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NON BANKING FINANCIAL COMPANY (NBFC) SECTOR IN INDIA - TRENDS,

REGULATORY ISSUES AND WAY FORWARD

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 NON BANKING FINANCIAL COMPANY (NBFC) SECTOR IN INDIA –
TRENDS, REGULATORY ISSUES AND WAY FORWARD

Author

Puneet Kaur
B.Com(Hons), MBA(Finance), UGC-NET, P.hD(Pursuing)
Assistant Professor
A.S College, Khanna. Punjab. India.
[email protected]

INTRODUCTION

A Non Banking Financial Company (NBFC) is a company registered under the Companies Act,
1956 of India. Non-banking financial companies (NBFCs) are financial institutions that offer
various banking services but do not have a banking license. Generally, these institutions are not
allowed to take traditional demand deposits—readily available funds, such as those in checking
or savings accounts—from the public. This limitation keeps them outside the scope of
conventional oversight from federal and state financial regulators. NBFCs play a critical role in
the Indian financial system. NBFCs can offer banking services such as loans and credit facilities,
currency exchange, retirement planning, money markets, underwriting, and merger activities. A
NBFC supplement banks by providing the infrastructure to allocate surplus resources to
individuals and companies with deficits. It also produces competition in the financial services
industry. NBFC’s keep their services flexible to meet the needs of specific client. NBFCs may
specialise in one particular sector and develop an information advantage. It enhances competition
through unbundling targeting and specialising.

The working and operations of NBFCs are regulated by the Reserve Bank of India (RBI) within
the framework of the Reserve Bank of India Act, 1934 (Chapter III-B) and the directions issued
by it. On November 9, 2017, Reserve Bank of India (RBI) issued a notification outlining norms
for outsourcing of functions/services by Non-Bank Financial Institution (NBFCs). As per the
new norms, NBFCs cannot outsource core management functions like internal audit,
management of investment portfolio, strategic and compliance functions for know your customer
(KYC) norms and sanction of loans. Staff of service providers should have access to customer
information only up to an extent which is required to perform the outsourced function. Boards of
NBFCs should approve a code of conduct for direct sales and recovery agents. For debt
collection, NBFCs and their outsourced agents should not resort to intimidation or harassment of
any kind. All NBFCs’ have been directed to set up grievance redressal machinery, which will
also deal with the issues relating to services provided by the outsourced agency.

ROLES OF NON BANKING FINANCIAL COMPANY

As recognised by RBI the specific roles of a NBFC are as follows:

1. Development of sectors like transport and infrastructure.

2. Substantial employment generation.

3. Help and increase wealth creation.

4. Broad based economic development.

5. To finance economically weaker sections.

6. Huge contribution to state exchequer.

7. Irreplaceable supplement to bank credit in rural segments, major thrust on semi-urban,

rural areas and first time users.

NBFCs are spread all across the country with more than 13000 + players registered with the RBI.
Approximately 570 NBFCs are authorised to accept public deposits. Assets worth Rs. 15000
crores are financed annually. Asset financing includes providing finance for commercial
vehicles, passenger laws, multi-utility vehicles, construction equipment, and consumer durables.

ROLE OF NBFC IN ECONOMIC DEVELOPMENT

NBFCs aid in economic development of country in the following ways:

 Mobilisation of resources by converting savings into investments.

 Capital formation which aids to increase capital stock of company.

 NBFCs provide long term credit and specialised credit.

 Aid in employment generation.

  Help in development of financial markets.

 Helps in attracting foreign grants.

 Helps in breaking the vicious cycle of poverty by serving as government’s instrument.

TYPES OF NBFCs IN INDIA

(A) ON THE BASIS OF THEIR ACTIVITY:

1. Asset Finance Company: According to RBI, any non-banking company can act as an asset
finance company, on condition; that the income arising from the aggregate physical assets
supporting the economic activity should not be less than 60% of its total assets and total income.
Asset finance company can either be deposit-taking or non-deposit taking. All deposit-taking
NBFC’s have to register themselves with RBI as per given RBI regulation.

