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Chaper 36
Non-Banking
Financial
lnstitutions
(NBFIs)
Financial companies. who formulate, intermediate and delivey financial products and services, as an imporlant
segment of a financial system of a country are called 'non-financial
companies'. Non-banking financial company
lneans only the non-banking
institution which is a loan company, an investment.orpuiy,
a hire purchase
finance company. an equipment leasing company or a mutual benefit financial company.
Non-banking
financial companies (NBFCs),
encompass an extremely heterogeneous group of intermediaries.
BFCs differ in various attributes, such as, size, nature of incorporation and regulation, as well as the basic
l'unctionality of financial intermedlation.
Notwithstand ing their d iversity, N BFCs ari characterized by their ability
provide
niche financial services in the Indian economy. Because of their relative organizational flexibility,
ing to a bener response mechanism, they are cften able to provide tailor-made serviices. relatively faster than
I
bahks and financial institutions. This enables NBFCs to build up a clientele that ranges from small borrowers to
'established
corporates. While NBFCs have often been leaders in financial innovations, which are capable of
ienhancing
the functional efficiency ofthe financial system. instances of unsustainabiliity, often on accouht of
high rates of i
rrlrdlrurar vraolllry. I ne regulatory tramework that has been put in place by the RBl, aims at ensuring financial
stability without dampening the very spirit of maneuverability and innovativeness that sustains the sector.
NBFCs proliferated
in the early nineties. This rapid expansion was driven by the scope created by the
ess offinancial liberalization in fresh avenues ofoperations in areas, such as, hire purchase, housing,
;utpntent
leasing and investment. The business of asset reconstruction has recently emerged as a
.Greenfield,
ithin this sector, following the passage
of the Securitization and Reconstruction of Financial Assets and
of Security Interest (SARFAESI)Act,
2002.
ln view of their rapid growth and in response to certain disconcerting developments, the Reserve Bank of
ia (RBl)
strengthened the supervisory framework in January 1998, consequent to amendments to the Reserve
mkotlndiaAct,
1934 in March lggT.lnsupervisoryterms,fiscal
2OO2-03 sawthecompletionoftheprocess
compulsory registration ofNBFCs, existing at the point ofthe amendment ofthe RBI with the Reserve Bank.
ldes, a system of asset-liability rnanagement has also been put in place. In the interest of greater transparency,
RBI also instituted a system of balance sheet disclosures, effective March 2003.
ENTIT!ES
financial entities include the following:
'
NBFCs, comprising equipment leasing, hire purchase finance, loan. investrnent and residuary non-
banking companies.
.
Mutual benefit financial cornpanies. i.e., nidhi companies.
.
Mutual benefit cornpanies, i.e., potential nidhi companies.
'
Miscellaneous non-banking companies, i.e., chitfundcompanies (to the extent of their deposit-taking
activity).
492 Financiqlservices
REGISTRATION
The Reserve Bank of Ind ia (Amendment)
Act, | 997 has made it obligatory for N B FCs to apply to the Rese r vi
Bank for a Certificate
of Registration (CoR).
The rninirnum Net Owned Fund (NOF)*
for registration wtr
stipulated
at Rs.25 lakh for the then existing NBFCs and Rs.2 crore for new NBFCs seeking grant of CoR
pn
rr
afterApril
2l.1999.The
three-year period provided in the Reserve Bank of India (RrnendmeitjAcq
I997: firr thr
NBFCs to attain the minimum
NOF necessary for registration expired on January 9,2000.
certain types of financial companies. viz., insurance companies. housirrg finance companies. stock brgkilrg
companies'
chit fund companies. companies notified as'nidhis'under Section 620Aof the Companies Atl
1956 and companies engaged in merchant banking activities (subject
to certairr conditions). however. huvr
been exempted from the Reserve Bank's registration as they are regulated by other agencies.
