Non-Banking Institutions 53l

CHAPTER 13 Banking and

NON-BANKING FINANCIAL COMPANIES

NBFCs supplement the
Non-banking financial companies (NBFCs) constitute an important segment of the financial system. role of the banking
financial intermediaries engaged primarily in the business of accepting deposits and deliv- sector in meeting
NBFCSare capital for-
credit. They play an important role in channelizing the scarce financial resources to the increasing
of
ering
mation.
NBFCs supplement the role of the banking sector in meeting the increasing financial needs financial needs of
borrowers. But they
corporate sector, delivering credit to the unorganized sector and to small local
the corporate sector,
the and hence,
diterfrom
banks in many ways. An NBFC can accept deposit but not demand deposits delivering credit
cannot raise low cost funds through savings or current accounts.
Moreover, it is not a part of the to the unorganized
from the RBI. sector and to small,
issue cheques drawn on itself and cannot borrow
thev
paynent and settlement system, cannot quick decisions,
flexible structure than banks. As Compared to banks, they can take
local borrowers.
NBFCs have a more to the needs of the clients. NBFCS have a more
greater risks, and tailor-make their services and charges according
assume providing the saver and investor a bundle of flexible structure
Their fexible structure helps in broadening the market by than banks.
basis.
services on a competitive defined vide clause (b) of Section 45-1 of Chapter
IIIB of
A non-banking financial company has been non-banking
financial institution, which is a company; (ii) a
the Reserve Bank of IndiaAct, 1934, as (1) a receiving of deposits under
as its principal business the
institution, which is a company and which has (iii) such other non-banking
other manner or lending in any manner;
any schemeor arrangement or inany bank may with the previous approval of the central govern
institutions or class of such institutions, as the
specify.
ment and by notification in the official gazette,(xi) of Paragraph 2(1) of Non-Banking Financial Com
NBFC has been defined under Clause 'non-banking finan
Public Deposits (Reserve Bank) Directions, 1998, as: investment
panies Acceptance of non-banking institution which is a loan- company or an
cial company' means only the benefit
finance company or an equipment leasing company or a mutual
Company or a hire purchase
lease finance, loans, and
finance company.
range of services such as hire purchase finance, equipment provided by them, there
NBFCs provide a NBFCs and a wide variety of
services
Investments. Due to the rapidgrowth of between banks and NBFCs except that commercial banks have
distinction
i2s been a gradual blurring of directors,
cheques.
the exclusive privilege in the issuance ofresources through deposits from public, shareholders, new
of debentures. In the year 1998, a
NBFCs have raised large amnount issue of non-convertible of
borrowings by shareholders in the case
d Oner companies and received from public, including companies, banks,
concept of public deposits meaning deposits debentures/bonds other than those issued to NBFC's accepting
and unsecured supervision of
emited companies introduced for the purpose of focused
inancial institutions. was
such deposits.
PART III Financial Institutions

Export / Import Factoring

The Foreign Exchange Department (FED) of the Reserve Bank gives
FEMA, 1999. Therefore. NBFC-Factors. intending to deal in forex authorization to Fzctors
through export import factoning
should make an application to FED for necessary authorization under FEMA.
adhere to the terms and conditions prescribed by FED and all the 1999 to deal in forex -
relevant
Rules, Regulations, Notifications. Directions or Orders made thereunder fromprovisions of the FEM: .
tíme to time.

Growth of NBFCs
NBFCs in India have existed since long. They came into limelight in the
the first half of the 1990s. second half of the 19805 andi
NBFCs flourished during the stock market boom of the early 1990s. In the
tion, they not only became prominent in a wide range of activities but they initialyears of liberzliza
raising owing to their customized services. They have backed many smalloutpaced banks in deposit
also lent small-ticket personal loans of size of 25,000to entrepreneurs. They have
tion boom. customers and thereby fuelled the consump
Total assets/liabilities of NBFCs grew at an average annual rate of
36.7 per cent during the
1990s (1991-98)as compared to 20.9 per cent during the 1980s
tance of this segment and the surfacing of some scams compelled the (1981-9l). The growing impor
RBI to increase regulator:
attention.
Almost allcorporate houses have set up their own NBFCS. Big banks also fioated
NBFCs to tan
certain segments on which restrictions were imposed by the regulator. Banks through the NBFCs
could generously lend funds to promoters to raise his holdings through a
Financial is one of the oldest foreign bank-owned NBFC and a pioneer increeping
this
acquisition. Citi
segment.
been an increase in the number of NBFCs, especially those floated by foreign banks as There has
there are stric
tures on branch licensing. The Reserve Bank tightened NBFC norms in
November 2006 to reduce
regulatory arbitrage between different financial sector players. According to the new guidelines. not
deposit taking NBFCs which have assets of over I00 crore will be subject to
adequacy norms. Banks will not be able to lend indiscriminately to them. Nor exposure and capital
will thev be allowed
to hold more than 10 per cent equity stake in deposit-taking NBFCs.
Moreover, foreign banks with
NBFCsubsidiaries will be required to include the activities of their NBFC arms in their reporting to
the Reserve Bank.

