In this article, Nritika Sangwan, a student of Army Institute of Law, Mohali, pursuing Diploma in Entrepreneurship Administration and Business Laws from NUJS, Kolkata answers frequently asked questions on Non-Banking Financial Companies in India

An important sector in our country’s financial ecosystem is constituted by the financial intermediaries that play a pivotal role in promoting an all-inclusive growth of our economy. These are called the Non-Banking Financial Companies. Over the last few years, the NBFCs have grown substantially, undeterred by the current economic slowdown. With regard to the year-over-year growth rate, the NBFCs trounced the banking sector in most years from 2006 to 2013, growing by 22% on an average, every year. In this article, the author has attempted to succinctly lay down everything important about NBFCs by answering certain FAQs.

What is an NBFC?

As the name suggests, a Non-Banking Financial Company is a Company that offers financial assistance and other banking services without actually being a bank. It is a Company registered under the Companies Act, 1956 and undertakes the following kinds of businesses:

1. Loans and advances,
2. Acquisition of shares/stocks/bonds/debentures/securities,
3. Leasing,
4. Hire-purchase,
5. Insurance business, and
6. Chit business

Further, Companies whose primary business constitutes receiving deposits either in instalments or lump sum in any manner are also deemed as NBFCs. However, NBFCs exclude institutions engaged in the following kinds of business:

1. Agriculture activity,
2. Industrial activity,
3. Purchase or sale of any goods (other than securities) or
4. Providing any services and sale/purchase/construction of immovable property.

What are the financial activities of NBFCs?

A company is deemed to be an NBFC if its primary business is “Financial Activity”. Now, the question that arises is “When can it be said that a company’s principal business is financial activity?”

Financial activity is said to be the principal business of a company if the company’s financial assets form more than 50% of its total assets, and the income from the financial assets account for more than 50% of its total income. This test is commonly called the 50-50 test and is used to determine if a company is engaged in financial business or not. A company which fulfils both these criteria can then be registered as an NBFC by RBI or other regulatory bodies.

How are NBFCs different from banks?

In terms of lending and making investments, the Non-Banking Financial Companies are similar to banks. However, there are some important differences between them which have been underlined hereunder:

1. NBFCs cannot accept demand deposits
2. NBFCs cannot issue cheques to its customers as they do not form a part of the payment and settlement system
3. As opposed to banks, NBFCs cannot avail the deposit insurance facility of DICGC.
4. They cannot issue demand drafts

Do NBFCs need to be registered with RBI?

Section 45-1A of the RBI Act, 1934, makes it mandatory for all NBFCs to be registered with the Reserve Bank of India for the purpose of commencing any business or carrying on the businesses defined in clause (a) of Section 45-1 of the Act of 1934. However, this comes with an exception.

Certain categories of NBFCs like Venture Capital fund, Chit funds, Housing Finance etc are regulated by regulators like SEBI, State Governments, National Housing Banks etc. To eliminate the possibility of dual regulation, these categories of NBFCs are spared from the requirement of registering with RBI.

What are the different categories of NBFCs?

Infrastructure Finance Company (IFC)

IFCs are companies in which infrastructure loans constitute at least 75% of the gross assets, they have at least 300 crore INR worth of net fund and have a CRAR of 75%.

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

These are companies which are only engaged with investment activities. Evidently, investment in securities of companies constitutes 90% of their gross assets which are over 100 crore INR. Investments in equity shares of such companies should form at least 60% of its total assets

Non-Banking Financial Company-Factors (NBFC-Factors)

These companies are engaged in the business of factoring. It is required that they obtain at least 50% of its gross assets through factoring and factoring should constitute more than 50% of its total income.

Mortgage Guarantee Company (MGC)

These are companies possessing a net fund of ₹100 crore and obtaining at least 90% of its gross income from mortgage guarantee.

What categories of NBFCs are to be registered with RBI?

The NBFCs registered with RBI have been classified as:

Asset Finance Company (AFC)

These are companies whose primary business is financing the physical assets (like automobiles, generator sets etc) that support production and other economic activities.

AFC’s are of two types:

• AFC’s accepting deposits
• AFC’s not accepting deposits

Investment Company (IC)

Investment Companies are those which are engaged in the acquisition of securities like shares, debentures, equity etc.

