Non-Banking Financial Companies

About NBFCs

• NBFCs are Companies registered under the Companies Act, 1956 engaged in giving loans; acquisition of shares, stocks, bonds, debentures & securities issued by Govt or local authorities; leasing higher purchase insurance, and chit fund business.
• It holds 12.3% of assets in Financial systems. It does not include any institution whose principal business is Agriculture, Industry, buying or selling of goods other than security or providing any services and sale and purchase constitution of immovable properties.
• A Non-banking institution which is a Company that can receive deposits in any scheme also comes under NBFCs (Deposit taking NBFCs) aka Residuary Non-Banking Company.
• It is engaged in the acquisition of stocks/ bonds/ debentures.
• It does not include that entity whose principal business is that of Agriculture, Industrial activity, Purchase or sale of any goods (other than securities) or services and sale/ purchase/ construction of immovable property.
• They are not a part of the Payment and Settlement System.
• Both NBFC and Banks can issue Demand Draft and has Deposit insurance. NBFCs cant issue Cheque book. NBFC cannot accept Demand deposits.
• They cannot issue cheques drawn on themselves. The deposit insurance facility of DICGC is not available to depositors of NBFCs.
• After the IL&FS case, Forensic auditing is now mandatory. As per RBI, service providers need to maintain the same high standard of cadre in performing services as it is expected by RBI. These NBFCs can also maintain SLR.

RBI introduced Liquidity Management Framework for NBFCs

• All non-deposit-taking NBFCs with asset size of >= 10000 crores and all deposit-taking NBFCs have to maintain a liquidity buffer in terms of Liquidity Coverage Ratio (LCR). LCR is for short-term obligations.
• LCR requirement will be binding on NBFCs from 1st December 2020 with the minimum High-Quality Liquid Assets (HQLAs) to be held being 50% of the LCR, progressively reaching up to the level of 100% by 1st December 2024.
• Assets to be included as HQLA include cash, government securities and marketable securities issued or guaranteed by foreign sovereigns. These assets should be free of any financial liability.

Banks get more headroom for lending to NBFCs

• Why? To increase credit flow to the NBFC sector because of the liquidity crunch faced by NBFCs.
• RBI raises cap on Bank’s exposure to a single NBFC to 20% of Tier I capital from 15%.
• Banks have been allowed to lend to the NBFCs for on-lending to the agriculture sector up to? 10 lakh, up to? 20 lakh to micro and small enterprises, and for housing, up to 20 lakh per borrower. These will be classified as priority sector lending.
• Mutual funds and insurance companies are also creditors to stressed NBFCs. IRDAI has taken a decision to enable the insurance companies to be a part of the inter-creditor agreement.
• To encourage banks to extend loans to retail consumer segments like vehicle loans and personal loans, RBI has decided to lower the risk weight from 125% to 100%.

RBI has asked the NBFCs with an asset size of > Rs 5,000 crore to appoint a Credit Risk Officer (CRO)

• The role of the CRO will be identification, measurement and mitigation of risks and all credit products (retail or wholesale) shall be vetted by the CRO from the angle of inherent and control risks.
• The CRO is required to function independently.
• The troubled NBFC sector is facing difficulties like credit squeeze, overleveraging, excessive concentration, the massive mismatch between assets and liabilities and misadventures by some large entities like the IL&FS group.

RBI has announced the extension of the Ombudsman Scheme for NBFCs

• It was launched in 2018 for redressal of complaints against NBFCs registered with RBI and covered all deposits accepting NBFCs. Now it is extended to all eligible non-deposit-taking NBFCs having an asset size of >= Rs 100 crore with customer interface.
• There is also an appellate mechanism against the decision of Ombudsman.
• It still excludes various NBFC groups such as Infrastructure Finance Companies (NBFC-IFC), Core Investment Company (CIC), Infrastructure Debt Fund-Non-Banking Financial Company (IDF-NBFC) and also NBFCs under liquidation.

Other efforts for NBFCs

• RBI to create a Specialised Supervisory and Regulatory cadre for Commercial Banks, Urban Cooperative Banks and NBFCs.
• RBI directs NBFCs with asset size > 5000 crores to appoint Chief Risk Officer.

• Housing Finance Companies to be treated as NBFCs. RBI is the new regulatory body for housing finance.
• Harmonization of NBFC categories: RBI has decided to merge 3 categories of NBFCs into a single category to provide greater operational flexibility to non-banking lenders. NBFCs categorized as Asset Finance Companies (AFC), Loan Companies (LCs) and Investment Companies (ICs), will be merged into a new category called NBFC - Investment and Credit Company (NBFC-ICC).
• Chit Funds: They are regulated under Chit Funds Act, 1982. They are regulated by RBI as they come under NBFC.
• Core Investment Companies
  1. They are specialized NBFCs. It has an asset size of Rs. 100 crore.
  2. Main business is Acquisition of shares and securities with certain conditions like: These should not hold < 90% of its net assets in the form of investment in equity shres, preference shares, bonds, debentures, debt or loans in a group company.

What is the news?

• The Reserve Bank of India (RBI) has issued norms for NBFC dividend distribution to infuse greater transparency in the practice.
• The norms will be effective for dividend declaration from the profit for the financial year ending March 31, 2022.
• One of the criteria is the net NPA ratio must be lower than 6% in each of the last three years.
• No specific ceiling on payout has been set for NBFCs not taking public funds and not having a customer interface.
• The maximum payout ratio for core investment firms would be 60%, standalone primary dealers 60% and other NBFCs 50%.
• The board of directors, while considering the proposals for dividend, will take into account supervisory findings of the Reserve Bank (National Housing Bank (NHB) for HFCs) on divergence in classification and provisioning for non-performing assets (NPAs), qualifications in the auditors’ report to the financial statements; and long-term growth plans of the NBFC.
• The NBFCs will need to comply with the minimum prudential requirements to be eligible to announce dividend.