Non-Banking Financial Company

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By admin August 9, 2019 15:34

A Non-Banking Financial Company (NBFC) is a company registered under the Companies Act, 2013 or 1956 carrying on the business listed under Section 45 I (c ) of the RBI Act, 1934, i.e.:

  • loans and advances,
  • acquisition of shares/stocks/bonds/debentures/securities issued by Government or local authority or other marketable securities of a like nature,
  • leasing, hire-purchase,
  • insurance business,
  • Chit business.

It does not include any institution whose principal business is that of

  • agriculture activity,
  • industrial activity,
  • purchase or sale of any goods (other than securities) or providing any services and
  • Sale/purchase/construction of immovable property.

A non-banking company that has principal business of receiving deposits under any scheme or arrangement in one lump sum or in instalments by way of contributions or in any other manner, is also a non-banking financial company (Residuary Non-banking Company).

NBFC Registration Requirements

  • The company must be registered as a public limited company or private limited company in India.
  • The company must have a minimum net owned fund of Rs.2 Crore.

What does ‘Principle business’ mean?

  1. An activity becomes a principle business when a company’s assets from that activity constitute more than 50 per cent of its total assets and
  2. Income from those assets constitute more than 50 per cent of the gross income.

The motive behind defining the term ‘Principle business’ by RBI was, to ensure that only companies predominantly engaged in financial activity get registered with it and are regulated and supervised by it.

It also means that if a company is engaged in any Financial business in very small way and has a principle business in agricultural operations, industrial activity or sale or construction of immovable property, it will not be regulated by RBI.

Types of NBFCs

NBFCs as per the RBI has been classified into various categories based on the types of liabilities and type of activities, they perform.

By the type of liabilities

NBFCs whose asset size is of ₹ 500 cr or more as per last audited balance sheet are considered as systemically important NBFCs.

The tag of systemically important NBFCs depicts their importance for the financial stability of the overall economy.

By the kind of activities, they conduct

Note: Following classification is regulated by RBI only. For list of all types of NBFCs, please refer the list given in the next segment

Asset Finance Company (AFC)

Principle business for this category has been increased at not less than 60% of its total assets and total income respectively.

The companies that are involved in a principle business financing of physical assets that supports productive/economic activity, such as automobiles, tractors, lathe machines.

Investment Company (IC)

Companies carrying on as its principal business the acquisition of securities.

Loan Company (LC)

It includes companies carrying on as its principal business the providing of finance whether by making loans or advances or otherwise for any activity other than its own.

It does not include an Asset Finance Company.

Infrastructure Finance Company (IFC)

A Non-Banking Finance Company- IFC is a one:

  1. which deploys at least 75 per cent of its total assets in infrastructure loans,
  2. has a minimum Net Owned Funds of ₹ 300 crore,
  3. has a minimum credit rating of ‘A ‘or equivalent
  4. And a CRAR of 15%.

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

CIC-ND-SI is an NBFC carrying on the business of acquisition of shares and securities which satisfies the following conditions: –

  • It assets size should be ₹ 100 crore or above
  • it holds not less than 90% of its Total Assets in the form of investment in equity shares, preference shares, debt or loans in group companies;
  • its investments in the equity shares in group companies constitutes not less than 60% of its Total Assets
  • it does not trade in its investments in shares, debt or loans in group companies except through block sale for the purpose of dilution or disinvestment;

Non-Banking Financial Company – Micro Finance Institution (NBFC-MFI):

NBFC-MFI is a non-deposit taking NBFC having not less than 85% of its assets in the nature of qualifying assets which satisfy the following criteria:

  • Loan to rural household annual income not exceeding ₹ 1,00,000 or urban and semi-urban household income not exceeding ₹ 1,60,000;
  • Total indebtedness of the borrower does not exceed ₹ 1,00,000
  • aggregate amount of loans, given for income generation, is not less than 50 per cent of the total loans given by the MFIs
  • Loan is repayable on weekly, fortnightly or monthly instalments at the choice of the borrower

NBFC- Non-Operative Financial Holding Company (NOFHC)

It is financial institution through which promoter / promoter groups will be permitted to set up a new bank .It’s a wholly-owned Non-Operative Financial Holding Company (NOFHC) which will hold the bank as well as all other financial services companies regulated by RBI or other financial sector regulators, to the extent permissible under the applicable regulatory prescriptions.