Regulation of NBECs
In the 1960s, the RBI made an attempt to regulate NBFCs by issuing
directions relating to the
amount of deposits, the period of deposits, and rate of interest they could offer on the deposits maximum
Norms were laid down regarding maintenance of certain percentage of liquid assets. creation ofaccepted
funds, and transfer thereto every year a certain percentage of profit, and so on. These directions andresene
normS
were revised and amended from time to time.
In 1977, the RBI issued two separate sets of guidelines, namely, (i) NBFC
Acceptance of related
Directions, 1977, for NBFCs and (ii )MNBD Directions, 1977, for MNBCs. These directions wereDeposits
to deposit-taking activities of NBFCs. The Reserve Bank made an attempt to regulate the asset side of
NBFCs in 1994 in pursuance of the Shah Committee recommnendations. However, it was not empowered
to regulate the asset side of NBFCs.
NBFCs became prominent in the first half of the 1990s. The growth in aggregate deposits o!
NBFCs outpaced that of banks. However, bank finance to NBFCs dried up in 1995 after the RBI
cautioned banks against such lending. Therefore, NBFCs had to depend on fixed deposits often at
rates upto 26 per cent. To service high-cost deposits, NBFCs invested in bought-out deals. shares.
real estate and corporate financing-areas in which they had litle experience. The slackness in the
capital and real estate markets and general industrial activities resulted in sharp deterioration in
NBFC's quality of assets.
Crores of rupees of smallinvestors disappeared overnight as NBFCs like CRB Capital Markets. JVG
Finance, and Prudential Capital Markets failed in 1997. This shook investor confidence which resulted in
a rush of withdrawals of public deposits.
This is the only sector which hada number of committeestrying to regulate its working. The first was
the Shah Committee in 1992. It was followed by the Shere Committee, Khanna Committee. and various
committees of the RBI.
 537
CHAPTER 13 Banking and Non-Banking Institutions

In1997,theRBÊ Act was amended and the Rescrve Bank was given comprchensive powers to regu-
· NBFCs.Theannended act made it mandatory for evcry NBEC lo chtain acertificate of registration
dhave Minimum net owncd funds. Ceilings were prescribed for acccplance of deposits, capital ade-
ratingandi net-owned funds. Net owncd fund (NOF) of
pialand, NBFCsof loss:
tree rescrves, netted by (1) the amount of accumulated balance
is
the aggregate
and (ii)theof deterred
paid-up
RUCCNPpenditureand other intangible asscts, if any, and further reduced by investments in shares
ohdloansandadvancesto (a) subsidiaries, (b) companics in the same group and (c) other NBFCs, in
MNO 10per cent of owned fund. Norms relating to capital adequacy, credit rating Cxposure, asset
lsitication,and so on were laid down, The Reserve Bank also developcd a comprehensive system
NBFCs accepting/holding public deposits. Directions were also issued to thc statutory
gUitorstoreport noncompliance with the RBI Act and regulations to the RBI, board of directors and
NBFCs
harcholders ofthe
Thetask force constituted by Government of India under the Chairmanship of Shri C. M. Vasudev
Suhmittedits reporton October 28, 1998, after reviewing the existing regulatory framework for NBFCs.
The Government of India framed the Financial Companies Regulation Bill, 2000, to implement the rec-
niations requiring statutory changes, as also consolidate the law, relating to NBFCs and unincor
bodies with aview to ensuring depositor protection. According to this bill, all the NBFCs willbe
inlas financial companies instead of NBECs

