nbfc project

Regulatory Aspect in NBFCs: Vision & Revision

Regulation of Banking and Insurance

Regulatory Aspects in NBFCs:

Visions & Revisions

Submitted to:

Prof. O.V. Nandimath,

(Course Teacher)

Submitted by:

Neha Goyal (I.D. No. 573) and Parul Sinha (I.D. No. 577)

LL.M. 1 Year Course (Business Laws)

Batch: 2013-2014

Submitted on: 2nd December, 2013

National Law School of India University, Bangalore



ACKNOWLEDGMENT

We take this opportunity to express our deep gratitude and indebtedness to Prof O.V. Nandimath,

Professor for Regulation of Banking and Insurance and Prof. Prashant Desai, National Law School

of India University, Bangalore, for guiding us in the endeavour of writing this project and also for

their enlightening lectures on the subject. We would also like to thank the National Law School of

India University Library for the wealth of information therein. I would like to thank the Library

Staff for their co-operation.

Neha Goyal (I.D. No. 573) and Parul Sinha (I.D. No. 577)

1 Year LL.M. Course

(Business Laws)

2013-2014



Table of Contents

Serial no. Contents Page no.

1 Research Methodology 4

2 Introduction 5

3 Chapter 1: Evolution And Meaning of NBFCs 7

4 Chapter 2: Distinction between banks and NBFCs 16

5 Chapter 3: Classification and Functions of NBFC 19

6 Chapter 4: Regulatory Aspect in NBFC 26

7 Conclusion 35

8 Bibliography 36



Research Methodology

Aim and Objective:

The aim of the present research is to examine the history as to how NBFCs came into

existence.

The researcher seeks to identify as to what were the reasons for establishing NBFCs in India

in spite of having a well regulated banking system.

The objective of the research is to analyze the role played by NBFCs and functions performed

by it.

Scope and Limitation:

The scope of the project is to study the evolution of NBFCs and the contribution of different

committees in reviewing the framework and addressing its shortcomings. It briefly states the

reasons for its establishment in spite of the existing banking system. In this research the different

types of NBFCs have been explained.

However, the scope of the research is limited to the study of regulation of NBFCs in India.

Research Questions:

1. How Non Banking Financial Companies came into existence?

2. NBFCs are doing functions similar to that of banks. What is the difference between banks and

NBFCs?

3. How NBFCs are regulated in India?

4. What is the role and functions performed by NBFCs?

Methodology Adopted:

The researcher has used both a descriptive and analytical method of writing. The researcher has

heavily relied on the legislative provisions in reiterating views and reaching the conclusion on the

subject.

Sources of Data:

The researcher has relied on primary and secondary sources of data.

Mode of Citation:

The researcher has followed the NLSIU guide to Uniform Legal Citation.



Introduction

Apart from banks the Indian Financial System has a large number of privately owned, decentralized

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- funds

companies etc. NBFCs can be classified into deposit accepting companies and non- deposit

accepting companies. NBFCs are small in size 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 cooperative banks are a heterogeneous (varied) group of finance

companies means all NBFCs provide different types of financial services.

It constitutes an important segment of the financial system. They 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 are 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 services. NBFCs differ widely in their ownership: some are subsidiaries of large

Manufactures (e.g., T.V. Motors T.V. Finances and Services Ltd). Many others are owned by banks

such as ICCI Banks, ICCI 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.

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.

This research paper is divided into four chapters. Chapter 1 explains the evolution of the NBFCs in

India, stating the details about the recommendations given by the various committees. It also

includes various legislative provisions which provides for, the definition of Non-Banking Financial

Institution.

Chapter 2, provides the distinction between the banks and NBFCs, stating the need for NBFCs and

also it includes the reason as to why NBFCs have been established in spite of a well regulated

banking system.

Chapter 3, states the classification of NBFCs, which although cannot be restricted to an exhaustive

list but the researchers have tried to include all the important forms of NBFCs. In this chapter the

role and the functions of these companies have also been stated.

Chapter 4, deals with the regulatory framework of NBFCs in India. It describes the pre-requisites

for carrying on business of NBFCs and also how they are supervised by RBI.



Chapter 1: Evolution and Meaning of NBFCs

1. Evolution of NBFCs:

The non-banking financial companies (NBFCs) flourished in India in the decade of the 1980s

against the backdrop of a highly regulated banking sector. The simplified sanction procedures

and low entry barriers encouraged the entry of a host of NBFCs. However, in many cases

mismanagement / lack of efficient management resulted in problems arising out of adverse

portfolio selection, un-prudent operations, inability to manage risk both on asset and liability

side. In many cases due to non availability of adequate credit from the banking sector. NBFCs

had to rely excessively on unsecured public deposits for their existence / survival by paying

higher rate of interest. To service such high cost deposits, some NBFCs were forced to deploy

their funds which carried high return coupled with high risk. This ultimately resulted in higher

risks for their depositors, which in some cases had culminated in the crisis of confidence and

credibility.

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.1

Also, it was felt necessary to initiate immediate action for the protection of depositors’ interest.

RBI issued the Non Banking Companies (Reserve Bank) Directions, 1977, guidelines on

prudential norms and various other Directions and clarifications, from time to time for

governing the activities of NBFCs. Central Government, during 1974, introduced 58A in the

Companies Act, 1956 which empowered Central Government to regulate acceptance and

renewal of deposits and to frame rules in consultation with Reserve Bank of India (RBI)

prescribing (a) the limit up to, (b) the manner and (c) the conditions subject to which deposits

may be invited or accepted / renewed by companies. The Central Government in consultation

with RBI framed Companies (Acceptance of Deposits) Rules, 1975.

