled to the prize amount. Conducting any other form of chit or kuri
which is different from the type of business referred above.

Acceptance of deposit by miscellaneous non-banking companies

On and from the 1
st
J uly, no miscellaneous non-banking company shall, receive any
deposit repayable on demand, or on notice, or repayable after a period less than six
months and more than thirty-six months from the date of receipt of such deposit or renew
any deposit received by it whether before or after the aforesaid date unless such deposit,
or renewal is repayable not earlier than six months and not later than thirty-six months
from the date of such renewal. Provided that where a miscellaneous non-banking
company has before the 1
st
J uly, 1977, accepted deposits repayable after a period of more
than thirty-six moths, such deposits shall, unless renewed in accordance with these
directions, be repaid in accordance with the terms of such deposits. Further provided that
nothing contained in this clause shall apply to monies raised by the issue of debentures or
bonds.

General provision regarding repayment of deposits

(i) No miscellaneous non-banking company shall repay any deposit within a period
of three months from the date of its
.
(ii) Where a miscellaneous non- banking company repays a deposit after the period
indicated in sub-clause (i) above but before its maturity, it shall pay interest as a)
Three months but before expiry of six months no interest; b) Six months but
before the date of maturity - one percentage point less than the contracted rate.
Provided that the event of death of a depositor, the deposit may be repaid
prematurely to the surviving depositor/s, in the case of joint holding with survivor
clause, or legal heirs with interest at the contracted rate up to the date of
repayment.

101

(iii)A miscellaneous non-banking company may grant a loan up to seventy per cent of
the amount of deposit to a depositor after the expiry of three months from the date
of deposit at the rate of interest two per cent points above the interest payable on
the deposit.

Other directions include, i)Every miscellaneous non-banking company should furnish
copies of balance sheet and accounts together with directors report to the Reserve Bank;
ii) Every miscellaneous non-banking company should submit to the Reserve Bank a
return, furnishing the information specified the 1
st
schedule hereto, with reference to its
position as on the dates specified in the said schedule; iii) Balance sheet, returns, etc. to
be submitted to the Department of Financial Companies; iv)Every miscellaneous non-
banking company shall comply with the provisions of the non-banking financial
companies and miscellaneous non-banking companies (advertisement) rules, 1977, and
shall also specify in every advertisement to be issued there under, the following:

(a) The actual rate of return by way of interest, premium, bonus or other
advantage to the depositor.

(b) The mode of pa payment to the depositors.

(c) The maturity period of deposit

(d) The interest payable on a specified deposit.

(e) The rate of interest which will be payable to the depositor in case the
depositor withdraws the deposit prematurely, the terms and conditions
subject to which a deposit will be renewed, and

(f) Any other special features relating to the terms and conditions subject to
which the deposits are accepted/renewed.




102

Acceptance of Deposits by chit fund companies

The Reserve Bank of India, having considered it necessary in the public interest,
amended the Miscellaneous Non-Banking Companies (Reserve Bank) Directions, 1977,
in exercise of the powers conferred by sections 45j, 45k and 45l of the Reserve Bank of
India Act, 1934, (2 of 1934) and all the powers enabling it in this behalf, with immediate
effect vide their letter No. :RBI/2009-10/133,RNBS (PD) CC.NO.159 /03.03.01/2009-
10, prohibit MNBCs from accepting deposits from public except from shareholders,
which is subject to the conditions specified in the directions issued by the Reserve Bank.
Any deposit accepted and held by the MNBCs other than from its shareholders as on date
shall be repaid on maturity and shall not be eligible for renewal.

The Reserve Bank only regulates the deposits accepted by these companies, but it does
not regulate their Chit Fund business, which is administered by the respective State
Governments through the offices of Registrars of Chits. The Chit Funds Act, 1982 was
enacted as a Central Act for ensuring uniformity in the provisions applicable to Chit Fund
institutions throughout the country, and all State Governments are required to frame rules
for extending the provisions of this Act to their respective jurisdictions. At present, 16
States and 6 Union Territories have adopted the Central Act and the Reserve Bank is
pursuing with the State Governments of Andhra Pradesh, Arunachal Pradesh, Gujarat,
Haryana, Kerala, Maharashtra, Mizoram and Nagaland for early formulation of rules
under the Central Act.










