nbfc in inda

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A Report on NBFCs in India

A REPORT ON NBFCs IN INDIA

Mr. Sankar Rajan

Summer Intern, April- June

2010

Amrita School of Business,

Coimbatore

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TABLE OF CONTENTS

Executive Summary ................................................................................................ 3

Non-Banking Financial Institutions (NBFIs) ............................................................5

Non-Banking Financial Company (NBFC) .............................................................. 6

NBFCs: Why are they required? .............................................................................6

Re-classification of NBFCs ..................................................................................... 7

NBFCs are different from Banks .............................................................................9

Residuary Non-Banking Companies (RNBCs) ....................................................11

Ceiling on RNBCs taking Deposits .......................................................................11

Interest Payment on Deposits ...............................................................................11

Eligibility Criteria for Starting NBFC ......................................................................12

Capital Requirement............................................................................................. 14

Net Owned Fund ...................................................................................................14

Classification of NBFCs according to RBI............................................................14

Regulations on NBFCs taking Deposits ............................................................... 15

Ceiling on NBFC-D (Taking Public deposits) ....................................................... 16

Ongoing Regulations: NBFCs-D (Holding Public Deposits) .................................18

Other Regulations: NBFCs-ND (Not Holding Public Deposits) ............................18

Directions given to NBFCs and its Auditors by RBI.............................................. 20

A Special Mention : FDI in NBFC sector .............................................................. 21

References ............................................................................................................23

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Executive Summary

India growth story is most talked about and why not? The countrys

GDP is pegged to grow at a rate of more than 7.5%. Indias Stock

market has given the best returns in the last 6-8 months of more than

60%. The household savings continues to be as high as 35% inspite of

slowdown and recessionary pressures. Forex reserves have increased

by more than 10billion $ in the 1st quarter and the total reserves are

up, to 262 billion $. Current Budget focuses on reducing fiscal deficit

by the measures of disinvestments and improving the infrastructure of

the country. Overall the country is all set to grow at a rapid pace and

the government has laid a strong foundation for this. Having realized

this, one can strongly say that sufficient liquidity has to be maintained

in the system to enhance credit and economic growth.

NFBIs (Non Banking Financial Institutions) play an important role in

realizing the economic growth. They have access to larger markets and

provide financing for almost all activities.

Think of buying an automobile, and one will find financing companies

that provide EMIs at the doorstep. Think of buying any electronics, one

would be amazed the number of financing companies that one can

approach to make a deal. Thus the competitiveness of the companies

combined with fierce penetration across the length of the country

enables NBFIs to grow at a rapid pace.

In the following document, NBFIs in India are discussed with a focus on

NBFCs. The total assets managed by NBFCs amount to 95,727 crore as

on June 2009. This accounts for around 9.1 % of assets of the total

financial system [1]. Hence the business carried out by NBFCs is of great

importance for overall development of the country. Thus RBI is

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implementing various schemes and policies for maintaining enough

liquidity for funding requirements. Also various regulations are levied

on NBFCs for making the overall system robust.

[1].Source: RBI

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Non-Banking Financial Institutions (NBFIs)

Non-Banking Financial Institutions (NBFIs) play an important role in the

Indian financial

system given their unique position of providing complimentary and

competitiveness to banks. They score over the traditional banks by

providing enhanced equity and risk-based products.

Fig1.The Hierarchy of NBFCs in India

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EquipmentLeasing

DevelopmentFinanceInstitutions (DFIs)

Non-bankingfinancialcompanies(NBFCs)

Insurancecompanies

NBFIs

Primarydealers(PDs)

MutualFunds

HirePurchaseLeasing

LoanCompany

InvestmentCompany


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Non-Banking Financial Company (NBFC)

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

the Companies Act, 1956. It is engaged in the business of loans,

securities, insurance, chit funds etc

They also provide products/services that includes margin funding,

leasing and hire purchase, corporate loans, investment in non-

convertible debentures, IPO funding, small ticket loans, venture capital

etc.