PRINCIPAL
BUSTNESS
OF NBFCS
The inrportant
business ofNBFCs are identified as follows:
NBFCs Registered
wirh RBt
Non-Banking
Financial
comPany In terms of the Section 45 l(f)
[read
with Seoion a5l(c)] of rhe Rescrve
Bank of India Act' 1934, as amended in 1997, the principal business of a NBFC is tt at ori.ceJing deposits
or that of a flnancial institution,
such as. lending. investment in securities. hire purchase
finance or equip-
;
.
ment lea,sing' A brief description of the principal business of the various types of NBFCs is presented
bclowi
a' Equipmenl
Liasing Companl,
GLC)
- Equipment leasing or financing
of such activity.
b' Hire Purchase Finance Company (HPFC)-
Hire purchase transactions
or financing ofsuch transacti,rrrr.
c' lnvestment Company (lC)
- Acquisition of securities; includes primary
dealers (pDs)
which. rrrlul
alia, deal in underwriting
and market-making for government
securities.
'
d' Loan Contpany (LC)
- Providing finance by rnaking loans or advances,
or otherwise for any activltl
other than its own; excludes ELC/HpFC/ Housing Finance cornpanies (HFCs).
e' Residuary Non-Banking
Company
RNBC) - Receiving deposits under any scheme or arrangclrqll,
by whatever
name called, in one lunrp sum; in installrnents by way of contributions
or subscripli,lti:,
or by sale of units. certificates
or other instruments: or in any other manner. These companies 6. rr,l
belong to any ofthe categories
as stated above.
NBFCs not Registered
with RBt
l'Mutualbenefitfinancialcompany(MBFC),i.e.,Nidhicompany
Mutual benefitfinancial
cornpanynrgrlt
any company which is a financial institution notified by the Central Government
under section 6204 ol'llte,
CompaniesAcr,
1956 (t
of I 956).
2' Mutual benefit comPany (MBc),
i.e., potential
Nidhi company Mutual Benefit company mcirrr rt
company
not notified under section 620,{ofthe Compan
nd carrying on ihe busilrst 1f
a non-banking
financial institution on January 9,1997:h
6wned funds and prefcrerrllrrl
share capital, of not less than ten lakhs of rupees; and has
ate of registration to tho llirrrh
quirements contained in the relevant provisions
ol lhe
ct, 1956 to NidhiCompanies
by the Central Governnrcll
, Chit fund company The business of Miscellarrcorrr
supervising as a promoter,
foreman or agent ol rrrry
nters into an a-qreement tvith a specified nunrht,l rrl
r(nilllrrrr\.\
r,t tlrr. \.[lc gr.orrp itrrd other NBFCs. rn excess of l0
l)cr
cent of owned fund
Non-Bonking Fincrr rt, r r r I l, r.rl I I I I I trrlli
VISION OF NBFCS
at strengthening the supervisory framework for NBFCs to ensure sound and healthy functioning and
id excessive risk taking. The supervisory framework for NBFCs is based on three criteria, viz., the size of
'
the type of activiry performed, and the acceptance or otherwise of public deposits. Towards this end, a
;ru
lud,
hc ptrtv
(including requirement
of registration)
c;;;;y
- --
Micro linance company
supervisory strategy comprising the following has been put in place:
494 Finq.nciolServices
P
.
On-siteinspection
based on CAMELS
(Capital' Assets, Management,
Earnings'
Liquidity'
i
ana Procedures)
methodology'
i
Co.rnputerized
off-site surveillance
through
periodic control
returns'
1
An effective
market intelligence
network'
I
.
A systern
"f
tr;;ri;;i;;
oF"*ttpti*,:f1
hw arrditors of NBFCs' has been
put in place'
'
A systeln or suDntlSslull
ul sllePrrurr
tw
The regulation
and supervision
is cornprehensive
ensure
protection ofinterests
ofdepositors'
They are re
public deposits,
prudential norms' and liquid assets' an
Companies
not holding or accepting
public depo
They are iequired
to comply only with prudentia.l norm
asset classidcation
and
provisioning against bad and d
cornpanies
are presently not required to submit any retu
auditors' exception
reports constitute the important
su
ALM System
for NBFCs
The Reserve Bank annortnced
ALM
(Asset-Liability
Management)
guid
nranagement.