103

Table-3.1
Number of Non-Banking Financial Companies Registered with the Reserve Bank
(During 1999 to 2012)
(Figures are in NOs)
End June Number of
Registered NBFCs
Annual
Growth Rate
NBFCs Accepting Public
Deposits
Annual Growth
Rate
1999 7855 - 623(8.0) -
2000 8451 7.59 679(8.0) 8.99
2001 13815 63.47 776(5.6) 14.29
2002 14077 1.9 784(5.5) 1.03
2003 13849 -1.62 710(5.1) -9.44
2004 13764 -0.61 604(4.3) -14.93
2005 13261 -3.65 507(3.8) -16.06
2006 13014 -1.86 428(3.2) -15.58
2007 12968 -0.35 401(3.1) -6.31
2008 12809 -1.23 364(2.8) -9.23
2009 12740 -0.54 336(2.6) -7.69
2010 12630 -0.86 308(2.4) -8.33
2011 12409 -0.02 297(2.2) -0.04
2012 12385 -0.001 271(2.1) -0.09
Note: Figures in brackets indicate percentage to the total number of NBFCs.
Source: Report on Trend and Progress of Banking in India, RBI, Mumbai-various issues.










104

Table-3.2
Major Components of Liabilities of NBFCs-D by Classification of NBFCs
(During 2003-04 to 2011-12) (Amount in . Crore)
Classification
2003-04 2004-05 2005-06 2006-07 2007-08 2008-09 2009-10 2010-11 2011-12
Liabilities
Asset Finance
-- -- --
24,718
(50.9)
50,998
(68.4)
56,496
(73.2)
60,902
(64.6)
74,008
(70.2)
85,600
(73.2)
Equipment Leasing 7,996
(21.2)
3,744
(11.4)
4727
(13.1)
325
(0.7)
162
(0.2)

--

--

--

--
Hire Purchase 22,163
(58.8)
19,929
(60.8)
20,500
(56.9)
17,376
(35.8)
178
(0.2)
-- -- -- --
Investment 2,208
(5.9)
2,422
(7.4)
1,890
(5.2)
1,633
(3.4)
402
(0.5)
2
(0.0)
-- -- --
Loan
4,109
(10.9)
5,485
(16.7)
6,964
(19.3)
4,499
(9.3)
22,819
(30.6)
20,631
(26.7)
33,310
(35.4)
31,424
(29.8)
31,300
(26.8)
MNBC -- -- -- 2(0.0) 3(0.0) -- -- -- --
Others(include
MNBC)
1,233
(3.3)
1,173
(3.6)
1,922
(5.3)
-- -- -- -- -- --
Total 37,709 32,754 36,003 48,554 74,562 77,128 94,212 1,05,432 1,16,900
Deposits
Asset Finance
-- -- --
186
(8.9)
1,161
(56.9)
1,553
(78.8)
2,268
(83.2)
3,628
(80.4)
4500
(76.9)
Equipment Leasing 511
(10.1)
344
(8.0)
343
(8.7)
43
(2.1)
10
(0.5)
--

--

--

--

Hire Purchase 3,539
(70.3)
2,963
(68.6)
2,423
(61.7)
1,683
(81)
169
(8.3)
--

--

--

--

Investment 125
(2.5)
106
(2.5)
94
(2.4)
45
(2.2)
19
(0.9)
--

--

--

--

Loan 177
(3.5)
178
(4.1)
205
(5.2)
117
(5.6)
682
(33.4)
418
(21.2)
458
(16.8)
434
(10.6)
1,300
(23.1)
MNBC -- -- -- 2(0.1) 1(0.1) -- -- -- --
Others(include
MNBC)
683
(13.6)
727
(16.8)
861
(21.9)
--

--

--

--

--

--

Total 5,035 4,317 3,926 2,077 2,042 1,971 2,727 4,062 5800
Borrowings
Asset Finance
-- -- --
19,091
(58.8)
34,093
(67.4)
40,689
(72.8)
54,202
(78.5)
40,689
(72.8)
54,202
(78.5)
Equipment Leasing 6,472
(26.4)
2,811
(13.5)
3,112
(13.5)
128
(0.4)
76
(0.2)

--
--


--
--

Hire Purchase 13,650
(55.8)
12,141
(58.2)
13,385
(58.1)
10,683
(32.9)
38
(0.1)
--