As in the diagram, NBFCs are classified into four categories

1. Hire- Purchase Leasing

2. Loan Company

3. Investment Company

4. Equipment Leasing Company

Some of the prominent NBFCs in India are

Infrastructure Development Finance Corporation (IDFC)

Rural Electric Corporation ( REC)

Industrial Finance corporation of India (IFCI )

GE Capital

Till March 2009 there were 12,739 NBFCs out of which 336 NBFCs were

permitted to accept public deposits [2]

[2]Source: RBI Annual Report 2008-2009

NBFCs: Why are they required?

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NBFCs are required as they have a greater reach to various markets

and have great efficiency in mobilizing funds. Generally banks to

reduce their operational costs establish NBFC. NBFC enjoys many

liberal policies by RBI in comparison with the commercial banks.

However this scenario is changing. RBI now has strict measures for

NBFCs also.

Re-classification of NBFCs

From December 6, 2006 NBFCs registered with RBI have been

reclassified as

1. Asset Finance Company (AFC)

2. Investment Company (IC)

3. Loan Company (LC)

Asset finance Companies (AFC)

AFC are financial institutions whose principal business is of financing

physical assets such as automobiles, tractors, construction equipments

material handling equipments and other machines.

Eg: Bajaj Auto Finance corp. , Fullerton India etc

Investment Companies (IC)

ICs generally are involved in the business of shares, stocks, bonds,

debentures issued by government or local authority that are

marketable in nature

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Eg: Stock Broking Companies, Gilt firms

Loan Companies (LC)LCs are loan giving companies which operate in the business of

providing loans. These can be housing loans, gold loans etc

Eg: Mannapuram Gold Finance, HDFC

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NBFCs are different from Banks

NBFCs cannot accept demand deposits ( Demand deposits are

funds deposited in an institution, that are payable immediately

on demand e.g.: Savings account, Current account etc)

A NBFC cannot issue cheques, to their customers and is not a

part of the payment and settlement system

Deposit insurance facility of Deposit Insurance Credit

Guarantee Corporation (DICGC) is not available for NBFC

depositors

They are allowed to accept/renew public deposits for a

minimum period of 12 months and maximum period of 60

months.

They cannot offer interest rates higher than the ceiling rate

prescribed by RBI from time to time. (Currently the ceiling rate

is 12.5%)

They cannot offer gifts/incentives or any other additional

benefit to the depositors.

They should have minimum investment grade credit rating,

from the credit rating agencies

Fig2:

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Pulic Deposits in NBFCs & RNBCs

0

5000

10000

15000

20000

25000

30000

35000

1998

2000

2002

2004

2006

2008

2010

Year

INR

(Crores)

Public Deposits

Expon. (Public

Deposits)


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Source:RBI, Note: The figures for 2009 & 2010 are estimated figures

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Residuary Non-Banking Companies (RNBCs)

They form a part of NBFCs however their functioning is different from

the regular NBFCs Residuary Non-Banking Company is a class of NBFC

whose principal business is receiving of deposits, under any scheme or

arrangement. The deposits received do not involve investment, asset

financing, or loans.

These companies are required to maintain investments as per

directions of RBI, in addition to liquid assets. The functioning of these

companies is different from those of NBFCs in terms of method of

mobilization of deposits and requirement of deployment of depositors'

funds Sahara Mutual Fund was the first RNBC started in India.

Ceiling on RNBCs taking Deposits

There is no ceiling on raising of deposits by RNBCs but every

RNBC has to ensure that the amounts deposited and investments

made by the company are not less that the aggregate amount of

liabilities to the depositors

To ensure the safely of public investments RNBCs are required to

invest in a portfolio comprising of highly liquid and secured

instruments viz. Central/State Government securities, fixed

deposit of scheduled commercial banks (SCB), Certificate of

deposits of SCB/FIs, units of Mutual Funds, etc

Interest Payment on Deposits

The amount payable by way of interest, premium, bonus or other

advantage, by a RNBC in respect of deposits received shall not

be less than 5% (to be compounded annually) on the amount

deposited in lump sum or at monthly or longer intervals; and at

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the rate of 3.5% (to be compounded annually) on the amount

deposited under daily deposit scheme.