2. Investment Company: In layman term, Investment Company is a company whose main

business is managing and holding securities for investment. These companies invest funds on
behalf of their clients who, in return are expected to share the profits and losses. These
companies exist only to invest.

3. Loan Company: Loan companies under NBFC provide loans and advances for working
capital finance. A financial company would only be considered Loan Company if their 50%of
total assets are in lending and 50%of total income arises from the assets which are lent. The
known loan company registered as NBFC is LIC Finance Limited.

4. Infrastructure Finance Company: Infrastructure finance companies provide infrastructure

loans for the development of transport, water &sanitation, energy, communication, social and
commercial infrastructure. The companies need to follow the following stipulations to be
considered as infrastructure finance company they need to deploy at least minimum of 75% of
total assets in infrastructure loans, and the net worth of the company must be Rs. 300 crore. The
minimum credit rating of the company should be at 'A' or equivalent of CRISIL, FITCH,
ICRA, CARE, or an equivalent rating by any other crediting rating agencies. A certificate must
support the request for registering a (non-banking companies) NBFC's as infrastructure finance
company from their auditors confirming the asset pattern of the company of the latest financial
year. The famous infrastructure finance company is IndiaBulls Housing Finance.

5. Core Investment Company: Core investment companies are the non-banking financial
company doing the business of acquisition of securities and shares, and they hold 90% of its
asset in the form of bonds, equity shares, and preference shares. These companies need to invest
not less than 60 per cent in the equity shares of group companies.

6. Micro Finance Company: There are many microfinance companies in India, which play
some crucial role in the development of India. Microfinance companies are those financial
institutions that offer small-scale financial services in the form of credit and savings, to the poor
in rural, semi-urban areas. Micro financial services are meant to help them in economic
activities, increasing savings and supporting self-empowerment. Microfinance company is a non-
deposit taking firm regulated by reserve bank of India act, 1934. These companies are entitled to
provide loans up to Rs.50, 000 to individual coming under low-income group living in rural or
semi-urban areas. A company to be registered NBFC’s-MFC, they should have minimum net
capital of Rs.5 crore after incorporation as a private limited company having equity share capital.

7. Housing Finance Company: Housing finance companies have mention housing finance as
the main clause in its main memorandum of association. NBFC’s have complemented
commercials bank in providing mid-term capital loans to individual or firms; their flexibility and
less stringent regulation provide them competing for an edge over commercial banks.

(B) ON THE BASIS OF DEPOSITS THEY HOLD

1. The Deposit Accepting NBFC’s: Deposit accepting firm is required to register themselves
with RBI as per the regulations laid down in the RBI act, 1934. NBFC’s before incorporation
need to register themselves under companies act, 2013 and also attain a certificate of registration
from RBI and if the company accepts deposit from the public, they need to follow particular
additional regulation prescribed by RBI. A certain type of deposit accepting NBFC’s are:

(a) Loan Companies.

(b) Investment Companies

(c) Asset Finance Companies

2. Non-Deposit Accepting NBFC’s: Non-deposit accepting NBFC does also need to register
themselves. It is a misconception that NBFC’s not accepting public deposit need not register
themselves, RBI will any NBFC operating without registration as per there recent guidelines.
The only difference between NBFC’s accepting deposit and NBFC’s not accepting deposit is that
the prior has to follow certain extra guideline after registering themselves.

TOP 10 BEST NON BANKING FINANCIAL COMPANIES IN INDIA

In the year 2019, top companies are being rated which deals with various kinds of financial
services, these are:

1. HDFC
2. Power Finance Corporation
3. Reliance Capital
4. Infrastructure Development Finance Company
5. Rural Electrification Corporation
6. Shree Global
7. Shriram Transport Finance
8. Bajaj Holdings
9. M&M Financials
10. Muthoot Finance

TRENDS OF NBFCs

Non-banking financial companies have undergone significant transformation over the past few
years. Liberalisation of the legal regime, increasing digitisation and rising financial inclusion
have given a boost to innovation, growth and investment in the financial sector.

