Internal Audit of NBFCs

Introduction to
“NBFC”
 Meaning of NBFC
A company registered under the Companies Act, 2013 engaged
in:
• the business of loans and advances,
• acquisition of shares/stocks/bonds/debentures/securities issued by
Government or local authority or other marketable securities of a like
nature,
• leasing, Hire Purchase, Insurance Business, Chit Business but does not
include - any institution whose principal business is that of agriculture activity,
industrial activity, purchase or sale of any goods (other than securities) or
providing any services and sale/purchase/construction of immovable property.
• a non-banking institution which is a company and has principal business
of receiving deposits under any scheme or arrangement in one lump sum
or in installments by way of contributions or in any other manner, is also
a non-banking financial company (Residuary non-banking company)
 Definition of NBFC
Section 45I (f) of RBI act, 1934 defines “non‐banking financial
company” means –
• a Financial Institution which is a company;

• 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;

• such other Non‐Banking Institution or class of such institutions, as the RBI

may, with the previous approval of the Central Government and by
notification in the Official Gazette, specify;
 Types of NBFC
Infrastructure Core
Infrastructure
Finance Investment
Debt Fund
Company Company

Investment Asset Finance Loan

Company Company Company

Mortgage Housing
Micro Finance Finance
Guarantee
Institutions Company
Company
 Classification of NBFC
holds assets of
Rs.500 Crores
and above

Systematically
Important NBFC’s
Non Deposit (NBFC –ND-SI)
Accepting or
Holding (NBFC-ND)
Others

NBFC
Residuary NBFC
(RNBC)
Deposit Accepting
or Holding (NBFC-
D)
Others
 Residuary Non-Banking
Companies (RNBCs)
• Residuary Non-Banking Company is a class of NBFC which is a company
and has as its principal business the receiving of deposits, under any
scheme or arrangement or in any other manner and not being
Investment, Asset Financing, Loan Company.

• These companies are required to maintain investments as per directions

of RBI, in addition to liquid assets.

• The functioning of these companies is different from those of NBFCs in

terms of method of mobilization of deposits and requirement of
deployment of depositors' funds as per Directions.

• Besides, Prudential Norms Directions are applicable to these companies

also.
Audit of
NBFCs
Key Elements of Audit Universe
Defining the Audit Universe is
• The
the critical step in setting up an
organizational
Audit Plan
structure should
• The vastness and dynamic
be used to
nature of the business
corroborate the
• Geographical and
businesses corrobo
mapped Define demographic spread
rate

Identify Map • Mapping businesses using

• Common
financial statements is the
support /
first step towards
corporate
establishing the extent of the
functions
Audit Universe
of the NBFC
• Operations/back offices that
need to be
support these businesses
identified
need to be mapped
 Risk Map
Twice in
a year
High

Cell 3 Cell 2 Cell 1

Once in
EXPOSURE

a year
Medium

Cell 6 Cell 5 Cell 4

Once in
two Once in
years 18 months
Cell 9 Cell 8 Cell 7
Low

Once in
three Low 10 Medium 20 High
years RESIDUAL RISK
Audit of Asset Finance company
Infrastructure Core
Infrastructure
Finance Investment
Debt Fund
Company Company

Investment Asset Finance Loan

Company Company Company

Mortgage Housing
Micro Finance Finance
Guarantee
Institutions Company
Company
Audit of Asset Finance company
Product Life Cycle audit:

• Product Policy >> Standard Operating Procedures

• Sourcing - Direct Marketing Agents, Direct walk-ins , Sales team
• Credit Policy – Norms, Authorisations, Deviation Matrix
• Security Creation
• Operations
• Collections
• Post disbursement documentation – Invoice, Insurance, Registration
• Account Monitoring
• Compliance to Regulatory guidelines – such as Concentration of
Credit
 Concentration of
Credit/Investment (NBFC-D and
NBFC-ND-SI

• Group companies are to be determined as per Companies Act, 1956 and limits
are to be computed as percentage of owned funds
• Additional limit of 5% is available to Asset Finance Company.
• Ceiling applicable for funding to NBFC’s own group as well as borrower group.
• An Investment in Debentures is treated as loan and not investment.
• NBFCs not accepting ‘public funds’ or ‘not issuing guarantees’ may apply to RBI
for modification in above limits.
Audit of Investment company
Infrastructure Core
Infrastructure
Finance Investment
Debt Fund
Company Company

Investment Asset Finance Loan

Company Company Company

Mortgage Housing
Micro Finance Finance
Guarantee
Institutions Company
Company
 Audit of Investment company
Investment Policy Front office procedures Middle Office Settlement

