CHAPTER-1

INTRODUCTION

We studied about banks, apart from banks the Indian Financial System has a large
number of privately owned, decentralised and small sized financial institutions
known as Non-banking financial companies. In recent times, the non-financial
companies (NBFCs) have contributed to the Indian economic growth by providing
deposit facilities and specialized credit to certain segments of the society such as
unorganized sector and small borrowers. In the Indian Financial System, the
NBFCs play a very important role in converting services and provide credit to the
unorganized sector and small borrowers.

NBFCs provide financial services like hire-purchase, leasing, loans, investments,

chit-fund companies etc. NBFCs can be classified into deposit accepting
companies and non-deposit accepting companies. NBFCs are small in size and are
owned privately. The NBFCs have grown rapidly since 1990. They offer attractive
rate of return. They are fund based as well as service oriented companies. Their
main companies are banks and financial institutions. According to RBI Act 1934, it
is compulsory to register the NBFCs with the Reserve Bank of India.

The NBFCs in advanced countries have grown significantly and are now coming
up in a very large way in developing countries like Brazil, India, and Malaysia etc.
The non-banking companies when compared with commercial and co-operative
banks are a heterogeneous (varied) group of finance companies. NBFCs are
heterogeneous group of finance companies means all NBFCs provide different
types of financial services.

1
Non-Banking Financial Companies constitute an important segment of the
financial system. NBFCs are the intermediaries engaged in the business of
accepting deposits and delivering credit. They play very crucial role in
channelizing the scare financial resources to capital formation.

NBFCs supplement the role of the banking sector in meeting the increasing
financial need of the corporate sector, delivering credit to the unorganized sector
and to small local borrowers. NBFCs have more flexible structure than banks. As
compared to banks, they can take quick decisions, assume greater risks and tailor-
make their services and charge according to the needs of the clients. Their flexible
structure helps in broadening the market by providing the saver and investor a
bundle of services on a competitive basis.

Non Banking Finance Companies (NBFCs) are a constituent of the institutional

structure of the organized financial system in India. The Financial System of any
country consists of financial Markets, financial intermediation and financial
instruments or financial products. All these Items facilitate transfer of funds and
are not always mutually exclusive. Inter-relationships Between these are parts of
the system e.g. Financial Institutions operate in financial markets and are,
therefore, a part of such markets.

NBFCs at present providing financial services partly fee based and partly fund
based. Their fee based services include portfolio management, issue management,
loan syndication, merger and acquisition, credit rating etc. their asset based
activities include venture capital financing, housing finance, equipment leasing,
hire purchase financing factoring etc. In short they are now providing variety of

2
services. NBFCs differ widely in their ownership: Some are subsidiaries of large
Manufacturers (e.g., T.V. Motors T.V. Finances and Services Ltd). Many others
are owned by banks such as ICICI Banks, ICICI Securities Ltd, SBI Capital
Market Ltd, Muthoot Bankers Muthoot Financial Services Ltd a key player in
Kerala financial services. Other financial institutions are IFCIs IFCI Financial
Services Ltd or IFCI Custodial Services Ltd (Devdas, 2005).
Non-banking Financial Institutions carry out financing activities but their resources
are not directly obtained from the savers as debt. Instead, these Institutions
mobilize the public savings for rendering other financial services including
investment. All such Institutions are financial intermediaries and when they lend,
they are known as Non-Banking Financial Intermediaries (NBFIs) or Investment
Institutions.

The term “Finance” is often understood as being equivalent to “money”. However,

final exactly is not money; it is the source of providing funds for a particular
activity. The word system, in the term financial system, implies a set of complex
and closely connected or inter-linked Institutions, agents, practices, markets,
transactions, claims, and liabilities in the Economy. The financial system is
concerned about money, credit and finance. The three terms are intimately related
yet are somewhat different from each other:

 Money refers to the current medium of exchange or means of payment.

 Credit or loans is a sum of money to be returned, normally with interest; it
refers to a debt
 Finance is monetary resources comprising debt and ownership funds of the
state, company or person.

3
HISTORICAL BACKGROUND.

The Reserve Bank of India Act, 1934 was amended on 1st December, 1964 by the
Reserve Bank Amendment Act, 1963 to include provisions relating to non-banking
institutions receiving deposits and financial institutions. It was observed that the
existing legislative and regulatory framework required further refinement and
improvement because of the rising number of defaulting NBFCs and the need for an
efficient and quick system for Redressal of grievances of individual depositors.
Given the need for continued existence and growth of NBFCs, the need to develop
a framework of prudential legislations and a supervisory system was felt especially
to encourage the growth of healthy NBFCs and weed out the inefficient ones. With
a view to review the existing framework and address these shortcomings, various
committees were formed and reports were submitted by them. Some of the
committees and its recommendations are given hereunder:

1. James Raj Committee (1974)

The James Raj Committee was constituted by the Reserve Bank of India in 1974.
After studying the various money circulation schemes which were floated in the
country during that time and taking into consideration the impact of such schemes
on the economy, the Committee after extensive research and analysis had suggested
for a ban on Prize chit and other schemes which were causing a great loss to the
economy. Based on these suggestions, the Prize Chits and Money Circulation
Schemes (Banning) Act, 1978 was enacted

4
2. Dr.A.C.Shah Committee (1992):

The Working Group on Financial Companies constituted in April 1992 i.e. the Shah
Committee set out the agenda for reforms in the NBFC sector. This committee
made wide ranging recommendations covering, inter-alia entry point norms,
compulsory registration of large sized NBFCs, prescription of prudential norms for
NBFCs on the lines of banks, stipulation of credit rating for acceptance of public
deposits and more statutory powers to Reserve Bank for better regulation of
NBFCs.

3. Khan Committee (1995)

This Group was set up with the objective of designing a comprehensive and
effective supervisory framework for the non-banking companies segment of the
financial system. The important recommendations of this committee are as follows:
i. Introduction of a supervisory rating system for the registered NBFCs. The
ratings assigned to NBFCs would primarily be the tool for triggering on-site
inspections at various intervals.
ii. Supervisory attention and focus of the Reserve Bank to be directed in a
comprehensive manner only to those NBFCs having net owned funds of
Rs.100 laths and above.
iii. Supervision over unregistered NBFCs to be exercised through the off-site
surveillance mechanism and their on-site inspection to be conducted
selectively as deemed necessary depending on circumstances.
iv. Need to devise a suitable system for co-coordinating the on-site inspection
of the NBFCs by the Reserve Bank in tandem with other regulatory

5
 authorities so that they were subjected to one-shot examination by different
regulatory authorities.

v. Some of the non-banking non-financial companies like

industrial/manufacturing units were also undertaking financial activities
including acceptance of deposits, investment operations, leasing etc to a great
extent. The committee stressed the need for identifying an appropriate
authority to regulate the activities of these companies, including plantation
and animal husbandry companies not falling under the regulatory control of
Either Department of Company Affairs or the Reserve Bank, as far as their
mobilization of public deposit was concerned.

vi. Introduction of a system whereby the names of the NBFCs which had not
complied with the regulatory framework / directions of the Bank or had
failed to submit the prescribed returns consecutively for two years could be
published in regional newspapers.

4. Narasimhan Committee (1991)

This committee was formed to examine all aspects relating to the structure,
organization & functioning of the financial system.

These were the committee’s which founded non- banking financial companies.

6
NON-BANKING FINANCIAL COMPANY (NBFC)

-MEANING

Non-Banking Financial Companies (NBFCs) play a vital role in the context of

Indian Economy. They are indispensible part in the Indian financial system
because they supplement the activities of banks in terms of deposit mobilization
and lending. They play a very important role by providing finance to activities
which are not served by the organized banking sector. So, most the committees,
appointed to investigate into the activities, have recognized their role and have
recognized the need for a well-established and healthy non-banking financial
sector.

Non-Banking Financial Company (NBFC) is a company registered under the

Companies Act, 1956 and is engaged in the business of loans and advances,
acquisition of shares/stock/bonds/debentures/securities issued by Government or
local authority or other securities of like marketable nature, leasing, hire-purchase,
insurance business, chit business but does not include any institution whose
principal business is that of agriculture activity, industrial activity,
sale/purchase/construction of immovable property.

Non-banking institution which is a company and which has its principal business
of receiving deposits under any scheme of arrangement or any other manner,
or lending in any manner is also a non- banking financial company.

7
DEFINITIONS OF NBFC.

Non-Banking Financial Company has been defined as:

(i) A non-banking institution, which is a company and which has its principal
business the receiving of deposits under any scheme or lending in any
manner.

(ii) Such other non-banking institutions, as the bank may with the previous
approval of the central government and by notification in the official gazette,
specify.

NBFCS provide a range of services such as hire purchase finance, equipment lease
finance, loans, and investments. NBFCS have raised large amount of resources
through deposits from public, shareholders, directors, and other companies and
borrowing by issue of non-convertible debentures, and so on.

