NBFCs: Regulations, Operations and Critical Appraisal

In this article we will discuss about:- 1. Regulation of NBFCs 2. Operations of NBFCs 3. Critical Appraisal.

Regulation of NBFCs:

NBFCs were registered under the Indian Companies Act and not the Banking Regulation Act. So the RBI had no control over them. In recent years, they have grown in number and volume of business by entering into those areas where banks were not allowed to enter due to regulatory restrictions.

In view of their increasing role in the financial intermediation process, the Narasimham Committee recognised the need for integrating them within the mainstream of the financial system. Accordingly, the RBI constituted a Working Group under Dr. A.C. Shah in May 1992 to set out a programme of reform for financial companies.

On the basis of its recommendations, the RBI introduced a scheme of registration of NBFCs on 12 April, 1993. All NBFCs having Net Owned Fund (NOF) of Rs. 50 lakhs and above were required to register with the Reserve Bank. On 13 June, 1994, it issued prudential norms relating to income recognition, accounting standards, assets classification, provisioning for bad and doubtful debts, capital adequacy and concentration of credit/ investments for registered NBFCs.

The RBI also specified compulsory credit rating for them in a phased manner. They were required to achieve a minimum capital adequacy norm of 8%. Besides, they were required to get themselves rated by any one of the credit rating agencies at-least once a year. Credit rating provides objective information to depositors and creditors and helps in protecting their interest.

The RBI directions brought all public deposits and inter-corporate deposits of NBFCs within the discipline of its regulations. Further, the interest rates payable on deposits by NBFCs were also laid down. They were also required to attain a minimum liquid asset ratio to deposits. These measures had no statutory backing because the RBI Act, 1934 did not confer such’ powers to the Reserve Bank.

By the January 9,1997 Ordinance, the RBI has been given greater control over the activities of NBFCs. This ordinance was replaced by the RBI (Amendment) Act in March 1997. The conditions under which NBFCs can operate have been laid down by the RBI through several amendments to NBFCs regulations up to 2001.

(1) Entry point norm of Rs.25 lakhs as minimum NOF which can be raised to Rs.2 crores;

(2) Compulsory registration with the RBI;

(3) Maintenance of certain percentage of liquid funds in the form of unencumbered approved securities;

(4) Creation of reserve funds in which 20% of the net profit to be transferred every year;

(5) Issuing of directions for prudential norms by the RBI;

(6) Prohibition of NBFCs from accepting public deposits;

(7) Filing of winding-up positions for violation of RBI directions;

(8) Empowering the Company Law Board to direct a defaulting NBFC to repay deposits; and

(9) Stringent penal provisions in the form of pecuniary penalties for violation of RBI directions.

The various steps taken up by the RBI to consolidate the functioning of NBFCs failed to streamline their working. It, therefore, instituted a new regulatory framework for the operation of NBFCs.

Consequently, NBFCs were classified into the following three categories for purposes of regulation:

(a) Those accepting public deposits;

(b) Those not accepting public deposits but engaged in financial business; and

(c) Core investment companies holding at-least 90% of their assets as investments in the securities of group/holding/subsidiary companies.

While NBFCs accepting public deposits are subject to all types of regulations, those not accepting public deposits are regulated in a limited manner.

We will discuss each category briefly:

(a) Regulations over NBFCs accepting Public Deposits:

These regulations are applicable to equipment leasing/hire purchase (EL/HP) and loan companies/ investment companies (LC/IC).

(1) For old NBFCs, the minimum NOF remains at Rs.25 lakhs. But those seeking registration with the RBI and commencing business on or after April 21,1999, the minimum NOF is Rs.2 crores. NBFCs with NOF of below 25 lakhs cannot accept deposits. Companies with Rs.25 lakhs and above NOF can have public deposits not exceeding 1.5 times of NOF or Rs.10 crores whichever is less.

(2) The period of deposits should not be less than 12 months but not exceed 60 months.

(3) The rate of interest payable on such deposits should not be more than 16 per cent per annum.

(4) The brokerage fees and other expenses should not exceed 2% and 0.5% of the deposits respectively.

(5) The capital adequacy ratio has been fixed at 12% and above, in accordance with the eligibility criteria for accepting deposits.

(6) An EL /HP finance company accepting deposits is required to disclose in its advertisement and application form that it is an un-rated company having capital adequacy ratio of not less than 15% and within the RBI regulations mentioned above.

(7) Restrictions have been placed on NBFCs to invest in real estate, except for their own use, up to 10% of their NOF for EL/HP finance companies and 20% of NOF for LC/IC companies.

(8) NBFCs which fail to repay matured deposits cannot create assets in any manner, including giving loans or making investment, until the default is rectified. Depositors can also lodge their complaints to the Company Law Board.