Regulatory changes

The government is considering a proposal from the Reserve Bank of India (RBI) seeking more
powers to improve its regulatory and supervisory mechanism for non-banking financial
companies (NBFCs). Recent defaults by a section of NBFCs have created turbulence in the
financial markets, including debt market, leading to fears that potential solvency risks at certain
companies can be contagious. The RBI has conventionally adopted light-touch regulatory
approach towards NBFCs, to enable them to reach the masses through innovative financial
products and service delivery mechanisms. The central bank has taken various measures to help
NBFCs tide over the recent crisis, including raising the single-borrower exposure limit for
NBFCs that do not finance infrastructure to 15 per cent from 10 per cent, relaxation in minimum
holding period norm to encourage securitisation of loans assets and asking NBFCs with assets of
more than Rs 5,000 crore to appoint a chief risk officer. Amid payment delays and defaults in the
housing finance companies and NBFCs, the RBI in its Financial Stability Report warned that the
failure of any NBFC or HFC will act as “a solvency shock” to its lenders and solvency losses
caused by these shocks can “further spread by contagion”. NBFCs depend largely on public
funds such as bank borrowings, debentures and commercial papers, which account for 70 per
cent of the total liabilities of the sector.

NBFCs were the largest net borrowers of funds from the financial system, with gross payables of
around Rs 844,600 crore and gross receivables of around Rs 723,000 crore as on end-March
2019.The consolidated balance sheet size of the NBFC sector grew by 20.6 per cent to Rs 28.8
lakh crore in FY19, as against an increase of 17.9 per cent to Rs 24.5 lakh crore in 2017-18.
Gross NPAs of the NBFC sector as a percentage of total advances rose from 5.8 per cent in
2017-18 to 6.6 per cent in 2018-19.

Operational Innovation and Growth

NBFCs have become significant in India’s Banking, Financial Services and Insurance (BFSI)
sector. Today, BFSI’s mention looks incomplete without talking about NBFCs’ critical role in its
growth. Innovations are the lifeblood of Non-Banking Financial Companies (NBFCs), the
relatively new entrant making waves. It is creating disruptions across the financial landscape of
the country. Leveraging numerous IT-backed industry firsts, NBFCs have been able to script
many success stories in the Indian BFSI sector in a relatively short span of time. These 13,000
plus players (the figure registered with the Reserve Bank of India) hold immense potential in
terms of innovation and growth. Because of their several unique strengths; these are today
considered the future growth drivers of the BFSI sector.

Considering India is home to the largest unbanked or under-banked population across the world
makes it one of the most lucrative and sought-after destinations for NBFCs players. For instance,
consider the role of NBFCs in the financial inclusion of sectors such as Micro, Small and
Medium Enterprises (MSMEs) that represent a segment which is still underserved financially. As
per official estimates, the total unmet demand in the Micro, Small and Medium Enterprises
(MSMEs) is close to Rs 2.9 trillion – and to cater to this yet-to-be-tapped opportunity NBFCs are
utilising many cutting-edge technologies. While doing so, they have invested heavily in new
technologies that allow them to offer many tailored products. Citing the ability of NBFC players
in embracing a lot of new technologies such as cloud computing, Prem Narayan, Deputy Director
General, UIDAI, Government of India, says, “ Non-Banking Financial Companies (NBFCs)
form an integral part of Indian financial system. These play a critical role in reaching out to the
unbanked sections of Indian society, especially the Micro Small and Medium Enterprises
(MSMEs) segment.”