Further, an RNBC can accept deposits for a minimum period of

12 months and maximum period of 84 months from the date of

receipt of such deposit. They cannot accept deposits repayable

on demand.

Eligibility Criteria for Starting NBFC

Initial Procedure

The Start up NBFC should be incorporated under the CompaniesAct, 1956

It should be registered with RBI, under Section 45-I of the RBI

Act, 1934

The company is required to submit the application for

registration in the prescribed format along with necessary

documents for RBI's consideration. RBI then issues certificate of

registration after satisfying itself that the conditions as

enumerated in Section 45-IA of the RBI Act, 1934 are satisfied

For registration with RBI, the company is required to fill the

application, which can be downloaded from

www.rbi.org.in/scripts/BS/viewforms.aspx.

After downloading the EXCEL based application form, data should

be keyed in, it can be uploaded in the RBI's Secure website

https://secweb.rbi.org.in. Once uploaded, the company will get a

CoR (Company Application Reference Number). Subsequently,

the company should take the hard copy of the same with the

supported documents and submit it to the concerned regional

office.

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NOTE: Certain category of NBFCs like Venture Capital Fund/Merchant

Banking Companies/Stock Broking Companies etc need not be

registered with RBI they are governed by SEBI. Insurance companies

holding a valid certificate of registration are regulated by IRDA,

Housing finance companies regulated by National Housing Bank.

Nature of Business

The company should not have its principal business as

(a) Agricultural operations

(b) Industrial activity

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

providing of any services

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

Moreover no portion of the income should be derived from the

financing of purchases, constructions or sales of immovable property

by other persons

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Capital Requirement

The start up company should have a minimum net owned fund (NOF)

of Rs 25 lakh which is raised to Rs 200 lakh from April 21, 1999.

Net Owned Fund

Paid-up capital and free reserves, minus accumulated losses, deferred

revenue expenditure and other intangible assets

Less,

(i) Investments in shares of subsidiaries/companies in the same group/

all other NBFCs

(ii) The book value of debentures/bonds/ outstanding loans and

advances, including hire purchase and lease finance made to, anddeposits with, subsidiaries/ companies in the same group, in excess of

10% of the owned funds.

Note: NBFCs that were in existence who had previously NOF of Rs25

Lakhs (before the act) are given a time period of 3 years to attain a

NOF of 200 Lakhs. However RBI can still extend this time period for an

additional 3 years subject to the condition that such NBFCs should

intimate the RBI about attaining the NOF within 3 months from the

date of attainment

Classification of NBFCs according to RBI

NBFCs are classified into two categories

(i) NBFC accepting deposits from customers

(ii) NBFC which does not take deposits from customers

NBFCs taking deposits from public are referred to as NBFC-D

and those who dont take public deposits are referred to as

NBFC- ND

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Those NBFCs NBFCs-ND with an asset size of Rs.100 crore and

above (as per the last audited balance sheet) are designated as

systemically important NBFCs- ND (NBFCs-ND-SI)

NBFCs-ND-SI are advised to attain minimum CRAR of 12 per cent

by March 31, 2010 and 15 per cent by March 31, 2011

Regulations on NBFCs taking Deposits

1. All NBFCs are not entitled to accept public deposits. Only those

NBFCs holding a valid certificate of registration with

authorization to accept public deposits can accept/hold public

deposits

2. New NBFCs are not allowed to raise public deposits for period of

two years from the date of registration. After completion of two

years, detailed review is taken of the company by the regulator

3. 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

4. NBFCs cannot offer interest rates higher than the ceiling rate

prescribed by RBI from time to time. The present ceiling is 12.5

per cent per annum. The interest may be paid or compounded at

rests not shorter than monthly rests.