(9) NBFCs are required to maintain liquid assets of not less than 15% of their public deposits effective April 1,1999. In case of default in maintaining approved securities of requisite value, the RBI imposes penalties.

(10) The liquid assets of NBFCs are required to be deposited in scheduled commercial banks appointed by the RBI so that the securities are not utilised otherwise, except for repayment to depositors. They are also permitted to keep their liquid securities with the Stock Holding Corporation of India.

(11) The RBI has introduced certain regulations in respect of opening and closing of branches. For instance, for closing a branch 3 months’ public notice prior to the date of closure has to be given in at-least one national newspaper.

(12) The RBI has also instituted a comprehensive supervisory mechanism over NBFCs. This includes on- site inspection, external auditing and off-site surveillance system regarding submission of various returns at quarterly/half-yearly/annual intervals irrespective of the size of their NOF.

(13) An independent Department of Non-Banking Supervision has been opened in the RBI to supervise the operations of NBFCs with its 16 regional offices at different centres of the country.

(14) NBFCs are required to follow a uniform accounting year of March 31 every year effective March 31, 2001.

(15) Any NBFC with NOF of Rs.2 crores has been permitted to undertake insurance business as agent on fee basis without any risk participation since July 2000. But those NBFCs which have NOF of not less than Rs.500 crores with good track-record in terms of net profits, subsidiaries, net NPA of not less 5%, etc. can set up joint venture company or insurance business with risk participation.

(16) The RBI has also allowed an NBFC to become a private sector bank effective March 31,2001. For this it has laid down:

(a) The NBFC should have a minimum net worth of Rs.200 crores as per its’ latest balance sheet which would increase to Rs.300 crores within three years of the date of conversion,

(b) It should not have been promoted by a large industrial house or by local, state or central public authority,

(c) It should have a triple A credit rating in the previous year,

(d) It should have capital adequacy of not less than 12% and its net NPA should be below 5%.

(17) Effective April 2001, the RBI has permitted foreign direct investment (FDI) in the NBFC sector. Foreign NBFCs can set up wholly-owned operating subsidiaries subject to bringing in $ 50 million. Joint venture operating NBFCs having 75% or less foreign investment have been allowed to set up subsidiaries, provided they comply with the applicable minimum capital ‘inflow of $ 50 million.

(b) Other NBFCs:

Since January 2000, NBFCs engaged in:

(a) Micro-financing activities;

(b) Not accepting public deposits; and

(c) Mutual benefit companies, have been exempted from the purview of registration, maintenance of liquid assets, creation of reserve funds, etc. Similarly, core investment companies, not accepting public deposits have been exempted from all prudential norms except registration and creation of reserve fund.

Operations of NBFCs:

Prior to the RBI (Amendment) Act of 1997, there were over 40,000 NBFCs in the organised and unorganised sectors. With the implementation of various regulations by the RBI from time to time, there were 13,849 NBFCs in June 2003. Of these, only 918 NBFCs were registered with the RBI and only 710 NBFCs were accepting public deposits.

The total assets of 910 reporting NBFCs as on March 31,2002 were Rs. 50,290 crores, with NOFs of Rs. 4,383 crores and public deposits amounting to Rs. 18,822 crores.

Critical Appraisal of NBFCs:

NBFCs have been performing a vital function in economic development by mobilising savings and making investments, advancing loans, providing equipment leasing and hire-purchase facilities. But their operations leave much to be desired. However, the RBI (Amendment) Act, 1997 has empowered the RBI with greater controlling powers over the activities of NBFCs of both the incorporated and unincorporated varieties.

Now there is a compulsory registration for all NBFCs. The RBI is empowered to issue directions to them on such matters as deposits, NOF, recognition, asset classification, capital adequacy, loan and investment, interest payment, credit rating, accounting standards, etc.

Giving more statutory powers to the RBI has been felt long ago because the NBFCs have been openly flouting rules. They lack transparency with regard to the sources of income, bad debts and nonrecurring income. There has been no provision in the RBI Act to force an NBFC to refund the depositor his amount.

Still, there is dichotomy in control and regulation of NBFCs. The RBI is to control and regulate the activities of NBFCs. The Company Law Board (CLB) is the agency to redress the grievances of depositors. With the changing national scenario in the financial markets, most of the NBFCs face difficulties in getting lower-cost funds, stiff competition from large NBFCs and subsidiaries of foreign NBFCs and joint venture foreign companies with the result that their business is dwindling.

Even though the RBI has opened more avenues in the form of entry into insurance business and private sector banks, they are only for larger NBFCs. The smaller NBFCs are trying to spread to rural and semi-urban areas. A few NBFCs have started new lines of business, such as financing vehicles, working as agents of larger NBFCs and foreign banks, etc..