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

1 Rajkumar Adukia, A Manual on Non Banking Financial Institution, available at: http:/www.caaa.in/Image/45%20NBFC.pdf.



of healthy NBFCs and weed out the inefficient ones. Continuing this process, RBI Act, 1934

was amended in 1997 which authorized the Reserve Bank to determine policies, and issue

directions to NBFCs regarding income recognition, accounting standards, NPAs, capital

adequacy, etc. The amended Act, inter alia, provided for compulsory registration of all NBFCs

into three broad categories, viz., (i) NBFCs accepting public deposit; (ii) NBFCs not

accepting/holding public deposit; and (iii) core investment companies (i.e., those acquiring

shares/securities of their group/holding/ subsidiary companies to the extent of not less than 90

per cent of total assets and which do not accept public deposit).

Until some years back, the prudential norms applicable to banking and nonbanking financial

companies were not uniform. Moreover, within the NBFC group, the prudential norms

applicable to deposit taking NBFCs (NBFCs-D) were more stringent than those for non-deposit

taking NBFCs (NBFCs-ND). Since the NBFCs-ND were not subjected to any exposure norms,

they could take large exposures. The absence of capital adequacy requirements resulted in high

leverage by the NBFCs. Since 2000 however, the Reserve Bank has initiated measures to reduce

the scope of ‘regulatory arbitrage’ between banks, NBFCs-D and NBFCs-ND.2

2. NBFC’s - COMMITTEES FORMED

Various committees were formed in India to review the existing framework and address the

shortcomings. Some of the committees and its recommendations are given hereunder:

a) 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.

b) Chakravarthy Committee (1984)

This Committee headed by Shri Sukhamoy Chakravarty was formed to review the

Working of the Monetary System. It made several recommendations for the development

of money market.

2 Id.



c) Vaghul Committee (1987)

As a follow-up to the Chakravarty committee, the RBI set up a Working Group on Money

Market under the Chairmanship of Shri N. Vaghul, which submitted its Report in 1987

containing number of measures to widen and deepen the money market.

d) Narasimhan Committee (1991)

This committee was formed to examine all aspects relating to the structure, organization &

functioning of the financial system.

e) 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

f) Khanna 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 onsite 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

lakhs 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-ordinating 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.

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

3 Adukia, supra note 1.



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 mobilisation 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.

Most of the recommendations of the Committee were accepted by the Reserve Bank after

an in depth analysis and the revised framework for effective supervision of the NBFCs

including off-site monitoring of NBFCs is being put in place.4

g) Vasudev Committee (1998)

This committee emphasized the need for strengthening of the NBFC sector including entry

norms and prudential norms, and dealt with framework for acceptance of public deposits,

issues concerning unincorporated financial intermediaries and addresses issues of

supervision of NBFCs.

The important recommendations of this committee are as follows:

i. Present minimum capital requirement of Rs.25 lakhs to be reviewed upwards

keeping in view the need to impart greater financial soundness and achieve

economies of scale in terms of efficiency of operations and managerial skills.

ii. As operations of NBFCs are concentrated in remote areas, the RBI may apprise the

State Governments of the companies which have been granted registration as well

as the companies whose applications have been rejected.

iii. The present capital adequacy ratio requirement may be maintained at 12% for all

rated NBFCs, higher rate of about 15% need to be prescribed by RBI for those

NBFCs which seek public deposit without credit rating.

iv. RBI may stipulate that the NBFCs should invest at least 25% of their reserves in

marketable securities apart from the SLR securities already held by the NBFCs.

v. Linking of quantum of public deposits with credit rating because apart from having

the effect of conferring regulatory functions on the rating agencies, it also exposes

the NBFCs to frequent asset liability mismatches arising out of changes in credit

rating.




vi. RBI should consider measures for easing the flow of credit from banks to NBFCs

and then consider prescribing a suitable ratio as between secured and unsecured

deposits for NBFCs.

vii. Appointment of depositors’ grievance Redressal authorities with specified

territorial jurisdiction.

viii. The procedure for liquidation of NBFCs to be substantially in line with those

available for banks.

ix. A separate instrumentality for regulation and supervision of NBFCs under the aegis

of the RBI should be set up, so that there is a great focus in regulation and

supervision of the NBFC sector.

x. The Committee felt it was not judicious to introduce a deposit insurance scheme for

the depositors in NBFCs because of the moral hazard issues, likelihood of assets

stripping and likely negative impact on the growth of a healthy NBFC sector.

xi. Reserve Bank could use the services of chartered accountants with suitable

experience and capabilities to carry out inspection of the smaller NBFCs.5

h) Usha Thorat Committee (2011)

This committee was constituted to review the existing regulatory and supervisory

framework of non-banking finance companies (NBFCs) with special focus on the risks in

the sector.

Key recommendations were:

i. The minimum net owned fund (NOF) requirement for all new NBFCs wanting to

register with the Reserve Bank could be retained at the present Rs. 2 crore till the

reserve bank of India act is amended. The Reserve Bank of India should, however,

insist on a minimum asset size of more than Rs. 50 crore for registering any new

NBFC. Existing NBFCs below this limit may deregister or be asked to seek a fresh

certificate of registration at the end of two years;

ii. NBFCs not accessing public funds may be exempted from registration provided

their assets are below 1000 crore;

iii. Any transfer of shareholding, direct or indirect, of 25 per cent and above, change in

control, merger or acquisition of any registered NBFC should have prior approval

of the Reserve bank.




iv. The twin- criterion of assets and income for determining the principal business of

an NBFCs should be increased to 75 per cent of the total asset and 75 per cent of

the total income, respectively. A time period of three years may be given to fulfill

revised principal business criteria.

