In this article, Sucharita Ghosh discusses How NBFC can take foreign loans or foreign investments?
Over the years after the liberalization of the Indian economy in 1991, India witnessed a significant interest of foreign investors in the Indian NBFC sectors. In 2015-16, foreign direct investment in India grew by 29 percent year on year to USD 40 billion.
Before discussing the guidelines for taking foreign loans by NBFC, we need to get a brief idea about NBFC.
WHAT IS NBFC?
A Non-Banking Financial Company (NBFC) is a company engaged in the business of loans and advances, acquisition of shares, stock, bonds hire-purchase, insurance business or chit business but does not include any institution whose principal business includes agriculture, industrial activity or the sale, purchase or construction of immovable property.
Example: Bajaj Finance, LIC housing Finance, Indiabulls, Aditya Birla Finance etc are the most popular non-banking financial companies in India.
BANK VS NBFCs
Though bank and non-banking financial companies both are financial institutions and both performs similar kind of functions but there seems to be some basic differences between the two.
- NBFC cannot accept demand deposits like banks.
- It does not form part of the payment and settlement system and cannot issue cheques drawn on itself.
- Deposit insurance facility of Deposit insurance and credit guarantee corporation is not available in NBFC.
- The liabilities or deposits of the banks are widely accepted as a means of payment in the settlement of debt but the liabilities of NBFCs are not accepted as means of payment for settlement of debt.
WHY TAKE FOREIGN LOANS
In India, the interest rates are high in comparison to the rest of the world. Thus taking loans from other countries which have lower interest rates are very beneficial for an Indian company. An NBFC also prefer foreign investment over Indian investment because foreign investors may be able to invest much more money compared to an Indian resource.
On the other hand foreign investors are also attracted to Indian companies in various stages of growth for various reasons like this country has growing customer base and foreign capital can witness more growth in an emerging economy like India as compared to saturated western markets which offer limited growth opportunities.
LAW GOVERNING THE FOREIGN LOANS AND FOREIGN INVESTMENTS IN NBFC
All the provisions regarding foreign exchange in and are regulated by the FEMA,2000 and the working and operations of NBFCs are regulated by the Reserve Bank of India within the framework of the RBI Regulation Act 1934 and the directions issued by it.FDI in NBFCs has been allowed up to 100% since 1997 subject to the minimum capitalization norms as issued by the Government.
The Foreign Exchange Management Act,1999 and Foreign Exchange Management (Borrowing and Lending in Foreign Exchange) Regulation,2000 and the RBI regulations governs the provisions relating to foreign loans.
FOREIGN LOANS AND NBFC
Loans from foreign institutions are called external commercial borrowings or ECB. The foreign loans could be taken from foreign banks or foreign financial institutions.
One can also take ECB in the form of bonds, preference shares and debenture. A loan from a foreign shareholder who owns at least 25% of the shares of the borrower company will also come under the ambit of ECB.
However, not every sector of business can avail foreign loans. The RBI allows ECBs to be obtained only some specific sectors after fulfilling all the necessary requirements. To obtain foreign loans in a Non-banking financial company it only requires to comply with the procedural requirements. There is no need of approval of RBI while availing the loans.
MODES OF BRINGING FOREIGN INVESTMENTS
A non banking financial company can bring their foreign investment not only in liquid currency but also in some other ways like exchange of shares, conversion of loans to share, exchange of some skill sets etc.
MATURITY PERIOD AND INTEREST
In Foreign Exchange Management Regulation there are certain rules and restriction mentioned about the external commercial borrowing. There is specific rules one need to follow about the maturity period and the amount of interest to be paid.
The cost of an ECB includes the interest charged by the bank, other fees and expenses paid in foreign loans. It must be within the limit which is measured with respect to a reference rate called the LIBOR or London Interbank Offered Rate.
For a loan whose average maturity period is 3-5 years, its interest would be 3.5% over six months the LIBOR and for the loan which will be matured after more than 5 years its interest ceiling would be plus 5% over the six month LIBOR.
PROCEDURE OF TAKING FOREIGN LOANS
For taking the foreign loans under the automatic route the NBFCs are required to submit Form 83 to the Authorized Dealer bank to obtain the LRN number. The LRN number or Loan Registration Number must be certified by a company secretary or chartered accountant.
Then the AD bank must forward a copy of the form 83 to the department of statistics and Information Management of RBI. The loan can be only be taken after the allotment of the LRN number.
CONVERSION OF LOANS INTO EQUITY
When a non-banking financial company is unable to repay its loans, it can convert some or all of its debts into equity after taking the consent of the lender. Provided that, when a company wants to convert the loan into equity it must ensure that the shares are issued under the FEMA pricing guidelines.
CONSEQUENCES OF VIOLATION OF ECB REGULATIONS
According to the section 15 of the Foreign Exchange Management Act, if anyone contravenes the provisions of the ECB regulation he will get punishment up to thrice of the amount involved. Moreover, the corporate entities who violated the ECB policy are under investigation by RBI can only avail foreign loans under the approval route. When the violation is a continuous one in nature, an additional penalty of INR 5000 will be payable per day.