5. NBFCs cannot accept deposits from NRI except deposits by debit

to NRO account of NRI provided such amount do not represent

inward remittance or transfer from NRE/FCNR account.

6. NBFCs with net owned fund (NOF) of less than Rs. 25 lakhs (with

or without credit rating) are not entitled to accept public deposits

7. Evaluation of the quality of management in respect of the

promoters/directors is taken into consideration while giving

allowance for taking public deposits

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Minimum Investment Level Credit Rating:

The symbols of minimum investment grade rating of the Credit rating

agencies are:

Name of rating agencies Level of minimum investment

grade credit rating (MIGR)CRISIL FA- (FA MINUS)ICRA MA- (MA MINUS)CARE CARE BBB (FD)FITCH Ratings India Pvt. Ltd tA-(ind)(FD)

Ceiling on NBFC-D (Taking Public deposits)

(i) NBFCs having Net Owned Fund (NOF) of more than 200 Lakhs

Category of NBFC Ceiling on public deposits

AFCs maintaining CRAR of 15%

without credit rating

1.5 times of NOF or Rs 10 crore

whichever is less

AFCs with CRAR of 12% and

having minimum investment

grade credit rating

4 times of NOF

LC/IC with CRAR of 15% and


grade credit rating

1.5 times of NOF

AFC= Asset Finance Company

LC/IC= Loan Company/ Investment Company

(ii) NBFCs having NOF more than 25 lakhs but less than 200Lakhs

Category of NBFC Ceiling on public deposits

AFCs maintaining CRAR of 15%

without credit ratingEqual to NOF (1xNOF)

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AFCs with CRAR of 12% and


grade credit rating

1.5 times of NOF

LC/IC with CRAR of 15% and


grade credit rating

Equal to NOF( 1xNOF)

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Ongoing Regulations: NBFCs-D (Holding Public Deposits).

The NBFCs accepting public deposits should furnish to RBI:

Audited balance sheet of each financial year and an audited

profit and loss account in respect of that year as passed in the

general meeting together with a copy of the report of the Board

of Directors and a copy of the report and the notes on accounts

furnished by its Auditors

Statutory Annual Return on deposits - NBS 1

Certificate from the Auditors that the company is in a position to

repay the deposits as and when the claims arise

Quarterly Return on liquid assets Half-yearly Return on prudential norms

Half-yearly ALM (Asset Liability Management) Returns by

companies having public deposits of Rs 20 crore and above or

with assets of Rs 100 crore and above irrespective of the size of

deposits

Monthly return on exposure to capital market by companies

having public deposits of Rs 50 crore and above

A copy of the Credit Rating obtained once a year along with one

of the Half-yearly returns on prudential norms

Other Regulations: NBFCs-ND (Not Holding Public Deposits)

The NBFCs-ND having assets size of Rs 100 crore are required to

submit a Monthly Return on important financial parameters of

the company

Board resolution to be passed to the effect that the company

have neither accepted public deposit nor would accept any

public deposit during the year

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General Norms: RBI

Maintenance of Liquid Assets:

Minimum level of liquid asset to be maintained by NBFCs is 15 % of

public deposits outstanding as on the last working day of the second

preceding quarter .Of the 15%, NBFCs are required to invest not

less than 10% in approved securities and the remaining 5% can be

in unencumbered term deposits with any scheduled commercial

bank.. Thus, the liquid assets may consist of government securities,

government guaranteed bonds and term deposits with any

scheduled commercial bank.

Creation and Maintenance of Reserve fund:

All NBFCs are required to create a reserve fund and transfer not less

than 20% of their net profit (before declaration of dividend) to the

fund

Submission of Certificate:

All NBFCs should submit a certificate from their Statutory Auditors

every year to the effect that they continue to undertake the

business of NBFI requiring holding of CoR (Company Application

Reference Number) under Section 45-IA of the RBI Act, 1934.