Loan Company (LC)

These are companies engaged in providing financial assistance in the form of loans or advances for different activities and businesses.

Residuary Non-Banking Companies

Residuary Non-Banking Company is a category of Non-Banking Financial Company mainly engaged in the business of receiving deposits, under any scheme, arrangement or in any other manner which is not an AFC, LC or IC. These companies are required to sustain investments in accordance with directions of RBI.

What are the requirements to register with RBI?

3 Requirements

1. It should be registered under Section 3 of the Companies Act
2. They should possess a minimum net owned fund of ₹ 200 lakh
3. The company is required to submit its application for registration in the prescribed format along with necessary documents for bank’s consideration.

What is the role of RBI with regard to NBFCs?

The Reserve Bank of India has been conferred with various powers and functions in relation to NBFCs under the RBI Act 1934. They are authorized to register all NBFCs, formulate policies, issue directives, inspect, regulate, supervise and monitor NBFCs that satisfy the’ 50-50 test of financial activity as the principal business’. RBI is also empowered to penalize NBFCs in case they violate any provision of the RBI Act or any instruction, direction or order issued by RBI under the RBI Act. The penalty may even result in RBI cancelling the registration certificate issued to the NBFC, and prohibiting them from accepting deposits and disposing of their assets or filing a winding up petition.

What regulations are applicable to NBFCs?

Reserve Bank of India has issued detailed directions on prudential norms, vide

1. Non-Banking Financial (Deposit Accepting or Holding) Companies Prudential Norms (Reserve Bank) Directions, 2007
2. Non-Systemically Important Non-Banking Financial (Non-Deposit Accepting or Holding)
3. Companies Prudential Norms (Reserve Bank) Directions, 2015; and
4. Systemically Important Non-Banking Financial (Non-Deposit Accepting or Holding) Companies Prudential Norms (Reserve Bank) Directions, 2015.

The regulations that are applicable t these NBFCs depend upon the deposit acceptance or systemic importance of the NBFC.

These directions inter alia, formulate guidelines on income recognition, asset classification and provisioning requirements applicable to NBFCs, exposure norms, disclosures in the balance sheet, requirement of capital adequacy, restrictions on investments in land and building and unquoted shares, loan to value (LTV) ratio for NBFCs predominantly engaged in business of lending against gold jewellery, besides others. Deposit accepting NBFCs have also to comply with the statutory liquidity requirements. Details of the prudential regulations applicable to NBFCs holding deposits and those not holding deposits are available in the section ‘Regulation – Non-Banking – Notifications – Master Circulars’ in the RBI website.

Which NBFCs are entitled to accept public deposits?

Public deposits cannot be accepted by every NBFC. NBFCs need to hold a valid certificate that validates their registration and authorises them to accept and hold public deposits. It is mandatory for these NBFCs (those accepting public deposits) to comply with the guidelines which the bank issues and maintain a stipulated net owned fund.

At what rate of interest and for how long can NBFCs accept deposits?

Currently, the maximum interest rate at which an NBFC can accept deposits is 11%. Further, the interest can be compounded or paid at rests longer than monthly rests.

The minimum period for which the NBFCs are allowed to accept or renew these deposits is 12 months and maximum period is 60 months. However, they are not entitled to accept deposits that are repayable on demand.

Conclusion

According to P Vijaya Bhaskar, ex-Executive Director, RBI, NBFCs are the game changers of the economy because of various reasons: – The lower costs incurred by NBFCs make them more profitable when compared to the banking sector. This allows them to offer cheaper loans to their customers. As a consequence, the credit growth of NBFCs i.e. the escalation in the quantum of money being lent to customers has become higher than that of the banking sector with more customers opting for NBFCs.

Another major contribution of NBFCs is via infrastructure lending, i.e. lending to infrastructure projects, which form the foundations of a developing economy like India. Owing to the requirements of very high capital investments and long gestation lags, these infrastructure projects are considered to be very risky, thereby deterring the banks from lending. As a result, the last few years have seen a greater contribution from NBFCs to infrastructure lending when compared to banks.

Furthermore, NBFCs cater to a plethora of customers; in rural as well as urban areas. They finance projects of small-scale companies and provide small-ticket loans for affordable housing projects; thereby accelerating growth in rural areas.