NBFC stands for Nonbanking Financial Com panies. NBFC in India are registered companies conducting business activities similar to regular banks. Their banking operations include making loans and advances available to consumers and businesses, acquisition of marketable securities, leasing of hard assets like automobiles, hire-purchase and insurance business.
Though they are similar to banks, they differ in a couple of ways. NBFC’s cannot accept demand deposits (deposits that can be withdrawn at immediate notice), they cannot issue checks to customers and the deposits with them are not insured by the DICGC (the India equivalent of FDIC in the US system). Either the RBI (Reserve Bank of India) or the SEBI (Securities and Exchange Board of India) or both regulate NBFC’s.
Though the NBFC’s have been around for a long time, they have recently gained popularity amongst institutional investors, since they facilitate access to credit for semirural and rural India where the reach of traditional banks has traditionally been poor.
NBFC’s have also had a major impact in developing small business in rural India through local presence and strong customer relationships. Usually the loan officers in such NBFC’s know the end customer or have a strong “informal” understanding of the credibility of the borrower and are able to structure their loans appropriately.
With the next wave of growth in India expected to come from the semirural and rural sector, the unique ac cess of NBFC’s to these sector puts them in a great position to benefit from this growth.
On the flip side, there are some constraints in the microfinance sector such as lack of regulatory rules which are still evolving, lack of standardization, ability to attract quality human resources and an industry attitude that it is still a social enterprise versus for profit professional enterprises.
The specific banking products that can be offered by NBFCs depends on the jurisdiction, and may include services such as loans and credit facilities, savings products, investments and money transfer services.
In some jurisdictions, such as New Zealand, any company can engage in banking business, except they are not allowed to use the word bank in their name. A company can only call itself a bank if it is a registered as such with the nation’s central bank.
Types of NBFCs:
- Equipment Leasing Company: It is a company which carries on as its principal business, the business of leasing of equipments or the financing of such activity. Apart from their Net Owned Funds (NOF), the leasing companies raise funds in the form of deposits from other companies, banks and the financial institutions. Public deposits and intercorporate deposits account for 74 percent of their total funds. Leasing is a form of rental system. A lease is a contractual arrangement whereby the lessor grants the lessee the rights to use an asset in return for periodical lease-rent payments.
There are two types of lessees
(a) operating lease, and (b) financial or capital lease. The operating lease is a short-term lease which can be cancelled. Financial lease is a nonconcealable contractual commitments.
- Hire Purchase Finance Company: It is a company which carries on as its principle business, hire purchase transactions or the financing of such transactions. The sources of hire purchase are; Hire purchase Finance companies, retail and wholesale traders, and bank and financial institutions.
- Housing Finance Company: It is a company which carries on its principle business, the financing of acquisition or construction of houses including the acquisition or development of plots of lands for the construction of houses. These companies are supervised by National Housing Bank, which refinances housing loans by scheduled commercial banks, cooperative banks, housing finance companies and the apex co-operative housing finance societies.
- Investment Company: It is a company which carries on as its principle business the acquisition of securities. These types of companies formed by business houses. As such they provide finance mainly to the companies associated with these business houses. As compare to open-end investment companies or mutual funds/units trust, these investment companies are close end companies having a fixed amount of share capital.
- Loan Company: It is a company which carries on as its principle business, the providing of finance, whether by making loans, or advances or otherwise any activity other than its own. These types of companies are generally small partnership concerns which obtain funds in the form of deposits from the public and give loans to wholesale and retail traders, small scale industries and self-employed persons. These companies collect fixed deposits from the public by offering higher rates of interest and give loans to others at relatively higher rates of interest.
- Mutual Benefit Finance Company: It means a company which is notified by the Central Government under section 620A of the Companies Act, 1956. The main source for nidhis is share capital, deposits from their members and deposits from the public. Nidhis give, loans to their members- for several purposes like marriages, redemption of old debts, construction and etc. The nidhis normally follow the easy procedures and offer saving schemes and make credits available to those whose credit needs remain unmet by his commercial banks.
- Chit Fund Company: It is a company which collects subscriptions from specified number of subscribers periodically and in turn distributes the same as prizes amongst them. The chit fund companies operations are governed by the Chit Fund Act, 1982, which is administered by State Governments. Their deposits taking activities are regulated by the Reserve Bank.
- Residuary Non-Banking Company: It is a company which receives deposits under any scheme by way of subscription/ contributions and does not fall in any of the above categories.
Prerequisites of NBFC: No NBFC can commence business of a non-banking financial institution without the following:
- obtaining a certificate of registration from the Bank .
- without having a Net Owned Funds of Rs. two crore
Registration: The Reserve bank of India (Amendment) Act, 1997 provides for compulsory registration with the Reserve Bank of all NBFCs, irrespective of their holding of public deposits, for commencing and carrying on business, minimum entry point norms, maintenance of a portion of deposits in liquid assets, creation of Reserve Fund and transfer 20% of profit after tax annually to the fund. The act provides for an entry point norm of Rs 25 lakh as the minimum Net owned Fund (NOF). Subsequently, for new NBFC’s seeking registration with the Reserve Bank to commence business on or after April 21, 1999, the requirement of minimum level of NOF was revised upwards to Rs 2 crore. No NBFC can commence or carry on business of a financial institution ncluding acceptance of public deposit without obtaining a Certificate of Registration (COR) from the Reserve Bank.