Information Exchange:

NBFCs are required to furnish the information in respect of any

change in the composition of its board of directors, address of the

company and its directors and the name/s and official designations

of its principal officers and the name and office address of its

auditors.

Prudential Norms

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NBFCs should comply with RBIs policies and directions regarding

prudential norms and Deployment of funds

o Income Reconition

o Accounting Standards

o Classification of Assets

o Provision for NPA (Non Performing assets)

o Capital Adequacy

o Declaration of Purpose, Quantum & Advances of Loan

Directions given to NBFCs and its Auditors by RBI

RBI is empowered to give directions to NBFCs and their auditors

in matters related to

1) Profit and Loss account

2) Balance Sheet

3) Books of Accounts

4) Disclosure of liabilities

5) Any other matters or queries

Special Audits can be done by the RBI of any NBFC and also

appoint auditors for the same

RBI can prohibit any NBFC for taking public deposit for violation

of any provisions of RBI act

Nomination facility for deposits held by a NBFC is introduced. It is

on the lines of bank deposits

If an NBFC is downgraded to below minimum investment grade

rating, it has to stop accepting public deposit, report the position

within fifteen working days to the RBI.

Once downgraded, within 3 years It has to reduce the amount of

excess public deposit to nil or to the appropriate extent

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permissible under paragraph 4(4) of Non-Banking Financial

Companies Acceptance of Public Deposits (Reserve Bank)

Directions, 1998

A Special Mention : FDI in NBFC sectorFDI/NRI investments allowed in the following 19 NBFC activities shall

be as per levels indicated below:

Merchant banking Credit Reference Agencies

Underwriting Credit rating Agencies

Portfolio Management

ServicesLeasing & Finance

Investment Advisory

ServicesHousing Finance

Financial Consultancy Forex Broking

Stock Broking Credit card business

Asset Management Money changing Business

Venture Capital Micro Credit

Custodial Services Rural Credit

Factoring

Regulations for FDI in NBFCs

Minimum Capitalization Norms for Fund based NBFCs:

For FDI up to 51% - US$ 0.5 million should be brought upfront For FDI above 51% and up to 75% - US $ 5 million should be

brought upfront

For FDI above 75% and up to 100% - US $ 50 million out of which

US $ 7.5 million should be brought upfront and the balance in 24

months

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Minimum capitalization norms for Non-fund based activities:

Minimum capitalization norm of US $ 0.5 million is applicable in

respect of all permitted non- fund based NBFCs with foreign

investment

Foreign investors to set up 100% operating subsidiaries without

the condition to disinvest a minimum of 25% of its equity to

Indian entities, subject to bringing in US$ 50 million as per

minimum capitalization norms above (without any restriction on

number of operating subsidiaries without bringing in additional

capital)

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Joint Venture operating NBFCs which have 75% or less than 75%

foreign investment will also be allowed to set up subsidiaries for

undertaking other NBFC activities, subject to the subsidiaries

also complying with the applicable minimum capital inflow

FDI in the NBFC sector is put on automatic route subject to

compliance with guidelines of the Reserve Bank of India.

References

Web References www.rbi.org.in, accessed from 19th April to 23rd April 2010

nbfc.rbi.org.in , accessed from 19th April to 23rd April 2010

www.economywatch.com, accessed from 19th April to 23rd April

2010

Publications

Statutory guide for Non Banking Financial Companies-

Taxmanns Publications

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Non Banking Financial Companies orNBFC in India are registered companies

conducting business activities similar to regular banks. Their banking operations include

making loans and advances available to consumers and businesses, acquisition of

marketable securities, leasing of hard assets like automobiles, hire-purchase and

insurance business.

Though they are similar to banks, they differ in a couple of ways. NBFCs cannot accept

demand deposits (deposits that can be withdrawn at immediate notice), they cannot issue

checks to customers and the deposits with them are not insured by the DICGC (the India

equivalent of FDIC in the US system). Either the RBI (Reserve Bank of India) or the

SEBI (Securities and Exchange Board of India) or both regulate NBFCs.

