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INTRODUCTION

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.

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.

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CONCEPTUAL FRAMEWORK

NBFCs 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 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.

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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

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

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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:

Introduction of a supervisory rating system for the registered NBFCs. The ratingsassigned to NBFCs would primarily be the tool for triggering on-site inspections at

various intervals.

Supervisory attention and focus of the Reserve Bank to be directed in a comprehensivemanner only to those NBFCs having net owned funds of Rs.100 laths and above.

Supervision over unregistered NBFCs to be exercised through the off-site surveillancemechanism and their on-site inspection to be conducted selectively as deemed necessary

depending on circumstances.

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 authorities so that they were

subjected to one-shot examination by different regulatory authorities.

Some of the non-banking non-financial companies like industrial/manufacturing unitswere 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.

Introduction of a system whereby the names of the NBFCs which had not complied withthe regulatory framework / directions of the Bank or had failed to submit the prescribed

returns consecutively for two years could be published in regional newspapers.

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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 committees which founded non- banking financial companies.

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 ofshares/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.

DEFINITIONS OF NBFC

Non-Banking Financial Company has been defined as:

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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

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 savingsfor 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)

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

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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 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.

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.

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1. Equipment Leasing Company: 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.

The leasing business takes place of a contract between the lessor (lessor means theleasing company) and the lessee (lessee means a borrower).

Under leasing of equipment business a lessee is allowed to use particular capitalequipment, as a hire, against a payments of a monthly rent.

Hence, the lessee does not purchase the capital equipment, but he buys the right touse it.

There are two types of leasing arrangements, they are:o 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.o 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 useof 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.

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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.

2. Hire-purchase Finance Companies: Hire purchase finance company means any company which is carrying on the main

business of financing, physical assets through the system of hire-purchase.

In hire-purchase, the owner of the goods hires them to another party for a certain periodand for a payment of certain installment until the other party owns it.

The main feature of hire-purchase is that the ownership of the goods remains with theowner 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.

Hire-purchase is needed by farmers, professionals and transport group people to buyequipment on the basis of hire purchase.

It is a less risky business because the goods purchased on hire purchase basis serve assecurities till the installment on the loan is paid.

Generally, automobile industry needs lot hire-purchase finance. 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.

In India, there are many individuals and partnership firms doing this business. Evencommercial banks, hire-purchase companies and state financial corporations provide hire-

purchase credit.

3. Housing Finance Companies: 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

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purposes.

Housing finance companies also accept the deposits and lend money only for housingpurposes.

Even though there is a heavy demand for housing finance, these companies have notmade much progress and as on 31st March, 1990 only 17 such companies here reported

to the RBI.

The ICICI and the Canara Bank took the lead to sponsor housing finance companies,namely, Housing Development Corporation Ltd. and the Canfin Homes Ltd.

All the information about the Housing finance companies is available with the NationalHousing Bank. Housing finance companies also have to compulsorily to register

themselves with the Reserve Bank of India.

National Housing bank is the apex institution in the field of housing. It promotes housingfinance institutions, both on regional and local levels.

4. Investment Companies: Investment Company means any company which is carrying on the main business of

securities.

Investment companies in India can be broadly classified into two types:

1. Holding Companies: In case of large industrial groups, there are holding companies which buy shares

mainly for the purpose of taking control over another institution.

They normally purchase the shares of the institution with the aim of controlling itrather than purchasing shares of different companies.

Such companies are set up as private limited companies.2. Other Investment Companies:

Investment companies are also known as Investment trusts. Investment companies collect the deposits from the public and invest them in

securities.

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The main aim of investment companies is to protect small investors by collectingtheir small savings and investing than in different securities so that the risk can be

spread.

An individual investor cannot do all this on his own, due to lack of expertise ininvesting. Hence, investing companies are formed for collective investing.

Companies are formed for collective investments of money, mainly of small

investors.

Another benefit of an investment company is that it offers trained, experiencedand specialized management of funds.

It helps the investors to select a financially sound and liquid security. Liquid security means a security which can be easily converted into cash. In India investment trusts are very popular. They help in putting the savings of

people into productive investments.

Some of the investment trusts also do underwriting, promoting and holdingcompany business besides financing.

These investments trusts help in the survival of business in the economy bykeeping the capital market alive, act ive and busy.

5. Loan company: A loan company means any company whose main business is to provide finance through

loans and advances.