Non-banking Financial Institutions carry out financing activities but their resources
are not directly obtained from the savers as debt. Instead, these Institutions
mobilize the public savings for rendering other financial services including
investment. All such Institutions are financial intermediaries and when they lend,
they are known as Non-Banking Financial Intermediaries (NBFIs) or Investment
Institutions:

 UNIT TRUST OF INDIA.

 LIFE INSURANCE CORPORATION (LIC).
 GENERAL INSURANCE CORPORATION (GIC).

8
Factors contributing to the Growth of NBFCs:

According to A.C. Shah Committee, a number of factors have contributed to the

growth of NBFCs. Comprehensive regulation of the banking system and absence
or relatively lower degree of regulation over NBFCs has been one of the main
reasons for their growth. During recent years regulation over their activities has
been strengthened, as see a little later.

The merit of non-banking finance companies lies in the higher level of their
customer orientation. They involve lesser pre or post-sanction requirements, their
services are marked with simplicity and speed and they provide tailor-made
services to their clients. NBFCs cater to the needs of those borrowers who remain
outside the purview of the commercial banks as a result of the monetary and credit
policy of RBI. In addition, marginally higher rates of interest on deposits offered
by NBFCs also attract a large number of depositors

Regulation of NBFCs

In 1960s, the Reserve Bank made an attempt to regulate NBFCs by issuing

directions to the maximum amount of deposits, the period of deposits and rate of
interest they could offer on the deposits accepted. Norms were laid down regarding
maintenance of certain percentage of liquid assets, creation of reserve funds, and
transfer thereto every year a certain percentage of profit, and so on. These
directions and norms were revised and amended from time to time.

In 1997, the RBI Act was amended and the Reserve Bank was given
comprehensive powers to regulate NBFCs. The amended Act made it mandatory
for every NBFC to obtain a certificate of registration and have minimum net

9
owned funds. Ceilings were prescribed for acceptance of deposits, capital
adequacy, credit rating and net-owned funds. T he Reserve Bank also developed a
comprehensive system to supervise NBFCs accepting/ holding public deposits.
Directions were also issued to the statutory auditors to report non-compliance with
the RBI Act and regulations to the RBI, Board of Directors and shareholders of the
NBFCs.

10
 CLASSIFICATION OF NBFCs:

This classification is in addition to the present classification of NBFCs into

deposit-taking and Non-deposit-taking NBFCs. Depending on the nature their
major activity, the non-banking financial companies can be classified into the
following categories, they are:

(1) Equipment leasing companies.

(2) Hire-purchase finance companies.
(3) Housing finance-companies.
(4) Investments companies.
(5) Loan companies.
(6) Mutual Fund Benefit Companies.
(7) Chit fund companies.
(8) Residuary companies.

 Equipment Leasing Company:

(a) Equipment leasing company means any company which is carrying on the
activity of leasing of equipment, as its main business, or the financing of
such activity.
(b) The leasing business takes place of a contract between the lessor (lessor
means the leasing company) and the lessee (lessee means a borrower).
(c) Under leasing of equipment business a lessee is allowed to use particular
capital equipment, as a hire, against a payments of a monthly rent.

11
(d) Hence, the lessee does not purchase the capital equipment, but he buys the
right to use it.
(e) There are two types of leasing arrangements, they are:
(i) Operating leasing: In operating leasing the producer of capital equipment
offers his product directly to the lessee on a monthly rent basis. There is no
middleman in operating leasing.
(ii) Finance leasing: In finance leasing, the producer of the capital equipment
sells the equipment to the leasing company, then the leasing company leases
it to the final user of the equipment. Hence, there are three parties in finance
leasing. The leasing company acts as a middleman between the producer of
equipment and the user of equipment.

 Benefits/Advantages of Leasing:

(1) 100% finance:

They borrower in the equipment can get up to 100% finance for the use of
capital through leasing arrangement in the sense, that the leasing company
provides the equipment immediately and the borrower need not pay the full
amount at once. Hence, the borrower can use the amount for fulfilling other
needs such as expansion development, etc.

(2) Payment is easier:

Leasing finance is costlier. However, the borrower finds it convenient (easy)
as he has to pay in installments out of the return from the investment in the
equipment. Hence, the borrower does not feel the burden of payment.

12
(3) Tax concessions:
The borrower can get tax concessions in case of leasing equipments. The
total amounts of rent paid on leased equipment are deducted from the gross
income. In case of immediate purchase, interest on the loan and the
depreciation are deducted from the taxable income.

 Hire-purchase Finance Companies:

(a) Hire purchase finance company means any company which is carrying on
the main business of financing, physical assets through the system of hire-
purchase.
(b) In hire-purchase, the owner of the goods hires them to another party for a
certain period and for a payment of certain installment until the other party
owns it.
(c) The main feature of hire-purchase is that the ownership of the goods
remains with the owner until the last installment is paid to him. The
ownership of goods passes to the user only after he pays the last installment
of goods.
(d) Hire-purchase is needed by farmers, professionals and transport group
people to buy equipment on the basis of hire purchase.
(e) It is a less risky business because the goods purchased on hire purchase
basis serve as securities till the installment on the loan is paid.
(f) Generally, automobile industry needs lot hire-purchase finance.
(g) The problem of recovery of loans does not occur in most cases, as the
borrower is able to pay back the loan out of future earnings through the
regular generation of funds out of the asset purchased.

13
(h) In India, there are many individuals and partnership firms doing this
business. Even commercial banks, hire-purchase companies and state
financial corporations provide hire-purchase credit.
 Housing Finance Companies:

(a) A housing finance company means any company which is carrying on its
main business of financing the construction or acquisition of houses or
development of land for housing purposes.
(b) Housing finance companies also accept the deposits and lend money only
for housing purposes.
(c) Even though there is a heavy demand for housing finance, these companies
have not made much progress and as on 31st March, 1990 only 17 such
companies here reported to the RBI.
(d) The ICICI and the Canara Bank took the lead to sponsor housing finance
companies, namely, Housing Development Corporation Ltd. and the Canfin
Homes Ltd.
(e) All the information about the Housing finance companies is available with
the National Housing Bank. Housing finance companies also have to
compulsorily to register themselves with the Reserve Bank of India.
(f) National Housing bank is the apex institution in the field of housing. It
promotes housing finance institutions, both on regional and local levels.

 Investment Companies:
(a) Investment company means any company which is carrying on the main
business of securities.
(b) Investment companies in India can be broadly classified into two types:

14
(1) Holding Companies:
(i) In case of large industrial groups, there are holding companies which buy
shares mainly for the purpose of taking control over another institution.
(ii) They normally purchase the shares of the institution with the aim of
controlling it rather than purchasing shares of different companies.
(iii) Such companies are set up as private limited companies.

(2) Other Investment Companies:

(i) Investment companies are also known as Investment trusts.
(ii) Investment companies collect the deposits from the public and invest them
in securities.
(iii) The main aim of investment companies is to protect small investors by
collecting their small savings and investing than in different securities so
that the risk can be spread.
(iv) An individual investor cannot do all this on his own, due to lack of
expertise in investing. Hence, investing companies are formed for
collective investing. Companies are formed for collective investments of
money, mainly of small investors.
(v) Another benefit of an investment company is that it offers trained,
experienced and specialised management of funds.
(vi) It helps the investors to select a financially sound and liquid security.
Liquid security means a security which can be easily converted into cash.
(vii)In India investment trusts are very popular. They help in putting the
savings of people into productive investments.
(viii)Some of the investment trusts also do underwriting, promoting and
holding company business besides financing.
(ix)These investments trusts help in the survival of business in the economy by

15
 keeping the capital market alive, active and busy.

 Loan company:

(a) A loan company means any company whose main business is to provide
finance through loans and advances.
(b) It does not include a hire purchase finance company or an equipment leasing
company or a housing finance company.
(c) Loan company is also known as a “Finance Company".
(d) Loan companies have very little capital, so they depend upon public
deposits as their main source of funds. Hence, they attract deposits by
offering high rates of interest.
(e) Normally, the loan companies provide loans to wholesalers, retailers, small-
scale industries, self-employed people, etc.
(f) Most of their loans are given without any security. Hence, they are risky.
(g) Due to this reason, the loan company charges high rate of interest on its
loans. Loans are generally given for short period of time but they can be
renewed.

 Mutual Benefit Financial Company:

(a) They are the oldest form of non-banking financial companies.

(b) A mutual benefit financial company means any company which is notified
under section 620A of the Companies Act, 1956.
(c) It is popularly known as "Nidhis".
(d) Usually, it is registered with only very small number of shares. The value of

16
 the shares is often Rs. 1 only
(e) It accepts deposits from its members and lends only to its members against
tangible securities.
 Chit-fund Companies:
 History:

The chit fund schemes have a long history in the southern states of India. Rural
unorganized chit funds may still be spotted in many southern villages. However,
organized chit fund companies are now prevalent all over India. The word is Hindi
and refers to a small note or piece of something. The word passed into the British
colonial “lexicon” and is still used to refer to a small piece of paper, a child or
small girl

 How Chit Fund Help?