AIINBFCs
with asset size of Rs'100 crore or above or with pu
u, p.r"rh"i, balance sheet as on March 3 I
'
2001
'
were instructed
to have A
are required to constitute an ALM Committee'
under the charge of Chie
Executive and other specialist
members, for forrnalizing
ALM systems'
The ALM system is required
to bE
implerne.ted
by NBFCs by March 3l.2oo2.ln
the case"of
NBFis holding
public deposits
of Rs'20 c
above, the first ALM return, comprrsing
of staterfents
on structural
liquidity'
short-term
dynamic liquid
:,
interest rate sensitivity,
as on Septernber 30.2002,should
be submitted
to the Reserve
Bank by octo
;
2002'NBFCsnotholdingpublicdeposits'buthavingassetSizeofRs.l00croreorabovewouldbeadvisctlof
the supervisory
fro,..*Jrk
in due course of time. ihe
"o'panies
have been advised
to conduct
trial I'tttg
during the lralf-year end ing September
30, 200 t und r'utf-y"u, beginning
october I
'
200 I
'
and report operatiortBl-
difficulties
in inrplementing
the system tbr rectification'
fn. ihit F'nds and Nidhicompanies
have' for tlte
present. been kept out of tie puiview of these
guidelines' NBFCs not qualifoing
presently
have also bc(ln
advised to put in place an ALM systern, as it is thI endeavour
of the Reserve
Bank to extend these
guidelincs lrt
allNBFCs
in t'uture.
BegulatorY
Framework
l. As regards NBFCs
registered with RBI RBI has been rnaking
attempts to introduce'
a number
of meastttleq
to errhance the regulatory and supervisory
standards of NBFCs' by periodicalty
announcing
regulatory
meastll{'\
The objective
is to bring thern at par with commercial
banks, in select operations,
over a period oftime' Somc
ill
the regulatory
nteasutes adopted by the RBI in ,...nt years
fnclude'
aligning
interest rates in this sector
willr
the rares prevale,t in the resiof the economy,
tightenin;
prudential
norms' standardising
operating
procedttrt'r
and harrnonising
supervisory
directions
with tlre
"quiit'-"tnt'
of the amended
Cornpanies
Act' in respect
ol
inter alia,registration.
reporting requirements
and constitution
of audit committees'
TheneedTheneedforputtinginplacearegulatoryfrarrreworkbytheRBlisnecessitatedonaccountol-lltr.
following reasons:
Simplified sanction
procedures. orientation
towards customers,
attractive
rates of return on deposits
lrtIl
flexibility and timeliness
in rl1eetirrg
tlre credit needs of specified
sectors
(like equipment
leasing and hirc
purchase), are sonte of the factors enhancing
the attractiveness
of this sector' Non-banking
financial
comparrie
"
(NBFCs) have been the subiect of focused attention during
tlre nineties'
ln particular' the rapid
growth ol
Nll'Cs, especially
in the nineties. has led to a gradLral bturring
of dividing lines between
banks and NBlr(':'
with tlrc exception of the exclusive
privilege, th"at commercial
banks ex'ercise
in the issuance
of cheques'
Non-Bonking Finqncial Institutions
(NBf'l.s)
4gi
Owing to certain disquieting developnrents in the NBFC sector, the RBI Act was amended in l()()7.
providing for a comprehensive regulatory framework for NBFCs. The RBI (Amendment) Act, 1997 providcs lirl
cornpulsory registration with the Reserve Bank. of allNBFCs, irrespective of their holding of public deposits.
for commencing and carrying on business, minimurn entry point norms. rnaintenance of a portion of deposits irr
liquid assets, creation ofReserve Fund and transfer of20 per cent ofprofit after tax annuallyto the Fund. Thc
Amendment Act also conferred powers on Reserve Bank to issue directions to companies and its auditors.
prohibit deposit acceptance and alienatlon of assets by companies and effect winding up of companies.