Varied Investment Strategies

NBFCs have come a long way from an era of concentrated regional operations, low credibility
and poor risk management practices to highly sophisticated operations, pan-India presence and
most importantly an alternate choice of financial intermediation. NBFCs' growth had been
constrained due to lack of adequate capital. Going forward, we believe capital infusion and
leverage thereupon would catapult NBFCs' growth in size and scale. A number of NBFCs have
been issuing non-convertible debentures (NCDs) in order to increase their balance sheet
liquidity. Also to address this purpose, especially in the infrastructure financing space, a new
category of NBFCs was formed called Infrastructure financing companies (IFCs). A common
feature in all the advanced economies is their financial systems are well developed to deliver a
wide range of financial services and sophisticated products at competitive price that are
demanded by the sophisticated clientele. This was possible because of institutions such as NBFIs
that were found to be more aggressive and innovative. More importantly, it resulted in improving
the efficiency by inciting competition between NBFIs and banking system and ultimately stated
to have contributed to macroeconomic stability and sustained economic growth.

Structural Linkages between Banks and NBFCs

Banks and NBFCs operating in the country are owned and established by entities in the private
sector (both domestic and foreign), and the public sector. Some of the NBFCs are subsidiaries/
associates/ joint ventures of banks – including foreign banks, which may or may not have a
physical operational presence in the country. There has been increasing interest in the recent past
in setting up NBFCs in general and by banks, in particular. Investment by a bank in a financial
services company should not exceed 10 per cent of the bank’s paid-up share capital and reserves
and the investments in all such companies, financial institutions, stock and other exchanges put
together should not exceed 20 per cent of the bank’s paid-up share capital and reserves. Banks in
India are required to obtain the prior approval of the concerned regulatory department of the
Reserve Bank before being granted Certificate of Registration for establishing an NBFC and for
making a strategic investment in an NBFC in India. However, foreign entities, including the head
offices of foreign banks having branches in India may, under the automatic route for FDI,
commence the business of NBFI after obtaining a Certificate of Registration from the Reserve
Bank.

Sector to look out for

The government policy of demonetisation acted as a deterrent for the unorganised sector and led
to compulsive financial inclusion. The regulatory changes aimed towards promoting foreign
investment also provided a boost to the financial sector. This sector has evolved significantly in
the past few years and the growth of financial inclusion is expected to be driven further with
higher penetration into parts of the economy where public-sector banks are unable to penetrate.

REGULATORY ISSUES

NBFCs can undertake activities that are not permitted to be undertaken by banks or which the
banks are permitted to undertake in a restricted manner, for example, financing of acquisitions
and mergers, capital market activities, etc. The differences in the level of regulation of the banks
and NBFCs, which are undertaking some similar activities, gives rise to considerable scope for
regulatory arbitrage. Hence, routing of transactions through NBFCs would tantamount to
undermining banking regulation. This is partially addressed in the case of NBFCs that are a part
of banking group on account of prudential norms applicable for banking groups.

NBFCs - D may access public funds, either directly or indirectly through public deposits, CPs,
debentures, inter-corporate deposits and bank finance and NBFCs – ND may access public funds
through all of the above modes except through public deposits. The application of marginal
regulation to NBFCs – ND that are large and systemically important and also have access to
public funds can be a potential source of systemic risk through contagion even though these
entities are not members of the payment and settlement systems.

At present, there are no prudential norms or guidelines on the intra-group transactions and
exposures (ITEs) between the NBFCs and their parent entities. From the perspective of
consolidated supervision of a banking group/ financial conglomerate, it is necessary to have
some norms / limits on the ITEs to ensure that the activities of the banking group / financial
conglomerate are undertaken in a prudent manner so that they would not be a threat to financial
stability. Internationally, some regulators prescribe a ceiling on the level of transactions that a
bank can have with its affiliates. These limits may operate either at a single entity level and / or
at an aggregate level.

In terms of the provisions of the Banking Regulation Act, a bank is not allowed to set up a
banking subsidiary. This eliminates the scope for more than one entity within a group competing
for public deposits. However, this aspect is not well addressed under the existing framework
where a bank operating in India may set up an NBFC – D as a subsidiary or where they have /
acquire substantial holding in such an entity i.e., say more than 10 per cent.

Foreign direct investment in NBFCs is permitted under the automatic route in 19 specified
activities subject to compliance with the minimum capitalization norms. Once an NBFC is
established with the requisite capital under FEMA, subsequent diversification either through the
existing company or through downstream NBFCs is undertaken without any further
authorisation. This could give scope for undertaking those activities which do not qualify for FDI
through the automatic route.