Chit Funds have the advantage both for serving a need and as an investment.
Money can be readily drawn in an emergency or could be continued as an
investment.
Interest rate is determined by the subscribers themselves, based on mutual
decisions and varies from auction to auction.
The money that you borrow is against your own future contributions.
The amount is given on personal sureties too; unlike in banks and other financial
institutions which demand a tangible security.
Chit funds can be relied upon to satisfy personal needs. Unlike other financial
institutions, you can draw upon your chit fund for any purpose - marriages,
religious functions, medical expenses, just anything...

17
Cost of intermediation is the lowest.

(a) Chit funds companies are one of the oldest forms of local non-banking
financial institution in India.
(b) They are also known as "kuries".
(c) These institutions have originated from south India and are very popular
over there.
(d) A chit fund organisation is an organisation of a number of people who join
together and subscribe (contribute) amounts monthly so that any members
who is in need of funds can draw the amount less expenses for conducting
the chit. It is an organisation run on co-operative basis for the benefit of the
members who contribute money, the funds are used by them as and when a
particular member needs it.
(e) It helps the persons who save money regularly to invest their savings with
good chances of profit.
(f) Chit funds have many defects as the rate of return given to each member is
not the same.
(g) It differs from person to person, this leads in improper distribution of gains
and losses.
(h) Also, the promoters of these funds do everything for their own benefit to get
maximum income.
(I) Hence, the banking commission has made suggestions to pass uniform chit
funds laws for the whole of India.

18
 Residuary Non-banking Companies:

(a) The term "residue" means a small part of something that remains. As the
meaning of the term shows, a residuary company is one which does not fall
in any of the above categories.

(b) It generally accepts deposits by operating different schemes similar to

recurring deposit schemes of banks.
(c) Deposits are collected from a large number of people by promising them
that their money would be invested in banks and government securities
(d) The collection of deposits is done at the doorsteps of depositors through
bank staff, who is paid commission.
(e) These companies get the funds at low cost for longer terms, at they invest
them in investments which generates good amount of return.
(f) Many of these companies operate with very small amount of capital.
(g) They have some adverse (bad) features, such as:
(ii) Some do not submit periodic returns to the regulatory authority.
(iii) Some of them do not appoint banks, etc.

19
ROLE OF NON- BANKING FINANCIAL COMPANIES.
(1) Promoters Utilization of Savings:

Non- Banking Financial Companies play an important role in promoting the

utilization of savings among public. NBFC’s are able to reach certain deposit
segments such as unorganized sector and small borrowers were commercial bank
cannot reach. These companies encourage savings and promote careful spending of
money without much wastage. They offer attractive schemes to suit needs of
various sections of the society. They also attract idle money by offering attractive
rates of interest. Idle money means the money which public keep aside, but which
is not used. It is surplus money.

(2) Provides easy, timely and unusual credit:

NBFC’s provide easy and timely credit to those who need it. The formalities and
procedures in case of NBFC’s are also very less. NBFC’s also provides unusual
credit means the credit which is not usually provided by banks such as credit for
marriage expenses, religious functions, etc. The NBFC’s are open to all. Every one
whether rich or poor can use them according to their needs.

(3) Financial Supermarket:

NBFC’s play an important role of a financial supermarket. NBFC’s create a

financial supermarket for customers by offering a variety of services. Now,
NBFC’s are providing a variety of services such as mutual funds, counseling,
merchant banking, etc. apart from their traditional services. Most of the NBFC’s
reduce their risks by expanding their range of products and activities.

20
(4) Investing funds in productive purposes:

NBFC’s invest the small savings in productive purposes. Productive purposes

mean they invest the savings of people in businesses which have the ability to earn
good amount of returns. For example – In case of leasing companies lease
equipment to industrialists, the industrialists can carry on their production with less
capital and the leasing company can also earn good amount of profit.

(5) Provide Housing Finance:

NBFC’s, mainly the Housing Finance companies provide housing finance on easy
term and conditions. They play an important role in fulfilling the basic human need
of housing finance. Housing Finance is generally needed by middle class and lower
middle class people. Hence, NBFC’s are blessing for them.

(6) Provide Investment Advice:

NBFC’s, mainly investment companies provide advice relating to wise investment

of funds as well as how to spread the risk by investing in different securities. They
protect the small investors by investing their funds in different securities. They
provide valuable services to investors by choosing the right kind of securities
which will help them in gaining maximum rate of returns. Hence, NBFC’s plays an
important role by providing sound and wise investment advice.

(7) Increase the Standard of living:

NBFC’s play an important role in increasing the standard of living in India. People
with lesser means are not able to take the benefit of various goods which were once
considered as luxury but now necessity, such as consumer durables like Television,
Refrigerators, Air Conditioners, Kitchen equipments, etc. NBFC’s increase the

21
Standard of living by providing consumer goods on easy installment basis.
NBFC’s also facilitate the improvement in transport facilities through hire-
purchase finance, etc. Improved and increased transport facilities help in
movement of goods from one place to another and availability of goods increase
the standard of living of the society.

(8) Accept Deposits in Various Forms:

NBFC’s accept deposits forms convenient to public. Generally, they receive

deposits from public by way of depositor a loaner in any form. In turn the NBFC’s
issue debentures, units’ certificates, savings certificates, units, etc. to the public.

(9) Promote Economic Growth:

NBFC’s play a very important role in the economic growth of the country. They
increase the rate of growth of the financial market and provide a wide variety of
investors. They work on the principle of providing a good rate of return on saving,
while reducing the risk to the maximum possible extent. Hence, they help in the
survival of business in the economy by keeping the capital market active and busy.
They also encourage the growth of well- organized business enterprises by
investing their funds in efficient and financially sound business enterprises only.
One major benefit of NBFC’s speculative business means investing in risky
activities. The investing companies are interested in price stability and hence
NBFC’s, have a good influence on the stock- market. NBFC’s play a very positive
and active role in the development of our country.

22
Functions of Non- Banking Financial Companies:

(1) Receiving benefits:

The primary function of nbfcs is receive deposits from the public in various ways
such as issue of debentures, savings certificates, subscription, unit certification, etc.
thus, the deposits of nbfcs are made up of money received from public by way of
deposit or loan or investment or any other form.

(2) Lending money:

Another important function of nbfcs is lending money to public. Non- banking

financial companies provide financial assistance through.

(a) Hire purchase finance:

Hire purchase finance is given by nbfcs to help small important operators,

professionals, and middle income group people to buy the equipment on the
basis on Hire purchase. After the last installment of Hire purchase paid by
the buyer, the ownership of the equipment passes to the buyer.

(b) Leasing Finance:

In leasing finance, the borrower of the capital equipment is allowed to use

it, as a hire, against the payment of a monthly rent. The borrower need not
purchase the capital equipment but he buys the right to use it.

(c) Housing Finance:

NBFC’s provide housing finance to the public, they finance for construction
of houses, development of plots, land, etc.

23
(d) Other types of finance provided by NBFCs include:

Consumption finance, finance for religious ceremonies, marriages, social

activities, paying off old debts, etc. NBFCs provide easy and timely finance
and generally those customers which are not able to get finance by banks
approach these companies.

(e) Investment of surplus money:

NBFCs invest their surplus money in various profitable areas.

24
 Commercial Bank versus (v/s) Non-banking Financial Companies

While commercial banks and non-banking financial companies are both financial
intermediaries (middleman) receiving deposits from public and lending them.
Commercial bank is called as “Big brother” while the “NBFC” is called as the
“Small brother. But there are some important differences between both of them,
they are as follows:

No. Commercial Banks. Non Bank Financial companies.

1 Issue of cheques:
In case of commercial banks, a
cheque can be issued against bank
deposits.
2 Rate of interest:
Commercial bank offer lesser rate
of interest on deposits and charge
less rate of interest on loans as
compared to NBFC’s.
In case of NBFC’s there is no
facility to issue cheques against
bank deposits.
NBFC’s offer higher rate of
interest on deposits and charge
higher rate of interest on loans as
compared to Commercial banks.

3 Facilities provided by them:

Commercial banks can enjoy the NBFC’s are not given such facilities.
benefit of certain facilities like
deposit insurance cover facilities,
refinancing facilities, etc.

25
4 Law which governs them:
NBFC’s are regulated by different
Commercial banks are regulated by regulation such as SEBI, Companies
Banking Regulation Act 1949 and Act, National Housing Bank, Unit
RBI. Fund Act and RBI.
5 Types of assets:
NBFC’s specialize in one types of
commercial banks hold a variety of asset. For e.g.: Hire purchase
assets in the form of loans, cash companies specialize in consumer
credit, bill of exchange, overdraft loans while Housing Finance
etc. Companies specialize in housing
finance only.

26
RBI Guidelines for Asset-Liability Management (ALM)
system in NBFCs.

This note lays down broad guidelines in respect of interest rate and
liquidity risks management systems in NBFCs which form part of the Asset
Liability Management (ALM) function. This is applicable to all NBFCs and
Residuary non-banking companies meeting the criteria of asset base of
Rs.100 crores, whether accepting deposits or not, or holding public deposits of
Rs.20 crores or more. Sl.No. Description / Compliance requirement Comments.