Type of instruments Payment and

1 and limits 1 Fund Management 1 Limit monitoring 1 settlement on due date

2 Counterparty limits 2 Strategy 2 MIS 2 Accounting & Valuation

Order placement and

3 Stop Loss limit 3 execution 3 Validation of deals 3 Bank reconciliation

Deal size limit and

4 dealer limit 4 Regulatory Reporting

5 Deal confirmation
 Audit of Investment company
Valuation of Investments:

• All Investments should be marked to market

• Quoted Current Investment shall, for the purpose of valuation, shall be
valued at cost or market value, whichever is lower.
• Quoted current investments shall, for the purposes of valuation, be
grouped into the following categories, viz.,
• (a) equity shares, (b) preference shares, (c) debentures and bonds, (d)
government securities including treasury bills, (e) units of mutual fund,
and (f) others.
• Unquoted equity shares in the nature of current investment shall be
valued at cost or break-up value, whichever is lower.
• Investments in unquoted Government securities or Government
guaranteed bonds shall be valued at carrying cost.
 Audit of Investment company
Valuation of Investments:

• Unquoted investments in the units of mutual funds in the nature of

current investments shall be valued at the net asset value declared by
the mutual fund in respect of each particular scheme.
• Commercial papers shall be valued at carrying cost.
• Unquoted debentures shall be treated as term loans or other type of
credit facilities depending upon the tenure of such debentures for the
purpose of income recognition and asset classification.
• Long term Investment shall be valued in accordance with Accounting
Standard issued by ICAI.
 Other Audit Areas
• Branch Audits

• Borrowings:
 Lines of Credit
 Other instruments
 Public Deposits in case of NBFCs taking public deposits
 Compliance to regulatory norms

• Support Functions such as HR, Legal, Accounts & Finance etc.

• Compliance Audit

• Systems Audit both from a General IT controls and Functionality

Thank You
 Types of NBFC

1. Carry principal business of Financing of Physical assets

supporting productive/economic activity such as
automobiles, tractors, lathe machines, generator sets, earth
moving and material handling equipments, moving on own
Asset Finance power and general purpose industrial machine.
Company 2. Principal Business implies income arising from the above
activity is not less than 60% of its total assets and total
income respectively.

Investment Any company which is a financial institution carrying on as its

Company principal business the acquisition of securities.

Any company which is a financial institution carrying on as its

principal business the providing of finance whether by making
Loan Company loans or advances or otherwise for any activity other than its
own but does not include an Asset Finance Company.
 Types of NBFC

Systemically Important Core Investment Company (CIC-ND-SI)

carries the business of acquisition of shares and securities
which satisfies the following conditions:-
• Its Asset size is Rs.100 crore or above
• It holds 90% or more of its Total Assets in the form of
investment in equity shares, preference shares, debt or
loans in group companies;
Core Investment • Its investments in the equity shares (including instruments
Companies compulsorily convertible into equity shares within a period
not exceeding 10 years from the date of issue) in group
companies constitutes not less than 60% of its Total Assets;
• It does not trade in its investments in shares, debt or loans
in group companies except through block sale for the
purpose of dilution or disinvestment
• It accepts Public Funds
 Types of NBFC
• Deploys at least 75 per cent of its total assets in infrastructure
Infrastructure loans,
Finance Company • Has a minimum Net Owned Funds of Rs.300 crore,
• has a minimum credit rating of ‘A ‘or equivalent and a CRAR of
15%.
• To facilitate the flow of long term debt into infrastructure
projects.
Infrastructure Debt • It raise resources through issue of Rupee or Dollar denominated
Fund - MF bonds of minimum 5 year maturity.
• Only Infrastructure Finance Companies (IFC) can sponsor IDF-
NBFCs
• It is a non-deposit taking NBFC engaged in the principal business
of Factoring.
• The financial assets in the factoring business should constitute at
Factors least 50 percent of its total assets and its income derived from
factoring business should not be less than 50 percent of its gross
income.
• Has at least 90% of the business turnover is mortgage guarantee
business or
Mortgage Guarantee
• Has at least 90% of the gross income is from mortgage guarantee
Company
business and net owned fund is Rs.100 crore.
 Types of NBFC
• It is a non-deposit taking NBFC having not less than 85% of its assets
in the nature of qualifying assets which satisfy the following criteria:
• Loan disbursed by an NBFC-MFI to a borrower with a rural household
annual income not exceeding Rs.1,00,000 or urban and semi-urban
household income not exceeding Rs.1,60,000;
• Loan amount does not exceed Rs.50,000 in the first cycle and
Rs.1,00,000 in subsequent cycles;
• Total indebtedness of the borrower does not exceed Rs.1,00,000;
Micro Finance
• Tenure of the loan should not be less than 24 months for loan
Institutions
amount in excess of Rs.15,000 with prepayment without penalty;
• Loan to be extended without collateral;
• Aggregate amount of loans, given for income generation, is not less
than 50 per cent of the total loans given by the MFIs;
• Loan is repayable on weekly, fortnightly or monthly instalments at
the choice of the borrower

National Housing Board set up by the Government of India is the Apex

authority regulating the Housing Finance Company. NHB Directions, 2010
deals with the matters relating to acceptance of deposits by Housing
Housing Finance Finance Companies, Prudential norm for income recognition, asset
Companies classification, accounting standards, provision for bad and doubtful debts
etc.