UNDERLYING PRINCIPLES FOR A REVISED FRAMEWORK

Thus the regulatory gaps in the area of bank and NBFC operations contribute to creating the
possibility of regulatory arbitrage and hence giving rise to an uneven playing field and potential
systemic risk. In this backdrop, the related issues have been examined and as recommended by
the Group, a review of the existing framework of prudential regulations for bank and NBFC
operations was undertaken. The broad principles underlying the review are as under:

i) Entities offering financial services should normally be within the ambit of financial
regulations. However, all NBFCs – ND were largely excluded from the scope of financial
regulation in view of the state of development of the financial sector at that time and as a matter
of prioritisation of regulatory focus. In the light of the recent developments in the financial sector
and its growth, as a first step, all systemically relevant entities offering financial services ought
to be brought under a suitable regulatory framework to contain systemic risk. The definition of
what is considered systemically relevant will be as determined from time to time.

ii) The IMF publication, "Financial Sector Assessment - A Handbook" mentions that, "Similar
risks and functions should be supervised similarly to minimize scope for regulatory arbitrage"
and that, "Bank-like financial institutions should be supervised like banks." Similarly, the
‘Report of the Committee on Fuller Capital Account Convertibility’ has also identified that
"modifications to regulation to discourage or eliminate scope for regulatory arbitrage, focusing
on activity-centric regulation rather that institution-centric regulation will be needed" to enhance
the strengthening of the banking system. Hence, the focus will be to reduce or eliminate the
scope for regulatory arbitrage by ensuring that regulations are activity specific – irrespective of
the medium through which the activity is undertaken.

iii) The ownership of NBFCs, which are subjected to a relatively less stringent regulatory and
prudential framework, should be subjected to certain norms which will encourage improved
governance so that regulatory arbitrage or circumvention of bank regulations are not resorted to.
Further, the ownership pattern should be such that more than one entity in a Group does not
compete for public deposits. Additionally, the principle of ‘holding out’ will operate in a
situation where an NBFC is within a bank group. Hence, the eventual fall out of the holding out
principle will have to be factored-in while banks decide on the extent to which they would like to
be involved in an NBFC.

iv) Consequent upon certain adverse events in the banking sector in the early 1990s, banks are
not permitted to offer discretionary portfolio management scheme (PMS). As a corollary, the
NBFCs sponsored by banks (viz. NBFCs which are subsidiaries of banks or where banks have a
management control) are also not permitted to offer discretionary PMS. Whereas, other NBFCs
are allowed to offer this product. Hence, ownership structure of the NBFC should not be
determining factor to decide on the products that NBFCs may offer.

v) Foreign entities can undertake certain permitted activities in India under the automatic route
for FDI. However, it might not be appropriate to allow a foreign entity to set up a presence
through the automatic route and later expand into activities which are not permitted under the
automatic route, without going through a further authorisation process.

vi) The over arching principle is that banks should not use an NBFC as a delivery vehicle for
seeking regulatory arbitrage opportunities or to circumvent bank regulation(s) and that the
activities of NBFCs do not undermine banking regulations. In case it is observed that any bank
has not complied with the spirit of these guidelines, such non compliance should be viewed very
strictly by the Reserve Bank.

References

 Financial Institutions and Markets., L.M.Bhole., Tata McGraw Hill Publishers

 www.rbi.org.in
 www.recindia.nic.in
 www.shodhganga.inflibnet.ac.in
 www.roberthurdman.com
  www.profit.ndtv.com
 www.rediff.com
 www.moneycontrol.com
 www.bankrate.com/finance/investing/common-investment-strategies
 www.mondaq.com/india/x/656600/Financial+Services/Rising+Trends+In+NBFC+Sector
 www.trendrr.net/1504/top-10-best-non-banking-financial-companies-nbfc-in-india-at-
your-service/#1_HDFC

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