Overview of Regulation of NBFCs

1.Mission: To ensure that:
financial companies function on healthy lines:
policy framework, so that their function
"these companies function in consonance with the monetary
ing does not lead to systemic aberrations; and
RBI over the NBFCs keeps pace with
the quality of surveillance and supervision exercised by the
the developments in this sector.
(RBI) Act, 1934: RBI Act was amended in January 1997
2. Amendments to the Reserve Bank of India
providing for, inter alia:
under
deposit acceptance (save to the extent permitted
entry norms for NBFCs and prohibition of financial business;
engaged in
the Act) by unincorporated bodies assets and creation of reserve fund:
liquid
compulsory registration, maintenance of NBFC or to the NMBFCs in general or
to a class of
RBI to jssue directions to an
power of the
NBFCs.
supervisory framework
Basic structure of regulatory and supervision over
of deposit taking NBFCs and limited
Comprehensive regulation and supervision
those not accepting public deposits.
those applicable to banks.
rescription of prudentialnorms akin to purpose of off-sitesurveillance.
Submissionof periodical returns for the inspection (CAMELS pattern) (b)
off-site monitor
comprising (a) on-site auditors,
upervisory framework intelligence and (d) exception reports by
statutory
ig through returns (c) market
management system for NBFCs. prohibition from acceptance
sCtliability and risk certificate of registration (CoR),
cancellation of in extreme
rünitive action like
assets. filing criminal complaints and winding up petitions
deposits and alienation of observersin certain cases.
cases, and appointment of the RBI
4. Other depositors'interest
stepsfor protection of unauthorizedand fraudulent activities, training pro-
to curb
"Coordination governments
with State NBFCs, state governments and police ofticials.
workshops/seminars for trade and industry orga-
"
grammes for personnel ofeducationand awareness,
Publicity depositors'
for depositors'
associations, and
chartered accountants.
accepting/holding public deposits were advised
nizations,
In order to protect depositors'interest, all
NBFCs
available for public deposits acceptéd by
them, The
full asset cover
realisable/market value, whichever is lower, for this
to
ensure thatthere should be
their book value or cover calculated falls short of
assetsshould beevaluated at Bank in case the asset
Reserve
the
Purpose. NBFCs have to report to
the liability deposits.
account of public
 538 PART III Financial Institutions

Regulatory Norms and Directions for NBFCs

At present,there are two categories of NBFCs-deposit-taking and non-deposit taking. The
Bank has focussed on regulating deposit-taking NBFCs and subject them to regulations Such as Reserve
pru-
dential limits and capital adequacy requirements which are more stringent than regulations
R banks. For regulatory purpose, non-deposittaking NBFCs(NBFCs-ND) with asset size of irnposed
fi00 crore and
n
above have been classified as systemically important NBFCs (NBFCs-ND-SI). These NBFCs are
jected to limited regulations` and now subject to CRAR and exposure norms prescribed by the Resere
Bank. The CRAR prescription for such companies has recently been raised to 12 per cent by March 31
2009 and 15per cent by March 31,2010. They are allowed to issue perpetual debt instruments (PDi) in
rupees to augment their capital funds.

A. Important Statutory Provisions of Chapter IB of the RBIAct as Applicable to NBFCs

SI. No. Subject Particulars

1. Certificate of registration* No company, other than those exempted by the RBI, can com
mence or carry on the business of non-banking financial institution
without obtaining aCoR from RBI. The pre-requisite for eligibility
for suchaCoR is that the NBFC should have a minimum NOF of
T25 lakh (since raised to 2 crore on and from April 21, 1999 for
any new applicant BBFC). The RBI considers grant of the CoR after
satisfying itself about the company's compliance with the criteria
enumerated in Section 45-IA of the RBI Act.

2. Maintenance of liquid assets* NBFCs have to invest in unencumbered approved securities, valued
at a price not exceeding current market price, an amount which, at
the close of business on any day, shall not be less than five per
cent but not exceeding 25 per cent, specified by the RBI, of the
deposits outstanding at the close of business on the last working
day of the second preceding quarter.

