Non-Banking Financial Companies (NBFC)

1. 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, chit fund business..
2. It does not include any institution whose principle business is Agriculture, Industry, buying or selling of goods other than security or providing any services and sale and purchase constitution of immovable properties.
3. Both NBFC and Banks can issue Demand Draft and has Deposit insurance. NBFCs can’t issue Cheque book.
4. RBI recently strengthened its hold over NBFCs mainly those engaged in infrastructure, deposit, lending and housing sector.
5. After IL&FS case, Forensic auditing is now mandatory. As per RBI, service providers need to maintain the same high standard of care in performing services as it is expected by RBI. These NBFCs can also maintain SLR.
6. Chit Funds: They are regulated under Chit Funds Act, 1982. They regulated by RBI as they come under NBFC.

Non-Banking Financial Companies

• Companies registered under the Companies Act, 1956 engaged in
  1. Giving loans;
  2. Acquisition of shares, stocks, bonds, debentures & securities issued by Govt or local authorities;
  3. Leasing higher purchase insurance, chit fund business.
• It holds 12.3% assets in Financial systems
• It does not include any institution whose principle business is Agri, Industry, buying or selling of goods other than security or providing any services and sale and purchase constitution of immovable properties.
• NBFC cannot accept Demand deposits.
• They are not a part of the Payment and Settlement System. Hence cannot issue cheques drawn on itself.
• Deposit Insurance and Credit Guarantee Corporation (DICGC) deposit insurance not available.
• A Non banking institution which is a Company and can receive deposit in any scheme also comes under NBFCs (Deposit taking NBFCs) aka Residuary Non-Banking Company. SLR is applicable to them.
• NBFC with the paid up capital of 500 crore has to set aside Capital Adequacy Ratio.
• Chit Funds: regulated by RBI under Chit Funds Act, 1982. They are NBFCs.
• RBI prohibited NBFCs from outsourcing key functions like
  1. Internal audit,
  2. Investment portfolio and
  3. KYC compliance.
• Forensic auditing is now mandatory.

The different types of NBFCs:

The NBFCs can be categorised under two broad heads:

On the nature of their activity:

• Asset Finance Company
• Loan Company
• Mortgage Guarantee Company
• Investment Company
• Core Investment Company
• Infrastructure Finance Company
• Micro Finance Company
• Housing Finance Company

On the basis of deposits:

• Deposit accepting Non-Banking Financial Corporations
• Non-deposit accepting Non-Banking Financial Corporations

Recent news for NBFCs

• RBI to create a Specialised Supervisory and Regulatory cadre for Commercial Banks, Urban Cooperative Banks and NBFCs. RBI is also internally setting up a Research and Analysis wing within the department of supervision which will collate and correlate all the data, see the inter-connectedness and will comprehensively look at the banking structure.
• RBI directs NBFCs with asset size > 5000 crore to appoint Chief Risk Officer. To be functioned independently.
• Budget 2019-20 widens RBI autonomy:
  1. Housing Finance Companies to be treated as NBFCs. To be regulated by RBI now.
  2. RBI can supersede the board of NBFCs in the public interest. RBI can also remove auditors, and call for an audit of any group company of an NBFC.
• RBI raises the cap on the Bank’s exposure to a single NBFC to 20% of Tier I capital from 15%. On lending to the Agri sector 10 lakh, and 20 lakh to MSME and Housing will be treated as Priority Sector Lending. Mutual Funds and Insurance Companies are creditors to NBFCs. Hence Insurance companies are now part of Inter Creditor Agreement.
• 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).
• RBI intro Liquidity Management Framework for NBFCs
  1. 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)
  2. From 1 Dec 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.
  3. 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.
• ECB Reforms: Relaxed norms for the end use of funds via ECB
  1. ECBs are done by Companies and NBFCs. Regulated by RBI. Now it is a bidder under IBA.
  2. Relaxation was for 3 things: Working capital requirements, General Corporate purposes and Repayment of Rupee loans.
  3. Borrowers can raise ECB for 10 years of Working capital and General corporate purposes requirements.
  4. For repayment of rupee loans and for on-lending by NBFC = 7 years.
• Partial Credit Guarantee Facility for PSBs (Public Sector Banks)
  • It would enable the PSBs to purchase the high-rated pooled assets of financially sound NBFCs and housing finance companies (HFCs) worth rs 1 lakh crore. For a period of 6 months.
  • It is expected that this measure would provide liquidity to the NBFC Sector.
  • To address temporary asset-liability mismatches of otherwise solvent NBFCs/HFCs without having to resort to distress sale of their assets for meeting their commitments.
• RBI moots lighter norms for CICs (Core Investment Companies)
  1. CICs are specialized NBFCs. It has an asset size of Rs. 100 crore.
  2. The main business is the Acquisition of shares and securities with certain conditions These should not hold < 90% of its net assets in the form of investment in equity shares, preference shares, bonds, debentures, debt or loans in a group company.
  3. CIC should have a 2 Tier structure and stronger boards with at least 50% independent directors.
  4. Step down CICs will not be permitted to invest in any other CICs, but can 'freely' invest in other group companies.
• Peer to Peer (P2P) Lending
  • P2P lending is a form of crowdfunding used to raise unsecured loans which are repaid with interest. It serves as a link between borrowers & lenders. It refers to the financing of projects with small amounts of money raised from large number of people, with a portal serving as an intermediary.
  • The borrowing could be an individual or a legal person (such as company). Minimum Net worth of P2P lending is Rs. 2 crore. RBI in 2017 enabled P2P entities as NBFC. However, an existing NBFC will not be able to operate as NBFC P2P.
• Ombudsman Scheme for NBFCs, 2018
  • It 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
    1. Infrastructure Finance Companies (NBFC-IFC),
    2. Core Investment Company (CIC),
    3. Infrastructure Debt Fund-Non-Banking Financial Company (IDF-NBFC) and
    4. also NBFCs under liquidation.
• RBI changes the definition of "Relative" under the Companies Act, 2013: To check outward remittances. Now only to immediate relatives like parents, spouses, children and their spouses.