--

--

--

Investment 1,613
(6.6)
1,718
(8.2)
1,092
(4.7)
133
(0.4)
358
(0.7)
-
0
-
0
-
0
-
0
Loan 2,600
(10.6)
3,775
(18.1)
4,656
(20.2)
2,417
(7.4)
16,012
(31.7)
15,208
(27.2)
14,867
(21.5)
15,208
(27.2)
14,867
(21.5)
MNBC -- -- -- -- -- -- -- -- --
Others(include
MNBC)
145
(0.6)
407
(2.0)
799
(3.5)




--

--

--

--

Total 24,480
(100)
20,852
(100)
23,044
(100)
32,452
(100)
50,557
(100)
55,897
(100)
69,070
(100)
55,897
(100)
69,070
(100)
--: Nil/Negligible Note: Figures in parentheses are percentage share in respective total.
Source: Report on Trend and Progress of Banking in India, RBI, Mumbai-various issues.
105


Profile of NBFCs

RBIs supervision of NBFCs since the amendment to the RBI Act in 1997 has shown that
these companies are in a wide range in size - from the small with just the minimum
prescribed NOF of .25 lakh and assets built with this, to the large with deposits/assets of
over . 500 crore (RNBCs have deposits of very large size comparable to small sized
banks and stand as a distinct set of NBFCs. A size wise break up of these is furnished at
Table 3.1. It clearly evident that, the total number of NBFCs registered with the Reserve
bank, consisting of NBFCs-D (deposit-taking NBFCs), RNBCs, Mutual Benefit
Companies (MBCs), Miscellaneous Non Banking Companies (MNBCs) and Nidhi
companies, declined from 14,077 at end-J une 2002 to 12,385 at end-J une 2012.The
number of NBFC-D also declined from 784 at end-J une 2002 to 271 at end-J une 2012,
mainly due to exit of many NBFCs from deposit taking activity. The annual growth rates
are consistently negative from the year 2003, for both number of NBFCs registered and
number of NBFCs accepting deposits. Despite the decline in the number of NBFCs, their
total assets as well as net owned funds registered an increase during 2010-11, while
public deposits recorded a decline.



Operations of NBFCs (excluding RNBCs)

The liabilities, Deposits and Borrowings of major components of NBFCs-D are furnished
in the Table-3.2. It is observed that, Asset Finance Companies (AFCs) held largest share
in the Liabilities, Deposits and Borrowings consistently from the year 2006-2012,
followed by loan companies, hire purchase companies and equipment leasing companies.
It is mainly on account of the reclassification of NBFCs, which was initiated in
December 2006.





106

Table-3.3
Profile of public deposits of different categories of NBFCs
(During 1998 to 2011) (Amount in . Crore)
Year Classification of NBFCs
Asset
Finance
Equipment
Leasing
Hire
Purchase
Investment Loan RNBCs Others
including
MNBC
Total

1998 --
1,962.09
(8.2)
3,937.75
(16.5)
6,628.92
(27.8)
--
10,248.72
(43.0)
1,042.97
(4.5)
23,820.45
(100.0)
1999 --
1,172.91
(5.7)
3,339.78
(16.3)
4,455.80
(21.8)
--
10,644.27
(47.8)
816.17
(4.0)
20,428.93
(100.0)
2000 --
1,021.20
(5.2)
4,083.54
(21.2)
2517.46
(13.0)
--
11,003.77
(56.9)
715.75
(3.7)
19,341.72
(100.0)
2001 --
1,450.21
(8.0)
3,659.19
(20.2)
785.82
(4.3)
--
11,625.24
(64.3)
564.18
(3.1)
18,084.64
(100.0)
2002 --
668
(3.5)
3,709
(19.7)
1,029
(5.5)
--
12,889
(68.5)
528
(2.8)
18,822
(100.0)
2003 --
511
(10.1)
3,539
(70.3)
125
(2.5)
177
(3.5)
--
683
(13.6)
5,035
(100.0)
2004 --
344
(8.0)
2,963
(68.6)
106
(2.5)
178
(4.1)
--
727
(16.8)
4,318
(100.0)
2005 --
343
(8.7)
2,423
(61.7)
94
(2.4)
205
(5.2)
--
317
(11.9)
3,926
(100.0)
2006 --
153
(5.7)
2,039
(76.5)
81
(3.0)
77
(2.9)
--
317
(11.9)
2,667
(100.0)
2007
1,161
(56.9)
10
(0.5)
169
(8.26)
19
(0.9)
683
(33.44)
-- --
2,042
(100.0)
2008
1,161
(56.9)
10
(0.5)
169
(8.26)
19
(0.9)
682
(33.4)
1
(0.04)
--
2,042
(100.0)
2009
2,287
(83.3)
-- --
--