When the violation is unintended, it can be rectified by compounding with RBI, which may help in getting much lower penalty.
Extant FDI Policy for NBFC
As per the extant FDI policy, foreign investment in NBFC sector is permitted under the automatic route. An automatic route is one where no Foreign Investment Promotion Board or RBI approval is needed before making the proposed investment. In automatic route up to 100% foreign investment is permitted without the approval of foreign investment promotion board.
Under section 10 of FEMA all foreign transactions are required to routed only through entities licensed by the RBI.
Till very recently As per the extant FDI policy, foreign investment was permitted under automatic route only in the following 18 prescribed non-banking financial service activities. These are
- Merchant Banking
- Portfolio Management Services
- Stock Broking
- Asset Management
- Venture Capital
- Custodian Services
- Leasing & Finance
- Housing Finance
- Credit Card Business
- Micro Credit
- Rural Credit
Non-fund based activities
- Investment Advisory Services
- Financial Consultancy
- Forex Broking
- Credit Rating Agencies
- Money Changing Business
Foreign investment in non-banking sectors are permitted under the automatic route in these specified activities subject to compliance with the minimum capitalization norms. Once an NBFC is established with the requisite capital under the Foreign Exchange Management Regulation, subsequent diversification either through the existing company or through downstream NBFCs could be undertaken without any further authorization.
These investments were subject to the following minimum capitalization norms:
- US $0.5 million for foreign capital up to 51% to be brought upfront.
- US $5 million for foreign capital more than 51% and up to 75% to be brought upfront.
- 50 million for foreign capital more than 75% out of which $7.5 million to be brought upfront and the balance in 24 months.
- The NBFCs having foreign investment more than 75% and up to 100%, and with a minimum capitalization of $50 million, can set up step down subsidiaries for specific NBFC activities, without any restriction on the number of operating subsidiaries and without bringing in additional capital.
- Joint Venture operating NBFCs that have 75% or less than 75% foreign investment can also set up subsidiaries for undertaking other NBFC activities, subject to the subsidiaries also complying with the applicable minimum capitalization norm mentioned above.
- Non- Fund based activities: US $0.5 million to be brought upfront for all permitted non fund based NBFCs irrespective of the level of foreign investment.
But it is subject to certain conditions. It would not be permissible for such a company to set up any subsidiary for any other activity, nor it can be participate in any equity of an NBFC holding company.
All of the above capitalization norms also apply to each downstream subsidiary engaging in NBFC activities, except where its parent entity already has more than 75% foreign investment.
Further, if the activity being carried out was ‘non-fund based’ then irrespective of the level of foreign investment, capitalization was capped at USD 500,000.
NEW FDI POLICY AND THE RECENT CHANGES
The government has bought various guidelines and changes for investment in the NBFC Sector.
On 10th August 2016, the Government of India, in order to boost up the economic activities in financial sectors, has approved some changes pertaining to the FDI requirements in the Non Banking Financial Companies.
The Reserve Bank of India on 9 September 2016 released a notification amending the Foreign Exchange Management (Transfer and Issue of Securities to Persons Resident Outside India) Regulations, 2000, as a measure to make the foreign investments in the ‘non-banking financial services’ sector easier. This Notification operationalizes the policy which was announced on 10 August 2016. The two key relaxations which have been introduced by this Notification are:
- 100% FDI through the automatic route is now permitted in “Other Financial Services” beyond the 18 specified activities. Provided the activities are regulated by financial sector regulators such as RBI, SEBI, Pension Fund Regulatory Authority of India (IRDA) etc.
- any form of additional capitalization norms linked to foreign ownership under the FDI Policy has been removed, and thereby the capitalization norms has been aligned with those prescribed by the relevant regulators regulating these activities.the minimum capitalization norms as required under the FDI policy have been eliminated as most of the regulators have already fixed minimum capitalization norms. The foreign investment in NBFCs which are not regulated by any financial sector regulators i.e Unregulated NBFCs will require prior government approval.
These recent changes of doing away with the minimum capitalization norms is a boon since it will spur economic growth by increasing FDI in the NBFC sector. Increasing FDI will be beneficial for the business due to the relatively easier and faster sanction of loans with favorable interest rates. This is certainly a welcome move, and is expected to provide a much-needed boost to this sector.
One of the biggest benefits of loans against shares is that you pay interest only on the amount you utilize, and not on the entire loan amount. You can specify an account, to which the loan amount will be transferred. Alternatively, some banks may require that you open an account with them, to which an overdraft limit, based on the amount of the loan, is set. You can then withdraw as and when you require money and rest assured that the interest will be charged only on that much money.
Loans against shares work much in the same way as personal loans, in the sense that you can use the loan amount for pretty much anything. Of course, most lenders caution against speculative endeavors, and many bar you from this (speculative purposes could be something like using the money you got as a loan against your shares, to buy more shares). Add to this the fact that the interest rate on a loan against shares will be lower than what you would get on a personal loan, and this starts to sound like a pretty good deal. Thanks for sharing such useful info.