v. Tier I capital for Capital to Risk Weighed Assets Ratio (CRAR) purposes may be

specified at 12 per cent to be achieved in three years for all registered deposit

taking and non- deposit taking NBFCs;

vi. Liquidity ration may be introduced for all registered NBFCs such that cash, bank

balances and holdings of government securities fully cover the gaps, if any,

between cumulative inflows for the first 30 days;

vii. Asset classification and provisioning norms similar to banks to be brought in

phased manner for NBFCs. Suitable income tax deduction akin to banks may be

allowed for provisions made under the regulations. Accounting norms applicable to

banks may be applied to NBFCs.

viii. NBFCs may be subject to regulations similar to banks while lending to stock

brokers and merchant bankers and similar to stock brokers ,as specified by the

Securities and Exchange Board of India (SEBI), while undertaking margin

financing;

ix. Financing conglomerate approach may be adopted for supervision of larger NBFCs

that have stock brokers and merchant bankers in the group.

x. Government owned entities that qualify as NBFCs may comply with the regulatory

framework applicable to NBFCs at the earliest.

xi. Board approved limits for bank’s exposure to real estate may be made applicable for the

bank group as a whole, where there is an NBFC in the group. The risk weights for NBFCs

that are not sponsored by banks or that do not have any bank as part of the group may be

raised to 150 per cent for capital market exposures and 125 per cent for commercial real

estate (CRE) exposures. In case of banks sponsored NBFCs, the risk weights for capital

Market Exposures (CME) and CRE may be the same as specified for banks;

xii. NBFCs may be given the benefit under Securitisation and Reconstruction of Financial

Assets and Enforcement of Security Interest (SARFAESI) Act, 2002;

xiii. Captive NBFCs, the business models of which focus mainly (90 per cent and above) on

financing parent company’s products, may maintain Tier I capital at 12 per cent from the

time of registration. Supervisory risk assessment of such companies should take into

account the risk of the parent company;



xiv. For the purpose of applicability of registration and supervision, the total assets of all

NBFCs in a group should be taken together to determine the cut off limit of Rs. 100 crore;

xv. All NBFCs with assets of Rs.1000 crore and above, whether listed or not, should be

required to comply with Clause 49 of SEBI Listing Agreements including mandatory

disclosures;

xvi. Disclosure for NBFCs with assets over Rs 100 crore may include provision coverage ratio,

liquidity ratio, asset liability profile, extent of financing of parent company products,

movement of non-performing assets (NPAs), off-balance sheet exposures, structured

products and securitisations/assignments.

xvii. NBFCs with assets of Rs. 1000 crore and above should be inspected comprehensively on

an annual basis with an annual stress test carried out to ascertain their vulnerability.6

3. NON BANKING FINANCIAL COMPANY: MEANING

Non-banking financial companies (NBFCs) play a vital role in the context of Indian Economy.

They are indispensable 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 ok like marketable nature, leasing, hire- purchase, insurance business, chit business

but does not include any institution whose 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.

4. DEFINITIONS OF NBFC

Whereas the ‘Reserve bank of India Act 1934’ itself defines the term NBFC, there is a different

definition of the same term viz. NBFC in the ‘Non-Banking Financial Companies Acceptance of




Public Deposits (Reserve Bank) Directions, 1988’ that the RBI itself has issued under the

aforesaid Act of 1934.

a) NBFC under the RBI Act

Under section 45-I (a) of the RBI Act, 1934 ‘business of non banking financial institution’,

is defined in terms of the business of a financial institution and NBFC.

NBFI

Sec: 45-1(a): "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);

FI

The Act defines ‘Financial Institution’ (FI) u/s 45-I(c) as "financial institution" means any

non-banking institution 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 a

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 (26 of 1972);

iv. The carrying on of any class of insurance business;

v. Managing, conducting or supervising, as foreman, 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

are collected or to any other person, but does not include….”

The definition of FI uses the definition of a Non Banking Institution. (NBI) NBI has been

defined under the RBI Act 1934 as follows:

NBI

Sec.45-I(e): "non-banking institution" means a company, corporation or cooperative

society.7

7 S.45-I, Reserve Bank of India Act, 1934.



NBFC

‘NBFC’, itself is defined under sec. 45-I(f) of the Act, as under Sec. 45-I(f): "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.8

For this purpose, the definition of ‘Principal Business’ given, vide Press Release 1998-

99/1269 dated April 8, 1999 may be followed: “The company will be treated as a non-

banking financial company (NBFC) if its financial assets are more than 50 per cent of its

total assets (netted off by intangible assets) and income from financial assets is more than

50 per cent of the gross income. Both these tests are required to be satisfied as the

determinant factor for principal business of a company.” An analysis of forgoing

provisions reveals that except for specifically notified categories, a company that is a FI, or

a NBI receiving deposits, alone would qualify as an NBFC.

On reading jointly both of the definitions of FI and NBI reveals that for a company to be an

NBFC it should either carry on any of the businesses as enumerated in (i) to (vi) of FI Sec.

45-I(c) or it should otherwise receive public deposits in any manner.

8 S.45-I, Reserve Bank of India Act, 1934.



Chapter 2: Distinction between Banks and NBFCs

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

(i) A NBFC cannot accept demand deposits;

(ii) It is not a part of the payment and settlement system and as such cannot issue cheques to its

customers; and

(iii) Deposit insurance facility of Deposit Insurance and Credit Guarantee Corporation (DICGC) is

not available for NBFC depositors unlike in case of banks.9

1. Inefficiency of Banks

In principle, there is no reason why banks can’t provide all services – indeed to an extent they

do. However they are extremely inefficient in providing some services and even face

conflicting incentives in providing all services.

In short, the way in which banks provide their core services means that they cannot provide

all services equally efficiently.

In order to provide certainty of value for payments, bank deposits must be low risk. This

limits the range and nature of assets that banks can hold on the asset side of their balance

sheets and thereby the extent to which they can offer risk pooling. It also limits their ability to

offer a wide range of store of value services, especially equity type stores of value services.