Analysis of NBFCs

• The RBI has proposed a significant shift in its regulatory approach towards India’s non-banking financial companies (NBFCs), from a general approach of light touch regulation to one that monitors larger players almost as closely as it does banks.
• If implemented, this could be the biggest overhaul of the regulatory framework for such finance companies (or shadow banks) in over two decades.
• After multitudes of investors were left high and dry as CRB group firms reneged on high-interest fixed deposits in 1997, Parliament bestowed greater powers over such firms to the central bank to fix the mess.
• The trigger now is similar though the scale of the problem has changed.
• The size of NBFC balance sheets is now more than a quarter of that of banks’ balance sheets, from just about 12% in 2010.
• In absolute terms, their balance sheets have more than doubled, from ?20.7-lakh crore in 2015 to ?49.2-lakh crore in 2020. While this growth is a reflection of how lighter regulations have given them the flexibility to meet a range of financing needs, from home loans to micro-finance and large infrastructure projects, it also manifested into a systemic risk.
• And that risk was apparent when one of the largest infrastructure investment-focused NBFC players, IL&FS, unravelled in 2018, with its payment defaults catalysing a crisis for the entire sector.
• The collateral damage meant NBFCs could not raise funds easily, and faced liquidity pressures that escalated to solvency concerns in some instances.
• The descent of one such player, Dewan Housing Finance Corporation Limited (DHFL), began around the same time — its creditors approved a resolution plan for the firm last week.
• The RBI’s proposed regulatory reaction to such large NBFC failures that have had a systemic impact on the sector, could not have come sooner. It has sought to strike a balance between the need to be nimble and mitigate systemic risks, with a four-tiered regulatory structure.
• This entails a largely laissez-faire approach for smaller NBFCs, plugging some of the arbitrages available to mid-sized NBFCs vis-à-vis banks, and imposing tougher ‘bank-like’ capitalisation, governance and monitoring norms for the largest players and those which could pose a systemic risk due to the nature of their operations.
• A top tier has been envisaged with even more scrutiny, but the RBI wants to ideally use this approach only when a certain large player poses ‘extreme risks’. Given the banking sector’s own woes over the past two years (PMC Bank, Yes Bank, Lakshmi Vilas Bank), a holistic reboot of the oversight mechanism for NBFCs and banks is critical to retain confidence and maintain financial stability which central bank Governor Shaktikanta Das has termed a ‘public good’.
• It is hoped that the blueprint for the regulation of NBFCs which can lend for activities banks often do not support, be it micro-loans or infrastructure projects, is formalised soon.
• This would ensure the fledgling economic recovery is not hampered by funding constraints.