458
(16.7)
-- --
2,745
(100.0)
2010
3600
(90.0)
-- --
--

400
(10.0)
-- --
4,000
(100.0)
2011
4500
(77.58)
-- --
--

1300
(22.42)
-- --
5,800
(100.0)
Note: Figures in Parenthesis indicate percentage to respective tables.
Source: Report on Trend and Progress of Banking in India, RBI, Mumbai-various issues.

107

Table-3.4
Range of Deposits held by Non-Banking Financial Companies
(During 2003-04 to 2011-12) (Amount in . Crore)
Number of NBCs/ Amount of deposits
Deposit Range 2003-04 2004-05 2005-06 2006-07 2007-08 2008-09 2009-10 2010-11 2011-12

Less than . 0.5
Crore
491
(56.44)
428
(55.3)
368
(52.57)
264
(57.02)
213
(60.86)
185
(64.24)
141
(61.84)
134
(61.75)
117
(59.69)
65
(1.3)
53
(1.2)
43
(1.1)
37
(1.4)
28
(1.4)
23
(1.1)
17
(0.6)
19
(0.47)
14
(0.24)
More than .
0.5 crore and
up to .2 crore
233
(26.78)
210
(27.13)
197
(28.14)
120
(25.92)
85
(24.29)
57
(19.79)
45
(19.74)
38
(17.51)
34
(17.35)
225
(4.5)
206
(4.8)
195
(5.0)
116
(4.3)
82
(4.0)
55
(2.8)
47
(1.8)
44
(1.08)
38
(0.65)
More than . 2
crore and up to
.10 crore
90
(10.34)
82
(10.59)
84
(12.0)
48
(10.37)
38
(10.86)
30
(10.42)
26
(11.4)
28
(12.9)
27
(13.78)
360
(7.1)
352
(8.2)
375
(9.6)
201
(7.5)
186
(9.1)
133
(6.7)
122
(4.5)
129
(3.18)
113
(1.93)
More than .
10 crore and
up to .20 crore
21
(2.41)
18
(2.33)
18
(2.57)
14
(3.02)
4
(1.14)
6
(2.08)
5
(2.19)
7
(3.23)
7
(3.57)
284
(5.6)
242
(5.6)
265
(6.7)
196
(7.3)
61
(3.0)
76
(4.0)
69
(2.5)
108
(2.66)
109
(1.87)
More than .
20 crore and
up to .50crore
12
(1.38)
17
(2.2)
18
(2.57)
6
(1.3)
2
(0.57)
4
(1.39)
3
(1.32)
2
(0.92)
4
(2.04)
364
(7.2)
569
(13.2)
601
(15.3)
199
(7.5)
56
(2.7)
142
(7.2)
107
(4.0)
81
(1.99)
120
(2.05)
.50 crore and
above
23
(2.64)
19
(2.45)
15
(2.14)
11
(2.38)
8
(2.29)
6
(2.08)
8
(3.51)
8
(3.69)
7
(3.57)
3,737
(74.3)
2,895
(67.0)
2,447
(62.3)
1,917
(71.9)
1,629
(79.8)
1,543
(78.2)
2,364
(86.6)
3,681
(90.62)
5,447
(93.25)
Total 870
(100.0)
774
(100.0)
700
(100.0)
463
(100.0)
350
(100.0)
288
(100.0)
228
(100.0)
217
(100.0)
196
(100.0)
5,035
(100.0)
4,317
(100.0)
3,926
(100.0)
2,667
(100.0)
2,042
(100.0)
1,971
(100.0)
2,727
(100.0)
4,062
(100.0)
5,841
(100.0)
Note: Figures in parentheses are percentages to total deposit. --: Nil/Negligible
Source: Report on Trend and Progress of Banking in India, RBI, Mumbai-various issues.