It does not include a hire purchase finance company or an equipment leasing company ora housing finance company.

Loan company is also known as a Finance Company". 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.

Normally, the loan companies provide loans to wholesalers, retailers, small-scale

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industries, self-employed people, etc.

Most of their loans are given without any security. Hence, they are risky. 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.

6. Mutual Benefit Financial Company: They are the oldest form of non-banking financial companies. A mutual benefit financial company means any company which is notified under section

620A of the Companies Act, 1956.

It is popularly known as "Nidhis". Usually, it is registered with only very small number of shares. The value of the shares is

often Rs. 1 only.

It accepts deposits from its members and lends only to its members against tangiblesecurities.

7. 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.

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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, and medical

expenses, just anything.

Chit funds companies are one of the oldest forms of local non-banking financialinstitution in India.

They are also known as "kuries". These institutions have originated from south India and are very popular over there. 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.

It helps the persons who save money regularly to invest their savings with good chancesof profit.

Chit funds have many defects as the rate of return given to each member is not the same. It differs from person to person, this leads in improper distribution of gains and losses. Also, the promoters of these funds do everything for their own benefit to get maximum

income.

Hence, the banking commission has made suggestions to pass uniform chit funds laws forthe whole of India.

8. Residuary Non-banking Companies: 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

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categories.

It generally accepts deposits by operating different schemes similar to recurring depositschemes of banks.

Deposits are collected from a large number of people by promising them that their moneywould be invested in banks and government securities

The collection of deposits is done at the doorsteps of depositors through bank staff, whois paid commission.

These companies get the funds at low cost for longer terms, at they invest them ininvestments which generates good amount of return.

Many of these companies operate with very small amount of capital. They have some adverse (bad) features, such as:

y Some do not submit periodic returns to the regulatory authority.y Some of them do not appoint banks, etc.

ROLE OF NON- BANKING FINANCIAL COMPANIES

1. Promoters Utilization of Savings: Non- Banking Financial Companies play animportant role in promoting the utilization of savings among public. NBFCs 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: NBFCs provide easy and timely credit tothose who need it. The formalities and procedures in case of NBFCs are also very less.

NBFCs also provides unusual credit means the credit which is not usually provided by

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banks such as credit for marriage expenses, religious functions, etc. The NBFCs are

open to all. Every one whether rich or poor can use them according to their needs.

3. Financial Supermarket: NBFCs play an important role of a financial supermarket.NBFCs create a financial supermarket for customers by offering a variety of services.

Now, NBFCs are providing a variety of services such as mutual funds, counseling,

merchant banking, etc. apart from their traditional services. Most of the NBFCs reduce

their risks by expanding their range of products and activities.

4. Investing funds in productive purposes:NBFCs 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: NBFCs, mainly the Housing Finance companies providehousing 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, NBFCs are blessing for them.

6. Provide Investment Advice: NBFCs, mainly investment companies provide advicerelating 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, NBFCs

plays an important role by providing sound and wise investment advice.

7. Increase the Standard of living: NBFCs play an important role in increasing thestandard 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. NBFCs increase the Standard of living by providing consumer goods on easy

installment basis. NBFCs also facilitate the improvement in transport facilities through

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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: NBFCs accept deposits forms convenient topublic. Generally, they receive deposits from public by way of depositor a loaner in any

form. In turn the NBFCs issue debentures, units certificates, savings certificates, units,

etc. to the public.

9. Promote Economic Growth:NBFCs play a very important role in the economic growthof 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

NBFCs speculative business means investing in risky activities. The investing

companies are interested in price stability and hence NBFCs, have a good influence on

the stock- market. NBFCs play a very positive and active role in the development of our

country.

Functions of Non- Banking Financial Companies:

1. Receiving benefits: The primary function of NBFCs is receive deposits from the publicin 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.

Hire purchase finance: Hire purchase finance is given by NBFCs to help smallimportant operators, professionals, and middle income group people to buy the

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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.

Leasing Finance: In leasing finance, the borrower of the capital equipment isallowed to use it, as a hire, against the payment of a monthly rent. The borrowerneed not purchase the capital equipment but he buys the right to use it.

Housing Finance: NBFCs provide housing finance to the public, they financefor construction of houses, development of plots, land, etc.

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.

Investment of surplus money: NBFCs invest their surplus money in variousprofitable areas.