More generally, NBFIs play a range of roles that are not suitable to banks:

Through the enhancement of equity promises (adding liquidity, divisibility,

informational efficiencies and risk pooling services), NBFIs broaden the spectrum of

risks available to investors;

In this way they encourage investment and savings and improve the efficiency of

investment and savings;

Through the provision of contingent promises they foster a risk management culture

by encouraging those who are least able to bear risk to sell those risks to those better

able to manage them; and

They can enhance the resilience of the financial system to economic shocks NBFIs

complement banks by providing services that are not well suited to banks; they fill

the gaps in financial services that otherwise occur in bank-based financial systems.10

9 Adukia, supra note 1.10 Available at: http:/www.rbi.org.in.



2. Serve as Competition for Banks

Equally important, NBFIs provide competition for banks in the provision of financial

services. NBFIs unbundle bank services and compete with them as providers. They specialize

in particular sectors and target particular groups.

3. Economic Development

There is a growing body of hard evidence to suggest that:

The development of financial intermediaries contributes strongly to economic growth;

That contribution is increased where intermediation is provided through a balanced

combination of NBFIs and banks – in particular, there is a strong correlation between

the depth and activeness of non-banks and stock markets on the one hand, and economic

development on the other.

In the first place, banks offer assets (deposits) that claim to be capital certain. If this promise is

to be honoured, then there must be limits to the range and nature of assets that a bank can

reasonably take on to its balance sheets. Notwithstanding the existence of universal banking in

many parts of the world (i.e., banks also engaged in securities market activities), this

consideration implies that bank-based financial system will tend to have a smaller range of

equity-type assets than those with a more broadly based structure including a wide range of

NBFIs. More generally, NBFIs play range of roles that are not suitable for banks and through

their provision of liquidity, divisibility, informational efficiencies, and risk pooling services;

they broaden the spectrum of risks available to investors. In this way, they encourage and

improve the efficiency of investment and savings. Through the provision of a broader range of

financial instruments, they are able to foster a risk management culture by attracting customers

who are least able to bear risks and fill the gaps in financial services that otherwise occur in

bank-based financial systems.11

4. Financial Stability

In a financial sector in which NBFIs are comparatively undeveloped, banks will inevitably be

required to assume risks that otherwise might be borne by the stock market, collective

investment schemes or insurance companies. However, there is basic incompatibility between

the kinds of financial contracts offered by the banks and those offered by the financial

institutions. Thus, banks are more likely to fail as a result. One way of minimizing financial

fragility in the developing economies may be to encourage a diversity of financial markets

and institutions, where investors are able to assume a variety of risks outside the banking

11 Supra note 10.



system itself. Without this diversity, there is a tendency for all risks to be bundled within the

balance sheet of the banking system, which may lead to severe financial crises more likely.

This point was widely noted by policymakers in their analysis of the lessons of the Asian

currency crisis, for instance.

As Alan Greenspan (1999) pointed out, the impact of the currency crisis in Thailand might

have been significantly less severe if some of the risks borne by the Thai banks had instead

been borne by the capital markets.12

12 Supra note 1.



Chapter 3: Classification and Functions of NBFC

1. Classification of NBFC:

Depending on the nature of their major activity, the NBFCs can be classified into various

categories. They are:

a) Equipment leasing companies:

It is a company which carries on the activity of leasing of equipment, as its main business

or the financing of such activity. Under leasing of equipment business a lessee is allowed

to use particular capital equipment, as a hire, against payment of a monthly rent as a result

of which although he has not purchased the capital equipment but has purchased the right

to used it. There are two types of leasing arrangements, they are:

Operating Leasing, in which the producer of the capital equipment offers his product

directly to lessee on a monthly rent basis. There is not middleman in such kind of

leasing;

Finance leasing, in which 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, in such type of leasing there are three parties, out of which the

leasing company acts as a middleman between the producer of the equipment and the

user of equipment.

b) Hire-purchase finance companies:

It means a company carrying on the main business of financing, physical assets through the

system of hire-purchase. The main feature of hire-purchase is 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. This type of finance is

required by farmers, professionals and transport group people to buy equipment on the

basis of hire purchase. It is less risky business because the goods purchased on hire

purchase basis serve as securities till the installment on the loan is paid.

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 firms engaged in this business. Even commercial banks, hire-

purchase companies and state financial corporation provide hire-purchase credit.13

13 Shodh Ganga, Financial System and Non-Bnaking Financial Companies- The Structure and status Profile, available at: http://shodhganga.inflibnet.ac.in/bitstream/10603/8650/11/11_chapter%203.pdf.


http://shodhganga.inflibnet.ac.in/bitstream/10603/8650/11/11_chapter%203.pdf


c) Housing finance-companies:

It is a company which carries on its main business of financing the construction or acquisition

of houses or development of land for housing purposes. These companies also accept the

deposits and lend money only for housing purposes. Even though there is heavy demand for

housing finance, these companies have not made much progress and as on 31 st 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 National

Housing Bank. Housing finance companies also have to compulsorily to register themselves

with the RBI. National Housing bank is the apex institution in the field of housing. It

promotes housing finance institution, both on regional and local levels.

d) Investment companies:

It means any company which is carrying on the main business of securities. Investment

companies in India can be broadly classified into two types:

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 it rather

than purchasing shares of different companies. Such companies are set up as private

limited companies.

Other Investment Companies: These are also known as the Investment trusts; they

collect deposits from the public and invest them in securities. 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.

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 money, mainly for small investors.

Another benefit of an investment company is that it offers trained, experienced and

specialised management of funds. It helps the investors to select a financially sound and

liquid security which can be easily converted into cash. In India investment truts are very

popular. They help in putting the savings of people into productive investments.