108

Profile of public deposits of different categories of NBFCs

The profile of public deposits of various Categories of NBFCs from the year 1998 to
2011 is presented in the Table-3.3. it is evident from the table that, public deposits held
by all groups of NBFCs taken together, declined moderately during the year 2003-04, and
2004-05, except loan companies and other companies increased during 2003-04, and
2004-05.This trend is indicative of the shift in preference of NBFCs from public deposits
to bank loans/debentures. Continuing the trend of the previous year, public deposits held
by all groups of NBFCs taken together, declined moderately during 2008-09. This trend
is indicative of the shift in preference of NBFCs from public deposits to bank
loans/debentures. The decline in public deposits was mainly evident in the case of loan
companies and equipment leasing companies due to reclassification of some of these
companies as asset finance companies. And they have shown a gradual increase in the
years 2009-2012.


Range of Deposits held by Non-Banking Financial Companies

From the Table-3.4 it is observed that, there is a sharp increase in the share of NBFCs-D
located at the upper-end having deposit size of . 50 crore and above accounting for about
90.6% of total deposits at end-March 2011.However there were only 8 MBFCs-D
belonging to this category constituting about 3.7% of the total No. of NBFCs-D. Thus,
only relatively bigger NBFCs-D was able to raise resources through deposits.










109

Table-3.5
Financial Performance of NBFCs-D
(During 1999 to 2011) (Amount in . Crore)
Classification of
NBFCs
As at end March
1999 2000 2003 2004 2005 2006 2007 2008 2009 2010 2011
A. Income(i+ii) 6809 6770 5084 4332 4582 4578 5721 11879 13656 13615 15200
(i) Fund Based

6551

6299

4709
(92.6)
4005
(92.5)
4208
(91.8)
4433
(96.8)
5590
(97.7)
11572
(97.4)
13489
(98.8)
13388
(98.3)
15100
(99.2)

(ii) Fee-Based
258 471 375
(7.4)
327
(7.5)
374
(8.2)
145
(3.2)
131
(2.3)
307
(2.6)
167
(1.2)
227
(1.7)
100
(0.8)
B. Expenditure (i +
ii + iii)
6416

6363

4491

3621

3657

4134

4831

8789

11166

11038

10900

(i) Financial

4355

3687

2.757
(61.4)
2099
(58.0)
2168
(59.3)
2174
(52.6)
2765
(57.2)
5663
(64.4)
6742
(60.4)
6546
(59.3)
6800
(62.3)
Of which interest
payment
--



--

--

783
(21.4)
--
(-)
508
(10.5)
211
(2.4)
289
(2.6)
730
(6.6)
900
(8.2)
(ii) operating

1077

1614

1734
(38.6)
1522
(42.0)
1489
(40.7)
1960
(47.4)
1261
(26.1)
2392
(27.2)
2587
(23.2)
2666
(24.2)
3000
(27.1)

(iii) Others
984

1062

-- -- -- -- 804
(16.6)
734
(8.3)
1837
(16.4)
1825
(16.5)
1100
(10.5)
C. Tax Provisions 273 270 254 180 353 291 385 1017 1085 1096 1400
D. Operating Profit
(PBT)
-- -- 593 711 924 443 890 3090 2490 2577 4300
E. Net Profit (PAT) 120 137 339 531 572 152 504 2073 1405 1482 2900
F. Total Assets 35968 40007 37709 32754 36003 35561 48554 77128 93709 94212 105400
G. Fin Ratios (as % to Total Assets)
i) Income 18.9 16.9 13.5 13.2 12.7 12.9 11.8 15.4 14.6 14.5 14.4
ii) Fund Based
Income
18.2

15.7

12.5

12.2

11.7

12.5

11.5

15.0

14.4

14.2

14.3
iii) Fee Based
Income
0.7

1.2

1.0

1.0

1.0

0.4

0.3

0.4

0.2

0.0

0.0

iv) Expenditure 17.8 15.9 11.9 11.0 10.2 11.6 9.9 11.4 11.9 11.7 10.4
v) Financial
Expenditure

12.1

9.2

7.3

6.4

6.0

6.1

5.7

7.3

7.2

0.1

0.1
vi) Operating Exp 3.0 4.0 2.9 3.1 4.1 5.5 2.6 3.1 2.8 2.8 2.8
vii) 2.7 2.7 -- -- -- -- -- -- -- -- --
viii)Tax provision 0.8 0.7 0.7 0.5 1.0 0.8 0.8 1.3 1.2 1.2 1.3
ix) Net Profit 0.3 0.3 0.9 1.6 1.6 0.4 1.0 2.7 1.5 1.6 2.7
H. Cost to Income
Ration
-- -- -- -- 79.8 90.3 84.4 74.0 81.8 81.1 72.0
Source: Report on Trend and Progress of Banking in India, RBI, Mumbai-various issues.