Accordingly, the Reserve Bank issued directions to companies on acceptance of public deposits, prudential
nonns like capital adequacy, income recognition, asset classification, provision for bad and doubtful debts.
exposure norms and other measures to monitor the financial solvency and reporting by NBFCs. Directions were
also issued to auditors to report non-cornpliance with the RBIAct and regulations to the Reserve Bank, Board
of Directors and shareholders.
Banks & NBFCs
-
A regulatory interface Banks and NBFCs essentially perform the function of financial
intermediation in the economy. Their regulatory design has serious implications for the efliciency of the
financial system, as well as for financial stability of a country. Gaps in their functiqning, often create the scope
for regulatory arbitrage, that impact the process of price discovery and efficient allocation of resources, or
result in regulatory repression of the various segments of the financial sector. For instance, banks and public
deposit-accepting N BFCs compete for deposits. Besides, banks and NBFCs are also competing for sources of
funds in certain sections of the credit markets. These two factors provide the basic case for regulatory
convergence in terms of li9{lll&
TpIg]
3dequacy, logqlpss+rsr4laqpg and risk rnanryment. At the same
time. a large number of NBFCs do not mobilize public deposits and therefore]-do-n6t fund their activities
through deposit money, as in the case ofbanks. This implies thatthe case for regulatory convergence based on
depositors'protection between banks and NBFCs does not apply unifornlly to the latter.
Lot of difference exists as regards regulation of deposit-taking entities viz., banks and NBFCs. The
differences in regulation of banks and NBFCs reflecttheir unique characteristics and the fundamental differences
q
in their operations. This is captured below:
While both bank and non-bank deposits reflect investor choice, bank accounts, current andlor savings are
necessary to settle financial transactions, since banks exclusively have the power of issuing cheques. as
constituents of the payments system. Further, transactions, putthrough banks and NBFCs carry very different
macroeconomic implications. For instance. a deposit with a bank sets off a process catled
'credit
creation',L.'/
while a deposit with an NBFC typically results in a transfer of ownership of bank defloilts-,iiliihout any
immediate monetary impact. This implies that certain regulatory measures, such as, the imposition of cash
reserve requirements, apply uniquely to banksl--
The irnpact ofNBFC activity on bank soundness is also complex. First, a shift ofterm deposits from banks
to NBFCs could ease the interest expenditure in the bank balance sheets. since NBFCs are more likely to place
funds in non-interest bearing current accounts. Second, in case of individual banks, there would also be the
cost of variability of cash flows as NBFCs transact their business. The net effect on banking soundness would.
thus, primarily depend on the relative strength of the two factors. Finally. as far as banks lend to NBFCs, their
performance directly impinges on the health of banks.
Banks & NBFCS
-
a regulatory comparison Banks and NBFCs diff-er in the following respects as regards
the regulatory framework that has been put in place:
496 Finonciol Services
Sl.No. Pa rticula rs
Banks
NBFCs
I
Minimum capital/
Net Owned Fund
Minimum capital requirements
of Rs.200 crore, to be raised to
Rs. 300 crore within three years
ofoperation, in case ofnew
banks; promoters'
minimum
contribution is 49 per cent of
the paid-up
capithl.r
a\
Net owned fund of not less than
Rs. 2 crore is a pre-requisite.
for
grant of CoR for-eommencing
-
the business of a non-banking
financial institution.
2 SLR (statutory
liquidity Reserve)
/
Maintained in lndia, in either,
cash. gold, unencumbered
approved securities valued at a
price specified by the Reserve
Bank, or net balances in current
accounts with nationalised
banks in India. at close of
business on any day on total of
demand and time liabilities in
India on fortnightly basis, or
suclr other percentage not
exceeding 40 per cent, as the
Reserve Bank rnay speci$, from
time to time.
Maintained in India in
unencumbered approved
securities, valued at current
market price. an amount at the
close ofbusiness on any day,
which shall not be less than l5
per cent of the public deposits
outstanding, as at the last
working day ofthe second
preceding quarter.