3. Creation of reserve fund* Every non-banking financial company shall create a reserve tund
and transfer thereto a sum not less than 20 per cent of its net profit
every year as disclosed in the profit and loss account and betore
NBFC
any dividend is declared. Such fund is to be created by every
irrespective of the fact whether it accepts public deposits r nol.
Further, noappropriation can be made from the fund for any pu
pose without prior written approval of the RBI.
Deposit Acceptance Related Regulations
 Institutions 54
CHAPTER13 Banking and Non-Banking

Supervision
that NBFCs function on sound lines and avoid excessive risk
t0 ensure
Inorder taking, the RBI has devel-
four-pronged supervisory framework based on the following:
opeda
inspection structured on the basis of assessment and evaluation of CAMELS (Capital,
" On-site
Assets, Management, Earnings, Liquidity, and Systems) approach.
.Of-site monitoring supported by state-of-the-art technology. It is through periodic control reports
from NBFCs.
, Use of market intelligence system.
. Reports of statutory auditors of NBFCS.
The RB0 supervises companies not holding public deposits in a limited manner. Companies with asset
size of 100crore and above are subject to annual inspection while other non-public deposit companies
are supervised by rotation once in every five years.

Role of Board for Financial Supervision in Monitoring NBFCs

With aview to having an integrated approach to the entire financial sector, the supervision of NBFCs was
brought under the jurisdiction of theBoard for Financial Supervision (BFS) with effect from July 1, 1995.
BFS directs, formulates, and oversees the implementation of policy as well as supervises NBFCs. BFS
also serves as an important forum for deciding the course of action against problem companies and moni
toring their status on an on-going basis. In addition, quarterly and half-yearly reports on the performance
of NBFCs are discussed in BFS meetings.
The outstanding deposits with NBFCs have declined since the scam hit the industry in 1997. Investors
e preferring other investment avenues like mutual funds, stock markets and other small saving schemes
oparktheir surplus funds. NBFCs, too, are raising funds through cheaper avenues like commercial papers
aDle 13.39). Six larger companies, constituting just about 2.8 per cent of the total number of NBFCs-D,
mobilized about 95 per cent of total deposits of the NBFCs-D at end-March 2013(Table 13.40).
Capital adequacy norms were made applicable to NBFCs in 1998. The norms relatingto capital to risk-
weighted assets ratio (CRAR) stipulate that every NBFCshall maintain a minimum capital ratio consisting
Oftier I and tier II capital that shall not be less than 12 per cent of its aggregate risk weighed assets and of
runratisk-eaddjudeposit
sted taking off-balance
value of sheet items in case of asset finance companies and 15 per cent in case of
loan and investment companies. Out of the 209 reporting NBFCs, 173 NBFCs had
CRAR above 30 per as on March 31, 2013. Of the total 209 reporting NBFCs-D, 206 companies had
maintained aCRAR incent
excess of 15 per cent as at end-March 2013 (Table 13.42).The ratio of public deposits
lo net
owned fund (NOF) of NBFCs-D increased marginally as at end-March 2013..The Gross NPAs to total
advances came downhidhis,
NBFCS s(excluding to 2.2potential
per cent nidhis,
in 2012andbut MNBCs)
marginallyas increased to 2.4 2013
on end March, per cent
(Tablein 2013
13.42).(Table 13.4l)
The RBI
are not placed NBFCs in August 2005. The key areas
restrictions on bank funding to NBI
alowed to lendto NBFCS are: Investments of NBFCs in shares and debentures of
where banks
any company,
TADE.
 Conclusion
NRES in India have become prominent in awide range of activities like hire purchase finance. equip
ont lease finance. loans, and investments. NBFCs have greater reach and fiexibility in tapping
resources.
in desperate times, NBFCs could survive owing to their aggressive character and customized services.
NBFCS are doing more fee-based business than fund-based. They are focusing now on retail sector
housing fnance, personal loans, and marketing of insurance. Many of the NBFCs have ventured into the
domain of mutual funds and insurance. NBFCs undertake both life and general insurance business as joint
tinancial
venture partic1pants in insurance companies. The strong NBFCs have successfully emerged as
inancial super
InSitutions` in a short span of time and are in the process of converting themselves into
self-regulatory organi
market'--a one-stop financial shop. The NBFCs are taking initiatives to establish a Financial Services
the Association of Leasing and
Zalon (SRO). At present, NBFCs are represented by
(FIHPA), and Equipment Leasing Association
(ALPS), Federation of Indian Hire Purchase Association has
The RBI wants these three industry bodies to come together under one root. The RBI
naia(ELA). benefit of smaller NBFCs.
of SRO particularly for the
piasizedthe formation

KEY TERMS Pavment System Tie

Market Risk
Tec
Asset Liability Management Credit Risk
Non-Banking FinanialCoupaies Regional Rural Banks
Demand Deposits
BarkinIAdequacy
g Ratio Liquidity Risk
Operational Risk
Priority Sector Lendng
Time Deposits
Tier I Capital