110

Table 3.6
Non Performing Asset Ratios of NBFCs-D
(During 2001 to 2012) (Figure in Percentage)
End-March Gross NPAs to Gross Advances Net NPAs to Net Advances
(1) (2) (3)
2001 11.5 5.6
2002 10.6 3.9
2003 8.8 2.7
2004 8.2 2.4
2005 5.7 2.5
2006 3.6 0.5
2007 2.2 0.2
2008 2.1 #
2009 2.0 #
2010 1.3 #
2011 0.7 #
2012 2.1 0.5
#P: Provisional. #Provision exceeds NPA
Source: Report on Trend and Progress of Banking in India, RBI, Mumbai-various
issues.











111

Table-3.7
Capital Adequacy Ratio of NBFCs-D
(During 2003 to 2011) (Figures are in number)
Category Year Ending March AFC EL HP LC/IC Total
1) Up to 15 per cent
2003 -- 11 25 16 52
2004 -- 6 16 9 31
2005 -- 4 55 7 66
2006 -- 6 13 3 22
2007 21 4 17 5 47
2008 22 4 15 10 51
2009 2 -- -- 3 5
2010 2 -- -- 3 5
2011 2 -- -- 1 3
2) More than 15 and up to
20 per cent
2003 -- 4 32 9 45
2004 -- 2 15 2 19
2005 -- 3 19 4 26
2006 -- -- 10 -- 10
2007 3 1 7 1 12
2008 5 0 0 3 8
2009 5 -- -- 2 7
2010 5 -- -- 3 8
2011 8 -- -- 3 11
3) More than 20 and upto 30
per cent
2003 -- 9 54 11 74
2004 -- 6 38 7 51
2005 -- 6 32 3 41
2006 -- 5 30 3 38
2007 2 2 23 6 33
2008 25 0 1 3 29
2009 19 -- -- 8 27
2010 19 -- -- 3 22
2011 16 -- -- 2 18
4) Above 30 per cent








2003 -- 32 334 121 487
2004 -- 28 300 55 383
2005 -- 28 219 33 280
2006 -- 22 211 19 252
2007 44 22 217 22 305
2008 117 10 66 46 239
2009 140 -- -- 37 177
2010 142 -- -- 27 169
2011 131 -- -- 27 158
Source: Report on Trend and Progress of Banking in India, RBI, Mumbai-various issues.

112

Financial Performance of NBFCs

The financial performance of NBFCs suffered a setback during 2005-06. While income
earned by NBFCs declined marginally, expenditure increased sharply. As a result,
operating profit and net profit declined sharply. It is evident from the Table-3.5, financial
performance of NBFCs in terms of income and net profit improved during 2008-09. Both
fund based income and fee based income registered robust growth. The financial
performance of NBFC-D witnessed improvement as reflected in the increase in their
operating profits during 2010-11. This increase in profit was mainly on account of growth
in income (fund based) while expenditure declined marginally. The operating profit along
with an increase in tax provision resulted in almost doubling of net profit during 2010-11.


Non Performing Assets:

Table 3.6 shows that, Gross NPAs (as a percentage of gross advances) as well as net
NPAs (as per cent of net advances) of reporting NBFCs, as a group, registered a steady
decline between end-March 2001 and end-March 2004 and further to 0.7 per cent in 2011
and stood at 2.1 per cent in 2012. While gross NPAs continued to decline during the year
ended March 2005, net NPAs increased significantly. Gross NPAs (as a per cent of gross
advances) as well as net NPAs (as per cent of net advances) of reporting NBFCs
registered a sharp decline during the year ended March 2012. In continuation of the trend
witnessed during the last few years, gross NPAs (as per cent of gross advances) as well as
net NPAs (as per cent of net advances) of reporting NBFCs declined further during the
year ended March 2012. The gross NPAs (as per cent of gross advances) of equipment
leasing and investment companies increased during 2006-07, while those of loan
companies and hire purchase companies declined. Net NPAs (as per cent of net advances)
also showed a decline in the case of equipment leasing and loan companies. The gross
NPAs of equipment leasing and hire purchase companies increased during 2007-08, due
to reclassification of NBFCs, while those of asset finance companies and loan companies
declined. Net NPAs (as per cent of net advances) increased marginally in case of asset
finance companies, hire purchase companies and investment companies, while those of
equipment leasing companies, and loan companies improved further. Gross NPAs (as
113