As we are aware, the guidelines for introduction of ALM system by banks and all
India financial intuitions have already been issued by Reserve Bank of India and
the system has become operational. Since the operations of financial companies
also give rise to Asset Liability mismatches and interest rate risk exposures, it has
been decided to introduce an ALM system for the NON- Banking Financial
Companies (NBFCs) as well, as part of their overall system for effective risk
management in their various portfolios. A copy of the guidelines for Asset
Liability Management (ALM) system in NBFCs is enclosed.

Is there an Asset Liability Committee (ALCO) consisting of the company’s

senior management to decide the business strategy of the NBFC.

1. In the normal course, NBFC'S are exposed to credit and market risks in
view of the asset-liability transportation. With liberalization in Indian
financial markets over the last few years and growing integration of
domestic with external markets and entry of MNC's for meeting the credit
needs of not only the corporate but also the retail segments, the risks
associated with NBFC's operations have become complex and large,

27
 requiring strategic management. NBFC’s are now operating in a fairly
deregulated environment and are required to determine on their own,
interest rates on deposits, subject to the ceiling of maximum rate of interest
on deposits they can offer on deposits prescribed by the Bank; and advances
on a dynamic basis. The interest rates on investments of NBFC's in
Government and other securities are also now market related. Intense
pressure on the management of NBFC's to maintain a good balance among
spreads, profitability and long-term viability. Imprudent liquidity
management can put NBFC's earnings and reputation at great risk.

2. NBFC's need to address these risks in a structured manner by upgrading

their risk management and adopting more comprehensive Asset-Liability
Management (ALM) practices than has been done hitherto. ALM, among
other function, is also concerned with risk management and provides a
comprehensive and dynamic framework for measuring, monitoring and
managing liquidity and interest rate equity and commodity price risks of
major operators in the financial system that needs to be closely integrated
with the NBFC's business strategy. It involves assessment of various types
of risks and altering the asset-liability portfolio in a dynamic way in order to
manage risks.

3. This note lays down broad guidelines in respect of interest rate and liquidity
risks management systems in NBFC's which form part of the Asset-Liability
Management (ALM) function. The initial focus of the ALM function would
be to enforce the risk management discipline i.e. managing business after
assessing the risks involved. The objective of good risk management
systems should be that these systems will evolve into a strategic tool for

28
 NBFC's management.

4. The ALM process rests on three pillars:

 ALM Information Systems

 Management Information Systems
 Information availability, accuracy, adequacy and expediency
 ALM Organisation
 Structure and responsibilities
 level of top management involvement
 Risk parameters
 Risk identification
 Risk management
 Risk policies and tolerance levels.

ALM INFORMATION SYSTEMS

ALM has to be support by a management philosophy which clearly specifies the

risk policies and tolerance limits. This framework needs to be built on sound
methodology with necessary information system as back up. Thus, information is
the key to the ALM process. It is, however, recognized that varied business
profiles of NBFC's in the public and private sector do not make the adoption of a
uniform ALM System for all NBFC's feasible.

NBFC's have heterogeneous organizational structures, capital base, asset sizes

management profile, business activities and geographical spread. Some of them

29
have large number of branches and agents/ brokers whereas some have unitary
offices.
ALM ORGANISATION

(a) Successful implementation of the risk management process would require

strong commitment on the part of the senior management in the NBFC, to
integrate basic operations and strategic decision making with risk
management.
(b) The Asset-Liability Committee (ALCO) consisting of the NBFC's senior
management including Chief Executive Officer (CEO) should be
responsible for ensuring adherence to the limits set by the Board as well as
for deciding the business strategy of the NBFC (on the assets and liabilities
sides) in line with the NBFC's budget and decided risk management
objectives.
(c) The ALM Support Groups consisting of operating staff should be
responsible for analyzing, monitoring and reporting the risk profiles to the
ALCO. The staff should also prepare forecasts (simulations) showing the
effects of various possible changes in market conditions related to the
balance sheet and recommended the action needed to adhere to NBFC's
internal limits.

30
LIQUIDITY RISK MANAGEMENT

Measuring and managing liquidity needs are vital for effective operation of
NBFCs. By ensuring an NBFC's ability to meet its liabilities as they become due,
liquidity management can reduce the probability of an adverse situation
developing. The importance of liquidity transcends individual institution, as
liquidity shortfall in one institution can have repercussions on the entire system.
NBFCs management should measure not only the liquidity positions of NBFCs on
an ongoing basis but also examine how liquidity requirements are likely to involve
under different assumptions.
Experience shows that assets commonly considered as liquid, like Government
securities and other money market instruments, could also become illiquid when
the market and players are unidirectional.

NBFCs holding public deposits are required to invest up to a prescribed percentage

(15% as on date) of their public deposits in approved securities in terms of liquid
asset requirement of section 45-IB of the RBI Act,1934. Residuary Non-Banking
Companies (RNBCs) are required to invest up to 80% of their deposits in a manner
as prescribed in the Directions issued under the said Act. There is no such
requirements for NBFCs which are not holding public deposits. Thus various
NBFCs including RNBCs would be holding in their investments portfolio
securities which could be broadly classifiable as 'mandatory securities' (under
obligation of law) and other 'non-mandatory securities'.

31
 CHAPTER-2

Financial Companies Regulation Bill, 2000.

The Government of India framed the Financial Companies Regulation Bill, 2000 to
Consolidate the law relating to NBFCs and unincorporated bodies with a view to
ensured posit or protection. The salient features of this Bill are:

All NBFCS will be known as Financial Companies instead of NBFCs; NBFCs

holding public deposits would not be allowed to carry on any non-Financial
business with out the prior approval of RBI; RBI would have the powers to
prescribe minimum net-worth norms; unsecured depositors would have first charge
on liquid assets and assets created out of deployment of part of the reserve fund.

Financial Companies would require prior approval of RBI for any change in
name, management or registered office; Regulation of unincorporated bodies
would be in the hands of the respective State Governments; Penalties have been
rationalized with the objective that they should serve as a deterrent and
investigative powers have been vested with District Magistrates and
Superintendents of Police; RBI would be empowered to appoint Special Officer(s)
on delinquent financial companies; Any sale of property in violation of RBI order
would be void; The Company Law Board will continue to be the authority to
adjudicate the claims of depositors. Financial companies would have no recourse
to the CLB to seek deferment of the depositors’ dues. The Bill has been introduced
in Parliament in 2000 and has since been referred to the Standing Committee on
Finance. 8.0 Anomalies in the NBFC regulations.

32
1. Clarity in Definition of NBFC:

The clause (a) of the section 45 I of the RBI Act define the term
‘Business of A Non Banking Financial Institution’. Herein, it has been
stated that, ‘‘‘business of a non-banking financial institution’’ means carrying
on of the business of a financial institution referred to in clause (c) and includes
business of a non-banking financial company referred to in clause (f).’

Therefore, to understand what the business of Non Banking Financial

Institution is a reference has to be made to two other clauses (c) and (f).
Clause (c) defines the term ‘Financial Institution’ and clause (f) defines NBFC
itself. However, the clause (f) contains a comprehensive and exclusive definition
an NBFC. As per this clause a ‘‘non-banking financial company’’ means–

(i) A financial institution which is a company;

(ii) A non-banking institution which is a company and which has as its

principal business the receiving of deposits, under any scheme or
arrangement or in any other manner, or lending in any manner;

(iii) Such other non-banking institution or class of such institutions, as the

Bank may, with the previous approval of the Central Government and
by notification in the Official Gazette, specify. Therefore, we can say
an NBFC is always a company and can be a corporation or a co-operative
only if notified by RBI with approval of Central Government. However, no
co operative or corporation has been notified till now. The definition
of NBFC should have been simple to understand and need to cross
references to other clauses could have been avoided.

33
The definition of NBFC in our view could have been:

‘‘Non-Banking Financial Company’’ means–

A non banking company which carries on as its business or part of its

business any of the following activities, namely:–

(i) The financing, whether by way of making loans or advances or

otherwise, of any activity other than its own.

(ii) The acquisition of shares, stock, bonds, debentures or securities issued

by the Government or local authority or other marketable securities of a like
nature.

(iii) Letting or delivering of any goods to a hirer under a hire-purchase

agreement as defined in clause (c) of section 2 of the Hire-Purchase Act,
1972.

(iv) The carrying on of any class of insurance business.

(v) Managing, conducting or supervising, as foreman, agent or in any other

capacity, of chits or kuries as defined in any law which is for the time
being in force in any State, or any business, which is similar thereto.