) CRR(Cash Reserve
Ratio)
Applicable
\_/
No such requirement
4 Reserve Fund
Applicable; transfer out of the
profit ofeach year before
dividend is declared, to such
reserve fund, a sum not less
than 20 per cent of such
profit.v
Same as in the case ofbanks.
5 Prior approval of
Reserve Bank for
appointment of
Managing Director
Necessary; applicable in case
amendment to the terms and
conditions of the appointment
of rranaeing directors, etc..
of No such requirement
6 Prohibition of
common directors
Applicable
No such requirement
7 Powers for
appointment of
additional directors
RBI may appoint one or more
persons to hold office as
additional directors. of a
bankine comDanv.
No such powers in the case of
NBFCs.
8
Control over
appointrnent of
aud itors
Prior approval of the RBI for
appointment, re-appointment or
removal of the auoitor required.
No such requirement for
NBFCs; these companies have
freedom to appoint their
auditors as per the Companies
Act. 1956.
Non-Bonking Finqnciol lnstitutions
(NBFIs)
497
9 Deposit directions On acceptance of deposits tiorn
the public. repayable on
dernand. interest rate
PaYable
on saving accounts,
Prescribed
by the RBI.
Detailed directions on
acceptance of publ ic dePosits
relatirrg lo. inrcr a/ra. minitnum
eligibility criteria.
quantum,
rninimum and maximuln
Period.
rate ofinterest. and
advertisement.
0 Payment systetx Menrber of payment and
lsettlement
system. can accept
deposits withdrawable by
oheoue.
Canfibt accept deposits
withdrawable by cheque
ll Deposit insurance
q'
tV
n\
Deposits insured bY the DePosit
Insurance and Credit Guarantee
Corporation of India uP to
Rs.l lakh for each dePositor in
respect ofdeposit in an insured
bank in the same caPacitY and
in the same rieht.
Deposits are not insured and no
official agency grrarantees the
payrnent of princiPal or the
interest on such dePosits.
J
r2 Refinance facilitV
I
RBI rray grant refinance,
red iscountitrg faci lities and
demand loans.
No such provision in the
Reserve Bank of lndia Act,
1934.
l3 Powers of
amalgamatiorr. and
scheme of
arrangentent
RBI has powers to sanctton
schenres of amalgamation,
reconstruction. and arrangenrent
approved by the requisite
majority of shareholders
of the
bank.
No such provision.
l4 Winding up
Special provisions for winding
up ofa banking comPanY under
ceftain circumstances.
'Winding
pP. subject to the
general provisions contained in
the Comoanies Act, 1956.
i
Following are the important regulations relating to N BFCs in lndia:
H
:---.
^rrl^ ^^+^^:-^ ^r
l^+araor
'otao
in rha fi um rate cf fl
[l. lnterest rates ln view of the softening of interest rates in the fi
'irr.r.rirf1,
NnfCs
linctud
ing nidhicompanies and chit fund compan
ic deposits
.was
reduced from 12.5 p",
".nip",
annum to 1l .0 per cent per annum wi '
Similarly'
rninimum rate of interest payable by RN BCs was reduced from 4.0 per cenl to r.) per !:ent
Ptrr
atrtrum on daily
rosit sclremes, and frorn d.O p"t cent to 5.0
per cent per annum on other types of deposits' In orderto ensttrc
rat rates on non-resident Indian
(NRl) deposits are uniform in the entire financial system, NBFCs. inclttding
NBCs, have been clirected that interest payable on such deposits accepted by them would be the same
as that
yable by scheduled commercial banks (SCBs)
,
i.e .25 basis points abo re the London Inter-Bank OtTcr Rate
LIBOR) i SWAP rate for US dollars of corresponding
maturity'
Transactions in
government securities All NBFGs were directed to invariably hold their investments
in Covernment securities in either of the following ways:
a) The Constitgents' Subsidiary General Ledger Account (CSGL) with a SCB. or the Stock Holdittg
Corporation of lndia Limit-ed
(SHCIL).