Some of the investment truts also do underwriting promoting and holding company

business besides financing. These investments truts help in the survival of business in the

economy by keeping the capital market alive, active and busy.14

e) Loan Companies:

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 or a housing finance company. It is also known as 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 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.

f) Mutual Fund benefit companies:

They are the oldest form of NBFCs. A mutual benefit financial company means any company

which is notified under S. 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 tangible securities.

g) Chit fund Companies:

Chit funds companies are one of the oldest forms of local NBFC 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 of 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 chances of profit. Chit funds have many defects as the rate of return

given to each members is not the same.

14 Id.



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 pass uniform chit funds laws for the

whole of India.

h) Residuary 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 category. It

generally accepts deposits by operating different schemes similar to returning deposits

schemes of banks. Deposits are collected from a large number of people by promising them

that their money would be invested in banks and government securities. The collection of

deposits is done at the doorsteps of depositors through bank staff, who is paid commission.

These companies get the funds at low cost for longer terms, as they invest them in

investments which generates good amount of return. Many of these companies operate with

very small amount of capital. They have some adverse features such as: a) Some do not

submit periodic returns to the regulatory authority; b) Some of them do not appoint banks,

etc.15

2. Role of NBFC:

a) Promoter Utilization of Savings:

NBFC 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

rates of interest. Idle money means the money which public keep side, but which is not

used. It is surplus money.

b) Provides easy, timely and unusual credit:

NBFC’s provide easy and timely credit t 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

15 Supra note 13.



functions etc. The NBFC’s are open to all. Every one whether rich or poor can use them

according to their needs.

c) Financial Supermarket:

NBFC plays an important role of a financial supermarket. It creates 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.

d) 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 can carry

on their production with less capital and the leasing company can also earn good amount of

profit.

e) 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 a boon for them.

f) 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 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.

g) Increase the Standard of Living:

NBFC plays 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 increases the Standard of living by providing

consumer goods on easy installment basis. NBFC’s also facilitates 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.16

h) Accept Deposits in Various Forms:

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

form public by way of depositor’s loaner in any form. In turn the NBFC’s issue debentures,

units’ certificates, units etc. to the public.

i) Promote Economic Growth:

NBFC’s plays 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. NBFCs play a very positive and active role in the

development of our country. 17

3. Functions of Non-banking financial companies:

a) Receiving Benefits:

The primary function of NBFCs is received deposits from the publics in various ways such

as issue of debentures, savings certificate, subscriptions, units 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.18

b) Lending Money:

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

companies provide financial assistance through:

o Hire purchase 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.

16 Supra note 13.17 Supra note 13.18 Supra note 10.



o 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.

o Housing Finance:

NBFC provide housing finance to the public, they finance for construction of

houses, development of plots, land etc.

o 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.

o Investment of surplus money:

NBFCs invest their surplus money in various profitable areas.19

19 Supra note 10.



Chapter 4: Regulatory Aspect of NBFC

1. Supervision of NBFCs by Reserve Bank

The supervisory framework for NBFCs is based on three criteria, viz.:

a) The size of NBFC,

b) The type of activity performed, and

c) The acceptance or otherwise of public deposits.

Towards this end, a four-pronged supervisory strategy comprising –

a) On-site inspection based on CAMELS (capital, assets, management, earnings,

liquidity, systems and procedures) methodology,

b) Computerised off-site surveillance through periodic control returns,

c) An effective market intelligence network, and

d) A system of submission of exception reports by auditors of NBFCs, has been put in

place.

The regulation and supervision is comprehensive for companies accepting or holding public

deposits to ensure protection of interests of depositors.

Companies holding or accepting public deposits are required to comply with all the directions

on acceptance of public deposits, prudential norms and liquid assets, and should submit

periodic returns to the Reserve Bank. They are supervised using all the supervisory tools

indicated above.

Companies not holding or accepting public deposits are regulated and supervised in a limited

manner. They are required to comply only with prudential norms relating to income

recognition, accounting standards, asset classification and provisioning against bad and

doubtful debts. They are less frequently inspected. Such companies are now required to

submit a monthly return to the Reserve Bank.20

2. REGULATORY FRAMEWORK FOR NBFCs IN INDIA

The NBFC sector is characterized by its heterogeneity. It is heterogeneous in term of size,

business, spread and ownership. It is more than three decades since RBI has started regulating

and supervising the functioning of the NBFC sector in India. RBI presently regulates the

NBFCs whether undertaking, exclusively or in combination, the activities of asset financing,

20 S. Durairajan, Regulation And Supervision of Non Banking Financial Companies, available at: http://www.icaihyd.org/pgcntnt/pgcNBFC_%20revised.pdf.



loaning and investment as their principal business, irrespective of whether they accept public

deposits or not.

The scheme of regulation of the deposit acceptance activities of the Non-Banking Companies

was conceived in the sixties as an adjunct to monetary and credit policy of the country and

also to provide an indirect protection to the depositors by insertion in the year 1963, of a new

Chapter III B in the Reserve Bank of India Act, 1934. The regulations till 1997 empowered

the Reserve Bank of India, only to regulate or prohibit issue of prospectus or advertisement

soliciting deposit, collect information as to deposits and to give directions on matters relating

to deposits.