(vi) Collecting, for any purpose or under any scheme or arrangement by

whatever name called, monies in lump sum or otherwise, by way of
subscriptions or by sale of units, or other instruments or in any other
manner and awarding prizes or gifts, whether in cash or kind, or
disbursing monies in any other way, to persons from whom monies

34
 are collected or to any other person, but does not include any institution,
which carries on as its principal business:–

(a) Agricultural operations; or (industrial activity; or)

(b) The purchase or sale of any goods (other than securities) or the
providing of any services; or

(c) The purchase, construction or sale of immovable property, so

however, that no portion of the income of the institution is derived
from the financing of purchases, constructions or sales of immovable
property by other persons

(d) A non banking company and which has as its principal business
the receiving of deposits, under any scheme or arrangement or in any
other manner, or lending in any manner;

(e ) Such other non-banking institution or class of such institutions, as

the Bank may, with the previous approval of the Central
Government and by notification in the Official Gazette, specify.

2. Clarification regarding what in Principle Business:

The sub clause (ii) of clause (f) which defines NBFC states that a non- banking
company that has as its principal business the receiving of deposits, under any
scheme or arrangement or in any other manner, or lending in any manner is
regarded as NBFC. Moreover, clause (c) that defined ‘financial institution’ also
refers to the phrase Principle business when it states that financial institution
does not include institution that carries on as its principle business(a)

35
agricultural operations; or (a) industrial activity; or (b) the purchase or sale
of any goods (other than securities) or the providing of any services; or (c)
the purchase, construction or sale of immovable property, so however, that
no portion of the income of the institution is derived from the financing of
purchases, constructions or sales of immovable property by other persons.

In the absence of a definition of the term ‘principal business’ in the Act itself, it is
not clear what should be the guidelines to be followed to determine the ‘principal
business’ of a company? In case of a company engaged exclusively in financial
business or a company doing exclusively non-financial business, the ‘principal
business’ will be evident enough and it may not be necessary to dwell upon
what constitutes ‘principal business’ of such a company. However, in the case
of companies which are carrying on multiple activities, both financial and
non- financial, in some what equal or near equal proportions, determining
the ‘principal business’ assumes considerable significance.

It would be necessary to define what constitutes the ‘principal business’ of these

companies, in the context of the obligations cast by the amended provisions
of the RBI Act on the NBFCs, viz., requirement of applying for registration in case
of existing companies and prior registration in case of new companies,
penalties for non-compliance with registration requirements, etc.

3. Applicability of Accounting Standards:

The clause 5 of the “Non-Banking Financial (Deposit Accepting or Holding )

Companies Prudential Norms (Reserve Bank) Directions, 2007” states that
Accounting Standards and Guidance notes issued by the Institute of Chartered

36
Accountants of India shall be followed in so far as they are not inconsistent
with any of the Directions. This clause should be rectified as ICAI has
issued Companies (Accounting Standards) Rules 2006, which are applicable
to accounting periods commencing on or after 7-12-2006.

The Government of India framed a new legislation to amend and consolidate the
provisions contained in Chapter IIIB, III-C and V of the RBI Act, 1934 relating to
the regulation and supervision of financial companies, hither to known as non-
banking financial companies (NBFCs). This included prohibition of acceptance of
deposits by unincorporated bodies and incorporating the recommendations of the
Task Force on NBFCs, which had made certain recommendations to this effect.
The salient features of the proposed legislation, which are materially different from
the corresponding provisions of RBI Act or are new provisions, are as follows:

I. Basic Stipulations:

(i) The draft bill has been named as “Financial Companies Regulations Bill,
2000”. All the NBFCs will be known as Financial Companies instead of
NBFCs.

(ii) The term 'public deposit' has been defined in the Bill for the first time and
the definition would mean the same as at present in the NBFC Directions.

(iii) There would be a nine member Advisory Council for Financial Companies
under the Chairmanship of Depute Companies and other experts in related
areas to advise the Reserve Bank.

(iv) NBFCs holding /accepting public deposits would be prohibited from

carrying on any non- financial business without the prior approval of the
Reserve Bank and the non-financial business presently carried on by them

37
 would have to be wound up or transferred to a subsidiary within three years.
Any other business or fee-based activity like insurance agency business,
portfolio management, etc., would require prior approval of the Reserve
Bank.

II .Entry Point Norms:

(i) The requirement of obtaining the COR from the Reserve Bank would be
compulsory for all financial Companies, irrespective of whether the
companies accept public deposits or not. However, the nonpublic Deposit
taking financial companies would require minimum owned fund of Rs.25
Lakh, whereas the public deposit taking financial companies would require
minimum net owned fund (NOF) of Rs.2 Crores and a specific authorization
from the Reserve Bank to accept public deposits.

(ii) There would be powers with the Reserve Bank to:

(a) Prescribe different capital for different classes of financial companies,

(b) Raise the requirement of minimum owned fund (entry norm) from Rs.25
Lakh to of Rs.25 Lakh to Rs.2 crores for the existing financial
companies accepting public deposits. However, sufficient time would be
allowed to such financial companies to attain the enhanced capital
requirement.

(iii) The requirement of creation of reserve fund would be applicable only to the
financial companies accepting public deposits, as against the earlier
requirement applicable to all NBFCs.

38
(iv) Unsecured depositors would have first charge on liquid assets and assets
created out of the deployment of the part of the reserve fund.

(v) The financial companies would require prior approval of the Reserve Bank
for any change in the name, change in the management or change in the
location of the registered office.

III Regulatory and Supervisory Issues:

(i) The Reserve Bank would be empowered to appoint Special Officer(s) on a

delinquent financial company and a duty has been cast on such company to
cooperate with such Special Officer(s).

(ii) The Company Law Board (CLB) would continue to be authority to

adjudicate the claims of depositors against the delinquent companies with
powers to order initial payment of a part of deposit, attach assets of the
fraudulent financial company and appoint Recovery Officer(s) for
management of such asset. Financial company would have no recourse to
the CLB to seek deferment of the depositors' dues.

(iii) The prohibitory provisions for unincorporated bodies would continue in the
Financial Companies Regulations Bill, but the role of exercising the powers
for enforcement of these provisions have been exclusively entrusted to State
Governments, in addition to the powers under the respective State Laws for
protecting the interests of investors in financial establishments.

(iv) There would be powers vested in the District Magistrates to call for
information and to proceed against delinquent unincorporated bodies.

39
(v) There would be a ban on the issue of advertisement for soliciting deposits
by all unincorporated bodies, irrespective of whether they are conducting
financial business or not.

(vi) Unauthorized deposit-taking by companies (a) whose applications for

Certificate of Registration have been rejected, (b) whose registration has
been cancelled, (c) who have been prohibited from accepting public
deposits would be a cognizable offence. The same would be the case for
unregistered financial companies as well as unincorporated bodies.

(vii) Powers would be vested with a police officer of the rank not below that of
the Superintendent of Police Of any State to order investigations into the
alleged violations of requirement of registration by financial companies and
prohibition from acceptance of deposits by unincorporated bodies.

(viii) Penalties have been rationalized in accordance with the severity of defaults,
with the objective that the penalty should serve as a deterrent to others. The
Bill has been introduced in the Parliament in 2000 and has since been
referred to the Standing Committee on finance.

The Government of India framed the Financial Companies Regulation Bill, 2000,
to consolidate the law relating to NBFCs and unincorporated bodies with a view to
ensure depositor protection.

40
AN APPRAISAL OF FINANCIAL COMPANIES
REGULATION BILL, 2000:

THE UNION Government's move to enact a separate law to regulate and control
the non-banking finance companies (NBFC) sector is indeed laudable, after a large
number NBFCs had failed to repay public deposits, ruining thousands of gullible
investors, drawn mainly from the middle class strata of the society. However, a
careful perusal of the new bill, introduced in the Lok Sabha on December 13,
shows that this legislation seeks largely to consolidate into a single stand-alone
enactment the regulatory provisions concerning the NBFC sector already existing
in Chapters 111-B and C of the Reserve Bank of India Act, 1934, (RBI Act), as
amended in 1997. Thus the new law, when enacted, will just be old wine in new
bottle.

It was in the wake of the CRB scam that left several thousands of depositors high
and dry that the RBI Act was amended in 1997 to empower, inter alia, the
Company Law Board (CLB) to hear and decide complaints from depositors on
defaults committed by financial companies. However, an objective study will
reveal that the RBI (Amendment) Act, 1997, which added Chapter IR-B to the
parent Act, has hardly benefited the depositor fraternity. The winding-up petition
filed against CRB by the RBI under the new provisions in 1997 is still pending
with the Delhi High Court. The perpetrators of the CRB fraud have been bailed out

41
and are scot-free. Many depositors have been devastated. Justice delayed is indeed
justice denied.