Services provided: NBFCs offer most sorts of banking services, such as loans and credit facilities, private education funding, retirement planning, trading in money markets, underwriting stocks and shares, TFCs (Term Finance Certificate) and other obligations. These institutions also provide wealth management such as managing portfolios of stocks and shares, discounting services e.g. discounting of instruments and advice on merger and acquisition activities. The number of non-banking financial companies has expanded greatly in the last several years as venture capital companies, retail and industrial companies have entered the lending business. Non-bank institutions also frequently support investments in property and prepare feasibility, market or industry studies for companies.
However they are typically not allowed to take deposits from the general public and have to find other means of funding their operations such as issuing debt instruments.
Regulation: For European NCs the Payment Services Directive (PSD) is a regulatory initiative from the European Commission to regulate payment services and payment service providers throughout the European Union (EU) and Euro Economic Area (EEA). The PSD describes which type of organisations can provide payment services in Europe (credit institutions (i.e. banks) and certain authorities (e.g. Central Banks, government bodies), Electronic Money Institutions (EMI), and also creates the new category of Payment Institutions).
Organisations that are not credit institutions or EMI, can apply for an authorisation as Payment Institution in any EU country of their URL choice (where they are established) and then passport their payment services into other Member States across the EU.
Classification: Based on their Liability Structure, NBFCs have been divided into two categories. 1. Category ‘A’ companies (NBFCs accepting public deposits or NBFCs-D), and 2. Category ‘B’ companies (NBFCs not raising public deposits or NBFCs-ND).
NBFCs-D are subject to requirements of Capital adequacy, Liquid assets maintenance, Exposure norms (including restrictions on exposure to investments in land, building and unquoted shares), ALM discipline and reporting requirements; In contrast, until 2006 NBFCs-ND were subject to minimal regulation. Since April 1, 2007, non-deposit taking NBFCs with assets of `1 billion and above are being classified as Systemically Important Non-Deposit taking NBFCs (NBFCs-ND-SI), and prudential regulations, such as capital adequacy requirements and exposure norms along with reporting requirements, have been made applicable to them. The asset liability management (ALM) reporting and disclosure norms have also been made applicable to them at different points of time.
Supervision of NBFCs: The supervisory framework for NBFCs is based on three aspects-
- the size of NBFC
- type of activity
- the acceptance or otherwise of public deposits.
Towards this end, a four-pronged supervisory strategy comprising
- On-site inspection based on CAMELS (Capital, Assets, Management, Earnings, Liquidity, Systems and Procedures) methodology
- Computerized off-site surveillance through periodic control returns
- An effective market intelligence network, and
- A system of submission of exception reports by auditors of NBFCs
Task Force: To review the regulatory framework and supervision of NBFCs, the government appointed a task force which submitted its report in October 1998. The recommendations made by the Task Force covering different aspects like ceiling on public deposits, investments in real estate and unquoted shares, minimum of NOF to be raised, registration, inspection disclosures etc. have been implemented.
Flow of credit from banks to NBFCs:
(i) Bank credit to NBFCs for their advances against commercial vehicles has been brought under the ambit of priority sector advances.
(ii) The ceiling on bank lending to NBFCs registered with the Reserve Bank has been removed with effect from May 1999.
RBI Directions to NBFCs: Reserve Bank of India announced a set of measures to protect the interest of depositors and provide more effective supervision over NBFCs on January 2, 1998. The regulations stipulate on the NBFCs, an upper limit both on public deposits to be accepted, on the rate of interest to deposits, in order to restrain then from offering incentives and mobilize excessive deposits.
The disclosure requirements have been strengthened and responsibilities cast on the Board of Directors and auditors of the companies to ensure proper conformation deposit regulations and prudential norms prescribed by RBI.
For the purpose of the new regulations, NBFCs have been divided into three broad categories an indicated below:
(a) NBFCs accepting public deposits.
(b) NBFCs not accepting public deposits are engaged in loan. Investment, hire purchase finance and equipment leasing activities.
(c) NBFCs not accepting public deposits and has acquired shares/ securities in their own group/ holding/subsidiary companies of not less than 90 % of their total assets and are not trading in these shares/ securities.
While NBFCs accepting public deposits will be subjected to all provisions of the Directors, those which do not accept public deposits will be supervised in a limited manner.
The Reserve Bank of India has also tightened bad loan classification norms for finance companies and has prescribed higher capital for deposit raising firms even as it withdrew its freeze on licensing new non-banking finance companies (NBFCs). The classification of a loan as a non-performing asset has been brought in line with that of a bank. However, when it comes to raising capital, restrictions have been placed afresh as an NBFC can mobilize deposits only up to 1.5 times its net owned funds as against four times earlier.
Besides opening its window for issuing new licences, the RBI has also eased the capital adequacy requirement for a section of finance companies. At present, all NBFCs with asset size of Rs 100 crore and above are required to have a minimum capital to risk weighted assets ratio of 15%. Consequently, tier 1 capital cannot be less than 7.5%.
Also, the existing minimum tier I capital requirement is 10%. Similarly, NBFCs primarily engaged in lending against gold jewellery have to maintain a minimum a tier 1 capital of 12%.
Prudential norms provide up to three-and-a-half years to adopt the new guidelines on NPAs and capital requirements. NBFC are gaining momentum and have come a long way over the decades.
The banking sector is financing only 40% of the trading sector the rest is by the NBFC’s. They are playing a major role in economic development of a nation.