During the nineties a spurt was observed in the number of non-banking companies and the

volume of deposits accepted. Proliferation of institutions both financial and non-financial

depending mainly or wholly on deposits from public was viewed with concern by the

authorities. Further in the absence of any prudential ceiling, the NBFCs deployed their funds

where they had little experience and expertise as also lent to those sectors with high risks. The

resultant high level of Non Performing Assets aggravated the liquidity crunch faced by many

companies and led to significant failures.21

3. Amendments to RBI Act and New Regulatory Framework

Various committees, which went into these aspects, strongly recommended that there should be

an appropriate regulatory framework over NBFCs and that more powers should be vested with

RBI to regulate NBFCs in a better manner. Chapters III-B, III-C and V of the RBI Act were

comprehensively amended in January 1997 for vesting more powers with the RBI and

providing, inter alia, for minimum entry point norm, compulsory registration with the Reserve

Bank of all existing and newly incorporated NBFCs for carrying on and commencement of

financial business. RBI put in place in January 1998 a new regulatory framework involving

prescription of prudential norms for NBFCs, regulation of deposit taking activity to ensure that

the NBFCs function on sound and healthy lines and strengthen the financial system of the

country. Regulatory and supervisory attention was focused on NBFCs -D which accept public

deposits so as to enable RBI to efficiently discharge its responsibilities to protect the interests of

the depositors. The process has helped in ensuring consolidation of NBFC sector as a whole.

With the amendment, any company seeking to commence/carry on business of NBFI was

required to obtain Certificate of Registration from the Bank under Section 45-IA of the RBI Act,

21 Id.



1934 and also have a minimum Net Owned Fund (NOF) of Rs 25 lakhs. The NOF requirement

was increased to Rs 200 lakhs with effect from April 21, 1999. While giving registration, an

evaluation of the quality of management is undertaken by applying ‘fit and proper’ norm based

on the information furnished by the company in respect of the promoters/directors, bankers’

report, report from other regulators like SEBI/IRDA etc. (in case the promoters/directors are

involved in activities regulated by these institutions). New Companies are not allowed to raise

public deposits for period of two years from the date of registration. For allowing these

companies to raise public deposits after a period of two years, detailed appraisal/review is

undertaken by the Bank. Further two sets of detailed directions on Prudential were issued by

RBI in 2007.

The directions interalia, prescribe guidelines on income recognition, asset as to enable RBI to

efficiently discharge its responsibilities to protect the interests of the depositors. The process has

helped in ensuring consolidation of NBFC sector as a whole. With the amendment, any

company seeking to commence/carry on business of NBFI was required to obtain Certificate of

Registration from the Bank under Section 45-IA of the RBI Act, 1934 and also have a minimum

Net Owned Fund (NOF) of Rs 25 lakhs. The NOF requirement was increased to Rs 200 lakhs

with effect from April 21, 1999. While giving registration, an evaluation of the quality of

management is undertaken by applying ‘fit and proper’ norm based on the information

furnished by the company in respect of the promoters/directors, bankers’ report, report from

other regulators like SEBI/IRDA etc. (in case the promoters/directors are involved in activities

regulated by these institutions). New Companies are not allowed to raise public deposits for

period of two years from the date of registration. For allowing these companies to raise public

deposits after a period of two years, detailed appraisal/review is undertaken by the Bank.

Further two sets of detailed directions on Prudential were issued by RBI in 2007.

The directions inter alia, prescribe guidelines on income recognition, asset classification and

provisioning requirements applicable to NBFCs, exposure norms, constitution of audit

committee, disclosures in the balance sheet, requirement of capital adequacy, restrictions on

investments in land and building and unquoted shares.22

4. Regulations over NBFCs accepting Public Deposits

The regulatory attention has been utilized to enable intensified surveillance of NBFCs

accepting public deposits. The Reserve Bank issued directions relating to acceptance of

22 Supra note 20.



public deposits prescribing, (a) the quantum of public deposits (b) the period of deposits

which should not be less than 12 months and should not exceed 60 months, (c) the rate of

interest payable on such deposits subject to a ceiling of 16 per cent, (d) the brokerage fees

and other expenses amounting to a maximum of 2 per cent and 0.5 per cent of the deposits,

respectively, and, (e) the contents of the application forms as well as the advertisement for

soliciting deposits.

The companies which accept public deposits are required to comply with all the prudential

norms on income recognition, asset classification, accounting standards, provisioning for

bad debts, capital adequacy, credit/investment concentration norms, etc. The capital

adequacy ratio has been fixed at 12 per cent and above, in accordance with 84 the eligibility

criteria for accepting public deposits. The credit and investment concentration norms have

been fixed at 15 per cent and 25 per cent of the owned funds, depending on whether the

exposure is to a single borrower to a borrower group, while the totality of loans and

investment has been subject to a ceiling of 25 per cent and 40 per cent of the owned fund,

respectively, depending on whether the exposure is to a single party or to an industry

group.23

5. Regulations over NBFCs not accepting public deposits

The NBFCs not accepting public deposits would be regulated in a limited manner. Such

companies have been exempted from the regulations on interest rates, period as well as the

ceiling on quantum of borrowings. The ceiling on the aforesaid factors for NBFCs accepting

public deposits is expected to act as a benchmark for NBFCs not accepting public deposits.

However, prudential norms having a bearing on the disclosure of true and fair picture of

their financial health have been made applicable to ensure transparency in the financial

statements to these companies, excepting those relating to capital adequacy and credit

concentration norms.24

6. PRE-REQUISITES FOR CARRYING ON BUSINESS OF NBFC

The company desiring to be registered as a NBFC is required to submit its application for

registration in the prescribed format along with necessary documents for RBI’s consideration.

RBI issues Certificate of Registration after satisfying itself that the conditions as enumerated in

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

23 Supra note 13.24 Supra note 13.



The following pre-requisites mentioned below are cumulative and not alternative:

a) Registration Requirement

In terms of Section 45-IA of the RBI Act, 1934, it is mandatory that every NBFC should be

registered with RBI to commence or carry on any business of nonbanking financial

institution as defined in clause (a) of Section 45 I of the RBI Act, 1934.

The registration is compulsory for all NBFCs, irrespective of their holding of public deposits.