Ineffective CLB orders

Close on the heels of this `mother' scam came a host of other NBFC failures - to
name a few, Prudential Capital Markets, Lloyds Finance, Enarai Finance and
Kirloskar Investments. The CLB's orders on all these cases, directing the
companies concerned, to pay the depositors in accordance with specified phased
repayment schedules are just dead letters. Repayments are yet to start at Prudential
though the CLB order was passed in 1998; Lloyds continues to default on
repayments and is way behind schedule. Repeated representations from the
aggrieved depositors of these companies to the CLB and the RBI have failed to
improve matters. The RBI simply passes the buck on to the CLB. The latter just
does not have either the determination or the will to punish the errant boards and
managements though it has all the requisite powers under the Companies Act to do
so. The result - the depositors continue to suffer. ICICI got the CLB order on
Enarai Finance stayed and filed a liquidation petition against the company, which
is still pending. The RBI was inspired to follow ICICI's example in the case of
Kirloskar Investments and is keenly awaiting the Karnataka High Court's order on
its liquidation petition filed last February.

Against such a dismal scenario, is it not disappointing that the new bill provides for
payment defaults by the NBFCs to be adjudicated by the CLB? The CLB has no
power to review its own orders. It refuses to entertain petitions from depositors to

42
amend/clarify its orders and curtly asks the petitioners to approach the High Court.
Their order is routinely challenged at the High Courts and stays obtained. The
courts being overburdened with cases are least bothered to hear and dispose of the
stay petitions expeditiously.

The lay depositor is an unsecured creditor; he is entitled to immediate relief if the

company defaults. This can be provided by compulsory insurance of his deposit.
Bank deposits are automatically insured up to Rs. 1 Lakh per account.

Moreover, as an added protection to depositors, the Finance Minister has declared

in Parliament that no public sector bank will be liquidated. Why cannot the RBI
make it mandatory for NBFCs too to insure the deposits taken by them and issue
certificates of insurance along with the deposit receipts? If this were done, in the
event of default, all that the depositor has to do is to approach the insurance
company and claim his deposit and expeditious remedy and merits incorporation in
the bill. With the opening of the insurance business to the private sector, insurance
of NBFC deposits should not pose any problem. The insurance premium could be
allowed as tax deductible expenditure in the company's assessments.

For the first time, the bill provides for a first charge on the company's assets to the
depositor. However, in practice, this will be no solace to the depositor. For, the
`first charge' is available only upon default. Further, the charge is not on the entire
assets. It is on a maximum of 25 per cent of the total value of deposits taken which
the company is supposed to hold in unencumbered term deposits/approved
securities. Realization of the charged assets, upon an order of the CLB, is another
exercise altogether. All in all, the charge provision in the bill, though innovative,
does not inspire confidence. The Finance Ministry would do well to review this bill
in the light of these comments and make it more investor friendly as the avowed

43
objective of the new legislation is to protect the interests of depositors. The
Supreme Court has time and again ruled that death sentences should be
pronounced only in the rarest of rare cases. Perhaps, the RBI should extend this
dictum to corporate as well and refrain from filing liquidation petitions against
failed NBFCs.

44
CHAPTER-3

NORMS for NBFCS.

In public interest and to regulate the credit system in the best interest of India, the
RBI has laid down the following important norms or rules to be followed by
NBFCs accepting public deposits:

(1) What constitutes public deposits?

Public deposit includes fixed or recurring deposits which are received from friends,
relative, shareholders of a public limited company and money raised in issued of
unsecured debentures or bond. It does not include money raised from issue of
secured debentures and bond or from borrowings of banks or financial institutions,
deposits from directors or inter- corporate deposits received from foreign national
citizens and from shareholders of private limited companies.

(2) Who is allowed to accept deposits from public?

The NBFCs which have net owned capital of less than Rs. 25 Lakh will not be
permitted to accept deposit from public. In order to raise funds the NBFC can
borrow from some other sources also.

(3) NBFCs have to submit financial statements:

All NBFCs will have to submit their annual financial statements and returns if they
accept public deposits.

(4) Certain deposits are not regulated by RBI:

45
The RBI has given directions to NBFCs accepting public deposits to regulate the
amount of deposit, rate of interest, time period of deposits, brokerage and
borrowings received by them. The directions do not include amount received or
generated by central bank or state government. Amount received from IDBI, ICICI
Nabard, Electricity Board and IFCI are also not included in directions of RBI.
Amount received from mutual funds, directors of firm and shareholders also do not
come under the category of amount received for regulation from RBI.

(5) Ceiling (limits on interest):

There is a maximum limit on the rate of interest of deposits. The limit charges with
the RBI directions.

(6) Period of deposits:

The deposits can be accepted for a minimum period of 12 months and a maximum
period of 2 year.

(7) Register of depositors:

The NBFCs have to maintain a register of depositors with details like name,
address, amount, date of each deposit, maturity period and other details according
to the required by RBI.

(8) Credit rating:

To protect the public NBFCs are required to get themselves approved by the RBI
through credit rating agencies. The NBFCs which have not owned funds of Rs 25
Lakhs can obtain public deposits if they are credit rated and they receive a
minimum investment grade for their fixed deposits from an approved rating
agency.

46
The NBFCs have to submit this different agency is as follow:

 The credit analysis and Research Limited (CARE) gives the minimum
rating of BBB in triple B rating.
 The investment information and credit Rating Agency of India LTD.
(ICRA) gives the minimum rating of (MA-)
 The Credit Rating Information Services of India Ltd. (CRISIL) and gives a
minimum rating of (FA-).
 FITCH Rating India Pvt. Ltd. Provides (BBB-) as its acceptable rating.
If the credit rating is below the minimum investment grate the NBFCs has
to send report to the RBI within 15 days of received the grating. During that
time the NBFC has to stop accepted the deposits and within 3 years makes
the repayment to the depositors.

RBI deposit norms for small NBFCs.

The RBI has tightened the rules governing access to such public deposits.
It said that NBFCs with a net owned fund (NoF) of between Rs 25 Lakh and Rs 2
crore, must limit their public deposits to the level of their net owned funds as
against the current ceiling of 1.5 times the net owned funds. Further, for those
companies (with NoF of between Rs 25 Lakh and Rs 2 crore) that had a capital
adequacy ratio of 12% and who enjoyed credit rating, the current ceiling of 4
times the NoF was being revised to 1.5 times the NoF. As per RBI statistics, there
were 243 companies in 2007 that would probably be affected by this regulation.

47
Their net owned funds were of the order of Rs 171 crore while the public deposits
that they held were about Rs 96 crore. This category of companies constitutes a
big chunk in the total category of NBFCs taking deposits that number about 359.
In terms of amount of deposits involved, this category of NBFCs is a very small
category. Total public deposits of all NBFCs with access to such deposits were of
the order of Rs 2042 crore in 2007.

These regulations are part of the RBI’s move to ensure that NBFCs who accept
deposits are adequately capitalized and have some minimum net owned funds.

Mr. T.T.Srinivasaraghavan, Managing Director, Sundaram Finance, said that this

regulation had adopted a fair approach to the issue of dealing with risks involved
in smaller companies accepting deposits. He said the regulation met the
aspirations of those small companies as it would now take the pressure off them
when they were scrambling for capital to reach the minimum NoF limits. It would
also force them to live within their means, by limiting their access to public
deposits.

48
 The current status of Non- Banking Financial Companies.

 PRUDENTIAL NORMS:

The Reserve Bank put in place in January 1998 a new regulatory framework
involving prescription of prudential norms for NBFCs which deposits are taking to
ensure that these NBFCs function on sound and healthy lines. Regulatory and
supervisory attention was focused on the ‘deposit taking NBFCs’ (NBFCs – D) so
as to enable the Reserve Bank to discharge its responsibilities to protect the
interests of the depositors. NBFCs - D are subjected to certain bank –like
prudential regulations on various aspects such as income recognition, asset
classification and provisioning; capital adequacy; prudential exposure limits and
accounting / disclosure requirements. However, the ‘non-deposit taking NBFCs’
(NBFCs – ND) are subject to minimal regulation.

The application of the prudential guidelines / limits is thus not uniform across the
banking and NBFC sectors and within the NBFC sector. There are distinct
differences in the application of the prudential guidelines / norms as discussed
below:

i) Banks are subject to income recognition, asset classification and

provisioning norms; capital adequacy norms; single and group borrower
limits; prudential limits on capital market exposures; classification and
valuation norms for the investment portfolio; CRR / SLR requirements;
accounting and disclosure norms and supervisory reporting requirements.

ii) NBFCs – D are subject to similar norms as banks except CRR requirements
and prudential limits on capital market exposures. However, even where

49
 applicable, the norms apply at a rigour lesser than those applicable to banks.
Certain restrictions apply to the investments by NBFCs – D in land and
buildings and unquoted shares.

iii) Capital adequacy norms; CRR / SLR requirements; single and group
borrower limits; prudential limits on capital market exposures; and the
restrictions on investments in land and building and unquoted shares are not
applicable to NBFCs – ND.

iv) Unsecured borrowing by companies is regulated by the Rules made under

the Companies Act. Though NBFCs come under the purview of the
Companies Act, they are exempted from the above Rules since they come
under RBI regulation under the Reserve Bank of India Act. While in the
case of NBFCs – D, their borrowing capacity is limited to a certain extent
by the CRAR norm, there are no restrictions on the extent to which NBFCs
– ND may leverage, even though they are in the financial services sector.