percentage of gross advances) of asset finance companies, equipment leasing companies
and investment companies and hire purchase companies declined during 2008-09. Net
NPAs (as percentages of net advances) increased marginally in case of asset finance
companies and hire purchase companies, while those of equipment leasing and
investment companies decreased. NPAs of loan companies remained negative during
2008-11.


Capital Adequacy Ratio

Capital to risk weighted assets ratio (CRAR) norms were made applicable to NBFCs in
1998, in terms of which every deposit-taking NBFC is required to maintain a minimum
capital consisting of Tier-1 and Tier-II capital of not less than 12 per cent (15 per cent in
case of unrated deposit-taking loan/investment companies) of its aggregate risk
weighted assets and of risk-adjusted value of off-balance sheet items. Total of Tier-II
capital, at any point of time, is required not to exceed 100 per cent of Tier-I capital.

It is noteworthy that the NBFC sector is witnessed a consolidation process in the last
few years, wherein the weaker NBFCs are gradually exiting, paving the way for a
stronger NBFC sector. It is clear from the Table-3.7 that, all NBFCs with minimum
CRAR 12% to above 30% at the end March 2011, declined gradually.












114

Table-3.8
Net Owned Funds / Public Deposits
(During 2003 to 2011) (Amount in crore)
Classification 2003 2004 2005 2006 2007 2008 2009 2010 2011
Asset Finance -- -- -- -- 2,673
(38.62)
6,939
(68.01)
9,863
(74.4)
8,697 10,818
186
(0.1)
1,161
(0.2)
2,268
(0.2)
2287
(0.3)
3628
(0.3)
Equipment
Leasing
154
(3.72)

96
(2.34)

430
(8.54)

553
(10.09)

-15
(-0.22)

-50
(-0.49)

--
511
(3.3)
344
(3.6)
343
(0.8)
153
(0.3)
43
(-2.9)
10
(-0.2)

Hire Purchase 2,979
(71.94)
2,235
(54.57)
2,521
(50.06)
3,896
(71.08)
3,004
(43.4)
-76
(-0.74)
--


3,539
(1.2)
2,963
(1.3)
2,423
(1.0)
2,039
(0.5)
1,683
(0.6)
169
(-2.2)

Investment 553
(13.35)
607
(14.82)
662
(13.15)
766
(13.98)
822
(11.88)
83
(0.81)
--


125
(0.2)
106
(0.2)
94
(0.1)
81
(0.1)
45
(0.1)
19
(0.2)

Loan 367
(8.86)
893
(21.8)
1,052
(20.89)
128
(2.34)
437
(6.31)
3,306
(32.4)
3,394
(25.6)
4806 4170
177
(0.5)
178
(0.2)
205
(0.2)
77
(0.6)
117
(0.3)
682
(0.2)
458
(0.2)
545
(0.1)
434
(0.1)

MNBC
-- -- -- -- 0

1
(0.01)
--
2
(6.6)
1
Others 88
(2.13)
265
(6.47)
371
(7.37)
138
(2.52)
-- -- --
683
(7.8)
727
(2.7)
861
(2.3)
317
(2.3)

Total 4,141
(100.0)
4,096
(100.0)
5,036
(100.0)
5,481
(100.0)
6,921
(100.0)
10,203
(100.0)
13,257
(100.0)
13503

14987
5,035
(100.0)
4,317
(100.0)
3,923
(100.0)
2,667
(100.0)
2,077
(100.0)
2,042
(100.0)
2,727
(100.0)
2831 4062
Note: Figures in Parenthesis indicate percentage to respective totals.
Source: Report on Trend and Progress of Banking in India, RBI, Mumbai-various
issues.