The RBI (Amendment) Act, 1997, which introduced comprehensive changes in Chapter III-

B, III-C and V, provides for an entry point norm of Rs.25 lakh as the minimum net owned

fund (NOF). Subsequently, for new NBFCs seeking registration with the Reserve Bank to

commence business on or after April 21, 1999, the requirement of minimum level of NOF

was revised upwards to Rs.2 crore. No NBFC can commence or carry on business of a

financial institution including acceptance of public deposit without obtaining a Certificate of

Registration (CoR) from the Reserve Bank. The company is required to submit its

application for registration in the prescribed format along with necessary documents for

RBI’s consideration. The Bank issues Certificate of Registration after satisfying itself that the

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

Requirements to be complied with and documents to be submitted to RBI by NBFCs

for obtaining certificate and Registration from RBI

An indicative list of documents/information to be furnished along with the application.

All documents/information is to be submitted in duplicate.

i. Minimum NOF requirement Rs. 200 lakh.

ii. Application to be submitted in two separate sets tied up properly in two separate files.

iii. Annex II to the Application Form to be submitted duly signed by the

director/Authorized signatory and certified by the statutory auditors.

iv. Annex III (directors’ profile) to the Application Form to be separately filled up for

each director. Care should be taken to give details of bankers in respect of

firms/companies/entities in which directors have substantial interest.

v. In case the directors are associated or have substantial interest in other companies,

indicate clearly the activity of the companies (whether NBFC or not).

vi. Board Resolution specifically approving the submission of the application and its

contents and authorizing signatory.

vii. Board Resolution to the effect that the company has not accepted any public deposit,

in the past (specify period)/does not hold any public deposit as on the date and will



not accept the same in future without the prior approval of Reserve Bank of India in

writing.

viii. Board resolution stating that the company is not carrying on any NBFC

activity/stopped NBFC activity and will not carry on/commence the same before

getting registration from RBI.

ix. Auditors Certificate certifying that the company is/does not accept/is not holding

Public Deposit.

x. Auditors Certificate certifying that the company is not carrying on any NBFC

activity.

xi. Net owned fund as on date.

xii. Certifying compliance with section 45S of Chapter IIIC of the RBI Act, 1934 in

which director/s of the company has substantial interest.

xiii. Details of changes in the Memorandum and Articles of Association duly certified.

xiv. Last three years Audited balance sheet along with directors & auditor’s report.

xv. Details of clauses in the memorandum relating to financial business.

xvi. Details of change in the management of the company during last financial year till

date if any and reasons thereof.

xvii. Details of acquisitions, mergers of other companies if any together with supporting

documents.

xviii. Details of group companies/associate concerns/subsidiaries/holding companies.

xix. Details of infusion of capital if any during last financial year together with the copy

of return of allotment filed with Registrar of Companies.

xx. Details of the bank balances/bank accounts/complete postal address of the

branch/bank, loan/credit facilities etc. availed.

xxi. Business plan for next three years indicating market segment to be covered without

any element of public deposits.

xxii. Cash flow statement, asset/income pattern statement for next three years.

xxiii. Brief background note on the activities of the company during the last three years and

the reasons for applying for NBFC registration.

xxiv. II(b) is the company engaged in any capital market activity? If so, whether there has

been any non-compliance with SEBI Regulations? (Statement to be certified by

Auditors).



xxv. Whether any prohibitory order was issued in the past to the company or any other

NBFC/RNBC with which the directors/promoters etc. were associated? If yes, details

thereof.

xxvi. Whether the company or any of its directors was/is involved in any criminal case,

including under section 138(1) of the Negotiable Instruments Act? If yes, details

thereof.

xxvii. Whether the company was granted any permission by ECD to function as Full-

fledged Money Changers?

xxviii. Whether the company was/is authorized by ECD to accept deposits from NRIs.

xxix. Whether “Fit and Proper” Norms for Directors have been fulfilled25

NBFCs exempted from Registration with RBI

However, to obviate dual regulation, certain category of NBFCs which are regulated by other

regulators are exempted from the requirement of registration with RBI viz. Venture Capital

Fund/Merchant Banking companies/Stock broking companies registered with SEBI, Insurance

Company holding a valid Certificate of Registration issued by IRDA, Nidhi companies as

notified under Section 620A of the Companies Act, 1956, Chit companies as defined in clause

(b) of Section 2 of the Chit Funds Act, 1982 or Housing Finance Companies regulated by

National Housing Bank. As laid down in RBI Master Circular RBI/2009-10/6 DNBS.PD.

CC.No. 148 /03. 02.004 / 2009-10 dated July 1, 2009 the following are some exemptions from

the provisions of RBI Act, 1934 but subject to certain conditions:

i. A Housing Finance Institutions has been exempted from provisions of Chapter III B of

the RBI Act, 1934.

ii. A merchant banking company has been exempted from the provisions of Section 45-IA

[Requirement of registration and net owned fund], Section 45-IB [Maintenance of liquid

assets] and 45-IC [Creation of Reserve Fund] of the RBI Act, 1934, Non-Banking

Financial Companies Acceptance of Public Deposits (Reserve Bank) Directions, 1998

and Non-Banking Financial Companies Prudential Norms (Reserve Bank) Directions,

1998.

iii. In the case of Micro Finance Companies and Mutual Benefit Companies- Sections 45-IA,

45-IB and 45-IC of the Reserve Bank of India Act, 1934 shall not apply

iv. In the case of Government Companies- Sections 45-IB and 45-IC of the Reserve Bank of

India Act, 1934 paragraphs 4 to 7 of the Non-Banking Financial Companies Acceptance