50
Current Status:

 Financial Linkages between Banks and NBFC:

Banks and NBFCs compete for some similar kinds of business on the asset side.
NBFCs offer products/services which include leasing and hire-purchase, corporate
loans, investment in non-convertible debentures, IPO funding, margin funding,
small ticket loans, venture capital, etc. However NBFCs do not provide operating
account facilities like savings and current deposits, cash credits, overdrafts etc.

NBFCs avail of bank finance for their operations as advances or by way of banks’
subscription to debentures and commercial paper issued by them.

Since both the banks and NBFCs are seen to be competing for increasingly similar
types of some business, especially on the assets side, and since their regulatory and
cost-incentive structures are not identical it is necessary to establish certain checks
and balances to ensure that the banks’ depositors are not indirectly exposed to the
risks of a different cost-incentive structure. Hence, following restrictions have been
placed on the activities of NBFCs which banks may finance:

i) Bills discounted / rediscounted by NBFCs, except for rediscounting of bills

discounted by NBFCs arising from the sale of –

a) Commercial vehicles (including light commercial vehicles); and

b) Two-wheeler and three-wheeler vehicles, subject to certain conditions;

c) Investments of NBFCs both of current and long term nature, in any

company/entity by way of shares, debentures, etc. with certain exemptions;

51
ii) Unsecured loans/inter-corporate deposits by NBFCs to/in any company.

iii) All types of loans/advances by NBFCs to their subsidiaries, group

companies/entities.

iv) Finance to NBFCs for further lending to individuals for subscribing to Initial
Public Offerings (IPOs).

v) Bridge loans of any nature, or interim finance against capital/debenture issues

and/or in the form of loans of a bridging nature pending raising of long-term
funds from the market by way of capital, deposits, etc. to all categories of
Non-Banking Financial Companies, i.e. equipment leasing and hire-purchase
finance companies, loan and investment companies, Residuary Non-Banking
Companies (RNBCs).

vi) Should not enter into lease agreements departmentally with equipment
leasing companies as well as other Non-Banking Financial Companies
engaged in equipment leasing.

52
Current Status:

 Structural Linkages between Banks and NBFCs:

Banks and NBFCs operating in the country are owned and established by entities
in the private sector (both domestic and foreign), and the public sector.

Some of the NBFCs are subsidiaries/ associates/ joint ventures of banks –

including foreign banks, which may or may not have a physical operational
presence in the country. There has been increasing interest in the recent past in
setting up NBFCs in general and by banks, in particular.

Investment by a bank in a financial services company should not exceed 10 per

cent of the bank’s paid-up share capital and reserves and the investments in all
such companies, financial institutions, stock and other exchanges put together
should not exceed 20 per cent of the bank’s paid-up share capital and reserves.

Banks in India are required to obtain the prior approval of the concerned regulatory
department of the Reserve Bank before being granted Certificate of Registration
for establishing an NBFC and for making a strategic investment in an NBFC in
India. However, foreign entities, including the head offices of foreign banks having
branches in India may, under the automatic route for FDI, commence the business
of NBFI after obtaining a Certificate of Registration from the Reserve Bank.

NBFCs can undertake activities that are not permitted to be undertaken by banks or
which the banks are permitted to undertake in a restricted manner, for example,
financing of acquisitions and mergers, capital market activities, etc. The
differences in the level of regulation of the banks and NBFCs, which are

53
undertaking some similar activities, gives rise to considerable scope for regulatory
arbitrage. Hence, routing of transactions through NBFCs would tantamount to
undermining banking regulation.

This is partially addressed in the case of NBFCs that are a part of banking group on
account of prudential norms applicable for banking groups.

54
CHAPTER-4

CURRENT NEWS.

1) MAT changes will hit NBFCs.

Tuesday, September 1, 2009

The Direct Taxes Code (DTC) is slowly being put to deeper scrutiny. As is always
the case, some of the changes may be ushered in with good intention, but inept
drafting leaves the door open for needless litigation.

The newly crafted Minimum Alternate Tax (MAT) is a case in point. Ever since
Rajiv Gandhi unleashed the book profits tax on India Inc. in 1987, it has generated
controversies galore and kept all the courts busy interpreting the intention and
scope of the provision.

At present, MAT is applicable to corporate at 15 per cent on published profits. The

nominal tax rate for the corporate sector is 33.99 per cent and the effective rate
after all deductions/concessions stands at around 22.22 per cent.

MAT computation

MAT, despite the controversy surrounding its existence, has lived by the year for
now 22 years and promises to open a new chapter from April 1, 2011.

The mechanics, as per the DTC, is simple. MAT will now be 2 per cent of the
value of gross assets as against 15 per cent on profits. For this purpose the value of
gross assets would be computed as shown in the Table.

55
It may be noted that even business assets such as sundry debtors, loans and
advances will now form part of the computation of gross assets for the purpose of
the levy.

Further, while in the vertical form of the balance sheet the current assets are
disclosed net of current liabilities, the proposed MAT computation mechanism
does not envisage a reduction of current liabilities from current assets.

This also leads to an anomalous situation where a company has to pay MAT on the
amount of deferred tax asset, if it appears in the balance sheet of a company. The
rate of MAT is proposed to be 0.25 per cent in the case of banking companies and
2 per cent in the case of all other companies, including foreign companies.

This is clearly a hardship for Non-Banking Financial Companies (NBFCs) where

70-75 per cent of the assets in the balance-sheet constitute loans and advances,
stock on hire and business receivables. There does not appear to be any
justification in levying 2 per cent MAT on business assets, which in any case yield
income on monthly basis liable to corporate tax at 33.99 per cent (proposed to be
reduced to 25 per cent by the DTC). In the case of several large NBFCs, 2 per cent
MAT on gross assets would be far greater than 25 per cent on taxable income.

To make matters worse, MAT will now represent a final tax and will not be
allowed to be carried forward for claiming tax credit in subsequent years. Not only
this, certain companies, will receive an additional blow — for example, those in
gestation period; having negative net worth because of huge accumulated losses;
having book losses in the current year; having low asset-turnover ratio low net
profit ratio; and those earning mainly exempt income.

Change in concept:

56
The justification for re-jigging MAT is that several countries have adopted a tax
based on a percentage of assets. The concept of MAT when it first originated in
1987 was completely different from what is proposed in the DTC.

The economic rationale of “assets-based tax” is that it serves as an incentive for

efficiency. If that be so then the normal tax itself should serve the purpose.

Any sort of tax that departs from the mainstream route of linkage with
income/profits is bound to be litigious.

Added to that is the discrimination between banking companies and other

companies on the rate of tax. Some serious rethinking is required on the proposed
MAT in the DTC.

2) NBFCs

Posted on 19 September 2008 by Sara Jain close Author: Sara Jain:-

A non-banking financial company (NBFC) is a company registered under the

Companies Act, 1956 and is engaged in the business of loans and advances,
acquisition of shares/stock/bonds/debentures/securities issued by government or
local authority or other securities of like marketable nature, leasing, hire-purchase,
insurance business, chit business, but does not include any institution whose
principal business is that of agriculture activity, industrial activity,
sale/purchase/construction of immovable property.

Major difference between Banks & NBFCs

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

57
A NBFC cannot accept demand deposits (demand deposits are funds deposited at a
depository institution that are payable on demand immediately or within a very
short period like your current or savings accounts).

It is not a part of the payment and settlement system and as such cannot issue
cheque to its customers.

Deposit insurance facility of DICGC is not available for NBFC depositors unlike
in case of banks.

The important regulations relating to acceptance of deposits by

NBFCs are as follows:

The NBFCs are allowed to accept/renew public deposits for a minimum period of
12 months and maximum period of 60 months. They cannot accept deposits
repayable on demand.

NBFCs cannot offer interest rates higher than the ceiling rate prescribed by RBI
from time to time. The present ceiling is 11 per cent per annum. The interest may
be paid or compounded at rests not shorter than monthly rests.

NBFCs cannot offer gifts/incentives or any other additional benefit to the

depositors.

NBFCs (except certain AFCs) should have minimum investment grade credit
rating.

The deposits with NBFCs are not insured.

The repayment of deposits by NBFCs is not guaranteed by RBI.

58
There are certain mandatory disclosures about the company in the Application
Form issued by the company soliciting deposits.

Non-banking financial companies (NBFCs) have seen considerable business model

shift over last decade because of regulatory environment and market dynamics.

In the early 2000s, the NBFC sector in our country was facing following problems:

 High cost of funds.

 Slow industrial growth.

 Stiff competition with NBFCs as well as with banking sector.

 Small balance sheet size resulting in high cost of fund and low asset profile.

3) On AM ET advertisement:

(Start September 23, 2009 4:488.)

Reserve Bank of India's (RBI) latest guideline allowing non-banking finance

companies (NBFC) to issue semi-closed system pre-paid payment instruments will
boost the growth of m-commerce in India. Industry sources estimate that, in the
next 3 years, India could have 25 mn m-commerce users up from the current 5 mn.
The industry currently stands at a market size of $10bn.