Though the NBFCs have been around for a long time, they have recently gained

popularity amongst institutional investors, since they facilitate access to credit for semi-

rural and rural India where the reach of traditional banks has traditionally been poor.

NBFCs have also had a major impact in developing small business in rural India through

local presence and strong customer relationships. Usually the loan officers in such

NBFCs know the end customer or have a strong informal understanding of the

credibility of the borrower and are able to structure their loans appropriately.

With the next wave of growth in India expected to come from the semi-rural and rural

sector, the unique access of NBFCs to these sector puts them in a great position to

benefit from this growth. As evidence of their attractiveness, Goldman Sachs bought a

20% stake in Sriram Credit for 75 mUSD in Q1 2008. Credit Suisse is planning to take a

majority stake in Bokdia Marketing and Finance (as reported in May 2008). Foreign

Institutional Investors (FII) are also setting up their own NBFCs in India to offer

corporate banking and private banking operations. As an example, Societe Generale got

approval for its NBFC launch in the country in October 2007. The French financial

services group plans to strengthen its brand in India though NBFCs.

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There are three categories of NBFCs,

a. Asset Financing Companies (AFC)

b. Loan Companies (LC)

c. Investment Companies (IC)

In our current post, we will focus on two NBFC sectors of Microfinance and

Infrastructure finance which fall under the category of AFC and LC. In a future post, we

would focus on consumer finance with specific focus on the automobile sector.

Microfinance Sector (very attractive)

There is a huge need for credit in the rural sector in India. Roughly 245 million people

need 52 bUSD of microfinance credit. This includes small and marginal farmers, landless

labourers, micro entrepreneurs in the rural and semi-urban areas. NBFCs constitute

almost 66% of the microfinance (MF) sector. The customer base covered by

microfinance is expected to reach 49 million people by 2012 growing at a CAGR of 43%

with an expected loan portfolio of 6 bUSD. (Source: Recent report on microfinance by

Intellecap, a research firm specializing in microfinance).

The key growth drivers in the microfinance sector are:

a. Need for broader suite of products: Products such as investment products,

insurance products, retirement planning can be offered to the customer base

b. Regional diversification: The NBFCs in this space are mostly concentrated in

South India. I expect this to grow in other regions.

c. Market consolidation and entry of FII: The smaller NBFCs will get acquired

and large FIIs (such as Fullerton) will come in and build franchising models

to accelerate the quality and penetration of MF in rural areas.

On the flip side, there are some constraints in the microfinance sector such as lack of

regulatory rules which are still evolving, lack of standardization, ability to attract quality

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human resources and an industry attitude that it is still a social enterprise versus for profit

professional enterprises.

Lastly, in terms of recent investment activity, SKS microfinance (37.3 mUSD), Share

Microfin (27.5 mUSD) and Spandana (12 mUSD) were financed in the last year.

Additional NBFCs such as Bandhan, Cashpor and Grameen Koota are looking actively

for investments.

Infrastructure Finance Sector (very attractive)

During the economic boom of the 1990s, the Govt. implemented many policies for

infrastructure development with focus on roads, telecommunications, ports, and power.

Special purpose vehicles (SPV) were formed to facilitate the credit demands of variousprojects. A majority of these were setup as NBFCs. The Govt. also implemented public

private partnerships (PPP).

As a perspective, during the period 1990-2006, 233 PPP projects were completed with

total investment of 69 bUSD. The PPP investments grew from 0.6 bUSD in 1991 to 17.1

bUSD by 2006 representing a CAGR of 25%.

During the period 2007-2017 the levels of investment is expected to further accelerate

fueled by the economic growth and the need to catchup on infrastructure to facilitate this

growth. During this period investment of roughly 1500 bUSD (Source: Govt. website,

World Bank and E&Y report) would be needed on power, roads and telecommunications.

The Govt. is setting up favorable policies to attract at least 50% of this investment from

the private sector.

nbfc in inda

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