25 Supra note 1.



of Public Deposits (Reserve Bank) Directions, 1998 and Non-Banking Financial

Companies Prudential Norms (Reserve Bank) Directions, 1998 except paragraph 13 A of

the said directions relating to submission of information to Reserve Bank in regard to

change of address, directors, auditors, etc shall not apply

v. In the case of Venture Capital Fund Companies Section 45-IA and Section 45- IC of the

Reserve Bank of India Act, 1934 shall not apply

vi. In the case of Insurance/Stock Exchange/Stock Broker/Sub-Broker-The provisions of

Section 45-IA, 45-IB, 45-IC, 45MB and 45MC of the Reserve Bank of India Act, 1934

and provisions of Non-Banking Financial Companies Acceptance of Public Deposit

(Reserve Bank) Directions contained in Notification No. DFC.118 / DG(SPT)-98 dated

January 31. 1998, the Non-Banking Financial Companies Prudential Norms (Reserve

Bank) Directions, 1998 dated January 31, 1998 shall not apply

vii. In the case of Nidhi Companies, the provisions of Sections 45-IA, 45-IB and 45-IC of the

Reserve Bank of India Act, 1934 shall not apply

viii. Chit Companies doing the business of chits exclusively are exempted.26

b) Incorporation under the Companies Act 1956

It should be a company incorporated under the Companies Act, 1956 and desirous of

commencing business of non-banking financial institution as defined under Section 45 I(a) of

the RBI Act, 1934.

c) Minimum Net Owned Fund

A company incorporated under the Companies Act, 1956 and desirous of commencing

business of non-banking financial institution as defined under Section 45 I(a) of the RBI Act,

1934 should have a minimum net owned fund of Rs 25 lakh raised to Rs 200 lakh w.e.f April

21, 1999 Vide Notification no DNBS 132/CGM (VSNM)-99, dated 20-4-1999, by the RBI

for an NBFC which commences the business of an NBFC after 21st April 1999. Thus, this

specification of higher “net owned fund” is not applicable to NBFCs that commenced

business before 21 April 1999. Net Owned Fund is defined in the Explanation to Section 45-

IA of the RBI Act 1934 as follows

a) The aggregate of the paid-up equity capital and free reserves as disclosed in the latest

balance sheet of the company after deducting there from:

i. Accumulated balance of loss;

ii. Deferred revenue expenditure; and

26 Supra note 1.



iii. Other intangible assets; and

b) Further reduced by the amounts representing-

i. Investments of such company in shares of-

a) Its subsidiaries;

b) Companies in the same group;

c) All other non-banking financial companies; and

ii. The book value of debentures, bonds, outstanding loans and advances

(including hire-purchase and lease finance) made to, and deposits with-

a) Subsidiaries of such company; and

b) Companies in the same group, to the extent such amount exceeds ten per

cent, of (a) above.

d) General Compliance Requirements

All NBFCs, being companies registered under the Companies Act, have to fulfil compliance

relating to the Board of Directors, Share Capital, Management Structure, Audits, Meetings,

maintenance as well as publication of books of accounts and general conduct as per the

requirements of the Companies Act 1956.

In addition, they have to fulfil the specific requirements of the Reserve Bank of India (RBI) as

set out in the Directions and various notifications and amendments by the RBI. The RBI also

prescribes a set of compliance norms for all NBFCs. The Prudential Norms for NBFCs accepting

public deposits are more rigorous.27

27 Supra note 10.



Conclusion

NBFCs are gaining momentum in the last few decades with wide variety of product 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 of financial system of our

country. The banking sector is financing only 40 percent to the trading centre and rest is coming

from the NBFC and private money lenders. At the same line 50 percent of the credit requirement of

the manufacturing is provided by NBFC. 65 percent of the private construction activities are also

financed by NBFC.

NBFC in India has become prominent in a wide range of activities like hire-purchase finance,

equipment lease finance, loans, and investments and so on. 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.

The strong NBFCs have successfully merged as financial institutions in short span of time and are

in the process of converting themselves into financial supermarket.

Thus, NBFC provide tailor made services to the clients, there has been a comprehensive regulation

of NBFCs, customers have been attracted to them by their higher level of customer- orientation,

lesser ore/ post sanction requirements, simplicity and speed of their services; the military and credit

policies have created and unsatisfied fringe of borrowers, i.e. the borrowers outside the purview of

banks. The NBFCs have catered to the needs of this section of borrowers; the relatively higher

interest rates offered by them on deposits have attracted a large number of small savers towards

them.



Bibliography

Books Referred:

1. Ravi Pulyani and Mahesh Pulyani, Manual of Non-Banking Financial Companies, Bharat

Publication, 11 Edition 2012.

2. M.L.Tannan, Tannan’s Banking Law and Practice in India, 21 Edition Volume 3,Wadhwa

Publication.

3. P.N. Varshney, Banking Law and Practice, 18 Edition, Sultan Chand Publication.

Website Referred:

1. http://.www.rbi.org.in.

2. http://www.caaa.in/Image/45%20NBFC.pdf .

3. http://shodhganga.inflibnet.ac.in/bitstream/10603/8650/11/11_chapter%203.pdf .

4. http://www.icaihyd.org/pgcntnt/pgcNBFC_%20revised.pdf

Articles Referred:

1. Rajkumar Adukia, A Manual on Non Banking Financial Institution.

2. Shodh Ganga, Financial System and Non-Bnaking Financial Companies- The Structure and

status Profile.

3. S. Durairajan, Regulation And Supervision of Non Banking Financial Companies.


http://www.icaihyd.org/pgcntnt/pgcNBFC_%20revised.pdf

http://shodhganga.inflibnet.ac.in/bitstream/10603/8650/11/11_chapter%203.pdf

http://www.caaa.in/Image/45%20NBFC.pdf

nbfc project

Documents

evolution of nbfcs

non financial companies

different types of nbfcs

present research

research questions

regulated banking system

indian financial system

existing banking system