"The new guideline will increase the reach of the services to the people at the
bottom of pyramid. Now, people not having any bank account could pay their
utility bill by electronic transfer. We expect a five fold increase in number of

59
people using m-commerce services," said Anil Gajwani, Senior Vice President -
Technology, Comviva Technologies.

After the new guideline, entry of a few NBFC MNCs into the segment could not be
denied. However, the most viable business plan would be for telecom operators, as
the guidelines will allow them to operate as a pre-paid payment instrument as well.
Considering the reach of the telcos, in urban, rural and semi-urban areas, their
entry will increase the penetration of the services among the masses.

Further, these telecom operators already have a large network of agents, who are
selling pre-paid recharge coupon to the end customer. As per industry estimate
every service provider has around 50,000 such agents. Telcos could use these
existing agents for m-commerce as well.

"This will certainly bring more people into the eco-system. Even people not having
any bank account would be able to do some basic financial transaction," said
Probir Roy, Co-founder and MD of Pay mate. Pay mate has currently half a million
users in the country. The company expects to grow manifold, in terms of the users,
by the end of current FY.

However, the new guidelines still have some bottlenecks, which the industry
people wanted to be removed. RBI restricts the maximum value of such payment
instruments that can be issued by the institutions/companies to Rs 5,000. Further,
these pre-paid payment instruments up to Rs 5,000 can be issued by accepting any
'officially valid documents' defined under Rule 2(d) of Prevention of Money
Laundering Act, as proof of identity.

Such instruments shall not permit cash withdrawal. The utility bills/essential
services shall include only electricity bills, water bills, telephone/mobile phone
bills, and insurance premium, cooking gas payments, ISP for Internet/broadband

60
connections, cable/DTH subscriptions and citizen services by government or
government bodies.

4) Invest in only top 15 NBFCs to play safe.

(On September 23, 2009 4:488)

NIVEDITA MOOKERJI

Investors once again faced disappointment with Kuber Finance defaulting on

payments. Although there have been several defaults in the past couple of years,
the Kuber fiasco brought back memories of the CRB scam in 1997. After the CRB
letdown, one thought investors were going to stay away from non-banking finance
companies (NBFCs) for a long time to come. But the temptation to earn high
returns was hard to resist, and investors burnt their fingers again.

But why don't investors learn from others' experiences? What is it that draws them
to NBFCs? Sheer Singh, banking and consumer analyst, Consult Opportune
(India's first consumer banking advisory service), explains why investors are still
opting for NBFCs.

Says Singh, ``the lure of earning returns, which are significantly higher than what
banks offer, is one of the reasons.'' Seen against the backdrop of dismal stock
market performance over the past few years, it becomes quite clear why people
still invest in NBFCs, he says. Lack of sufficient investment alternatives is also
why investors are drawn to NBFCs, says Singh. Giving a consumer point of view,
Singh says that through NBFC investments, people seek returns to hedge against

61
inflation. Plus, it is seen as a way to earn income to finance the growing
consumerist urge. And more than anything else, high returns promised by some
NBFCs seem to fulfill investors' desire to make a fast buck.

In such a scenario, sound guidelines may help investors in opting for the reliable
NBFCs. Sheer Singh offers guidelines which have been formulated by Consult
Opportune. The things to look for while investing in NBFCs, according to Consult
Opportune, are:

a) Deposits of NBFCs must have an adequate rating by one of the credit rating
agencies in India.

b) Preferably invest in deposits of only the top 10-15 NBFCs in India.

c) Review half-yearly factors such as credentials, market standing, and

professionalism of management and promoters track record of such NBFCs.

d) Take a close and critical look at the financing activities of such NBFCs to
decipher their long run viability.

e) Beware of glossy and misleading advertisements.

f) Avoid any NBFC offering unusually high interest rates which seem
`significantly higher' than prevalent rates offered by banks on similar
maturity periods.

g) Must prefer an NBFC with a nationwide network and more oriented towards
retail/ consumer finance activities due to significantly lower default rates
Apart from these dos and don'ts, the Reserve Bank of India also offers a
good data bank of the NBFCs which may be trusted. Particularly its website
at www.rbi.org. in has a list of over 500 NBFCs all over India which are

62
 authorized by the RBI to accept public deposits. Similarly, the site also
gives out the names of hundreds of NBFCs which have been denied
registration. Also, there's substantial information on RBI rules and
notifications in the subject Overall and valuable source of information and
assessment regarding investment in NBFCs. Such an information base could
sometimes prompt investors to even look for alternatives.

Talking about alternatives, Sheer Singh says that private sector banks rapidly
expanding their branch network in urban centers of India may emerge as preferred
alternatives to those NBFCs which are not among the top 20 in India.

He adds that high quality service being offered by new private sector banks;
beefing up of service and product levels by public sector banks; and expansion of
networks and product lines of the top NBFCs should offer investors other
alternatives.

On the future of NBFCs, Singh says: ``we foresee a bright future for the top 20
NBFCs in India.'' But it's not going to be a cakewalk. Says Singh: ``Considering
that in the future consumer-led growth rather than institutional-led growth would
be the trend, top NBFCs which focus on retail lending predominantly can
substantially leverage their networks to offer similar lending products offered by
banks.'' The focus has to be on marketing and service initiatives, he adds. And the
mantra for success: Offer cut-throat competition to banks.

63
 CHAPTER-4

List of Non-Banking Financial Companies:

A. R. T. LEASING PRIVATE LIMITED. ADOR FINANCE LTD.

144, M.C.ROAD, CHENGANNUR. ADOR HOUSE, 6 K DUBASH MARG
ALAPUZHA DISTRICT MUMBAI - 400 023
KERALA
AL BARR FINANCE HOUSE LTD AD-MANUM FINANCE LTD
(FORMERLY KNOWN AS 5, YESHWANT COLONY,
ALBARAKA FINANCE HOUSE INDORE 452 003 (MP)
LIMITED),
INDIA HOUSE NO. 2,
KEMPS CORNER,
MUMBAI – 400 036.
ADAYAR FINANCE & LEASING LTD., ALPIC FINANCE LTD.,
208, BHARATHI SALAI, NEW EXCELSIOR BLDG.,
ROYAPETTAH, 6TH FLOOR,
CHENNAI – 600 014 WALLACE STREET, FORT,
MUMBAI - 400 001

ALTA LEASING & FINANCE LTD. ANMOL FINANCIAL SERVICES LTD

ALTA BHAVAN, A -66, IST FLOOR,
532, SENAPATI BAPAT MARG GURU NANAK PURA , VIKAS MARG,
DADAR, DELHI - 110092
MUMBAI - 400 028

64
ANNA FINANCE LIMITED ABIRAMI FINANCIAL SERVICES
16 B/9, DEV NAGAR, (INDIA) LTD
D.B. GUPTA ROAD, 157, HABIBULLAH ROAD, T. NAGAR,
KAROL BAGH, CHENNAI - 600 017

AMARPREET FINANCE PVT. LTD., ANNA FINANCE LIMITED

182, NEW JAWAHAR NAGAR, 16 B/9, DEV NAGAR,
JALANDHR. D.B. GUPTA ROAD,
KAROL BAGH,
NEW DELHI -110005

65
 CHAPTER-5

Conclusion:

NBFCs are gaining momentum in last few decades with wide variety of products
and services. NBFCs collect public funds and provide loan able funds. There has
been significant increase in such companies since 1990s. They are playing a vital
role in the development financial system of our country. The banking sector is
financing only 40 per cent to the trading sector and rest is coming from the NBFC
and private money lenders. At the same line 50 per cent of the credit requirement
of the manufacturing is provided by NBFCs. 65 per cent of the private construction
activities was also financed by NBFCs. Now they are also financing second hand
vehicles. NBFCs can play a significant role in channelizing the remittance from
abroad to states such as Gujarat and Kerala.

NBFCs in India have become prominent in a wide range of activities like hire
purchase finance, equipment lease finance, loans, investments, and so on. NBFCs
have greater reach and flexibility in tapping resources. In desperate times, NBFCs
could survive owing to their aggressive character and customized services. NBFCs
are doing more fee-based business than fund based. They are focusing now on
retailing sector-housing finance, personal loans, and marketing of insurance. Many
of the NBFCs have ventured into the domain of mutual funds and insurance.
NBFCs undertake both life and general insurance business as joint venture
participants in insurance companies. The strong NBFCs have successfully emerged
as ‘Financial Institutions’ in short span of time and are in the process of converting
themselves into ‘Financial Super Market’. The NBFCs are taking initiatives to
establish a self-regulatory organization (SRO). At present, NBFCs are represented
by the Association of Leasing and Financial Services (ALFS), Federation of India

66
Hire Purchase Association (FIHPA) and Equipment Leasing Association of India
(ELA). The Reserve Bank wants these three industry bodies to come together
under one roof. The Reserve Bank has emphasis on formation of SRO Particularly
for the benefit of smaller NBFCs.

67