115

Table-3.9

Total Public Deposits Held by NBFCs and RNBCs
(During 1998 to 2011) (Amount in crore)
NBFC RNBC Per company
public deposits
Year(End-
March)
No of
Reporting
Companies
Public
Deposits
No of
Reporting
Companies
Public
Deposits
Total
Public
Deposits
Total
Reporting
companies
NBFC RNBC
1998 1420
(99.37)
13572
(56.97)
9
(0.63)
10249
(43.03)
23821
(100.0)
1429
(100.0)
9.6 1138.8
1999 1536
(99.29)
9785
(47.9)
11
(0.71)
10644
(52.1)
20429
(100.0)
1547
(100.0)
6.4 967.6
2000 996
(99.1)
8338
(43.11)
9
(0.9)
11004
(56.89)
19342
(100.0)
1005
(100.0)
8.4 1222.7
2001 974
(99.29)
6459
(35.71)
7
(0.71)
11625
(6428)
18085
(100.0)
981
(100.0)
6.6 1660.7
2002 905
(99.45)
5933
(31.52)
5
(0.55)
12889
(68.48)
18822
(100.0)
910
(100.0)
6.6 2577.8
2003 870
(99.43)
5035
(25.05)
5
(0.57)
15065
(74.95)
20100
(100.0)
875
(100.0)
5.8 3013
2004 774
(99.61)
4317
(21.98)
3
(0.39)
15327
(78.02)
19644
(100.0)
777
(100.0)
5.6 5109
2005 700
(99.57)
3926
(19.13)
3
(0.43)
16600
(80.87)
20526
(100.0)
703
(100.0)
5.6 5533.3
2006 432
(99.31)
2447
(10.82)
3
(0.69)
20175
(89.18)
22622
(100.0)
435
(100.0)
5.7 6725
2007 371
(99.2)
2075
(84)
3
(0.8)
22622
(91.6)
24697
(100.0)
374
(100.0)
5.6 7540.7
2008 288
(99.31)
1971
(9.14)
2
(0.69)
19596
(90.86)
21567
(100.0)
290
(100.0)
6.8 9798
2009 228
(99.13)
2727
(15.81)
2
(0.87)
14520
(84.19)
17247
(100.0)
230
(100.0)
12 7260
2010 217
(98.6)
4062
(28.0)
3
(1.4)
10500
(72.0)
14562
(100.0)
220
(100.0)
19 3500
2011 196
(98.0)
5841
(48.0)
3
(2.0)
6300
(52.0)
12141
(100.0)
199
(100.0)
30 2100
Note: Figures in brackets are percentage in total deposits and total reporting companies
respectively.
Source: Report on Trend and Progress of Banking in India, RBI, Mumbai-various issues.
116

Net Owned Funds Vis--vis Public Deposits of NBFCs-D

Net owned fund (NOF) of NBFCs is the aggregate of paid up capital and free reserves,
netted by (i) the amount of accumulated balance of loss, (ii) deferred revenue expenditure
and other intangible assets, if any, and adjusted by investments in shares and loans and
advances to (a0 subsidiaries, (b) companies in the same group and (c) other NBFCs (in
excess of 10 per cent of owned fund). Information of NOFs can complement the
information on CRAR.

Table 3.8 presented the picture of Net owned funds to Public deposits ratios of NBFCs.
The ratio of public deposits to NOF in respect of almost all NBFC groups except loan
companies, after increasing marginally during the year ended March 2004, declined
during the year ended March 2005-2008. The ratio of public deposits to NOF in the case
of loan companies and hire purchase declined during the year ended March 2009, while
that of other category companies witnessed a marginal increase. The ratio of hire
purchase companies continued to be negative because of negative NOF. The ratio of
public deposits to NOF for all categories of NBFCs taken together was unchanged at 0.2
per cent at end March 2009. The ratio of Public deposits to net owned funds (NOF) of
NBFCs taken together has increased marginally 0.3% at end March 2011. There was an
increase in NOF and Public deposits of NBFC-D during 2010-11. This increase was
mainly concentrated in the NOF size category of . 500 and above.


Total Public Deposits Held by NBFCs and RNBCs

Table 3.9 presents the information regarding total public deposits held by NBFCs and
RNBCs from the year 1998 to 2011. The number of NBFCs gradually decreased from
the year 1998 and the deposits held by NBFCs also gradually decreased till the year 2008.
The years 2009, 2010 and 2012 have noticed a growth in the public deposits held by
NBFCs. The number of RNBCs has not been considerably increased and the public
deposits held by RNBCs have noticed a sharp increase.