Housing Finance Company:

Any company which is carrying on as its principal business the financing of acquisition or development of plots of land in connection therewith is called Housing Finance Company.

Harmonisation of NBFC sector

RBI in a recent announcement merged the three categories of NBFCs viz. Asset Finance Companies (AFC), Loan Companies (LCs) and Investment Companies (ICs) have been merged into a new category called NBFC – Investment and Credit Company (NBFC-ICC).

As per the definition of RBI, NBFC-ICC means any company which is a financial institution carrying on as its principal business- asset finance, the providing of finance whether by making loans or advances or otherwise for any activity other than its own and the acquisition of securities; and is not any other category of NBFC as defined by the Bank in any of its Master Directions.

The objective of this harmonisation is to allow greater operational flexibility to NBFCs. Post the aforesaid harmonisation, there shall be the same set of regulations for all the three categories of NBFCs even as they vary widely in their business focus and sources of funding.

Housing Finance Company: Any company which is carrying on as its principal business the financing of

acquisition or development of plots of land in connection therewith is called Housing Finance Company.

Housing Finance Company: Any company which is carrying on as its principal business the financing of

acquisition or development of plots of land in connection therewith is called Housing Finance Company.

Comprehensive list of NBFCs according to regulators

How is it different to Banks?

Banks

NBFCs

Can accept demand deposits Cannot accept demand deposits
Banks are part of payment and settlement system NBFCs are not part of payment and settlement system
Banks can issue cheques drawn on themselves An NBFC cannot issue Cheques drawn on itself
Depositors of banks are provided deposit insurance facility of Deposit Insurance and Credit Guarantee Corporation deposit insurance facility of Deposit Insurance and Credit Guarantee Corporation is not available to depositors of NBFCs
Banks are required to maintain Reserve ratios (CRR, SLR) Unlike banks, NBFCs are not required to maintain Reserve Ratios

 

Regulations of NBFCs

NBFCs provide a variety of products, going through the domains of different regulators. Thus, to avoid conflicts and confusion it becomes necessary to specify that what type of NBFC will be regulated by which regulator. Following is the chart that provide this classification:

 

Ombudsman Scheme for Non-Banking Financial Companies, 2018

The Reserve Bank of India has introduced an Ombudsman Scheme for customers of Non-Banking Financial Companies (NBFCs).

The Scheme is being introduced under Section 45 L of the Reserve Bank of India Act, 1934, with effect from February 23, 2018.

The Ombudsman Scheme for Non-Banking Financial Companies, 2018 (the Scheme), is an expeditious and cost-free apex level mechanism for resolution of complaints of customers of NBFCs, relating to certain services rendered by NBFCs.

Initially this scheme was launched for the Deposit taking NBFCs with customer interface, but recently RBI extended the coverage of this scheme to Non-Deposit Taking Non-Banking Financial Companies having asset size of Rs 100 crore or above with customer interface.

Provisions of the scheme

An officer at the RBI not below the rank of general manager will be appointed by the regulator as the ombudsman with territorial jurisdiction being specified by the central bank.

The tenure of each ombudsman cannot exceed three years and can be reduced by the regulator if needed.

a customer can register complaints against an NBFC under 13 grounds such as non-observance of fair practices code, non-payment of deposits or interest by the NBFC, failure to provide adequate security documents or requisite notice, failure to ensure transparency, among others.

 

For redressal of grievance, the complainant must first approach the concerned NBFC. If the NBFC does not reply within a period of one month after receipt of the complaint, or the NBFC rejects the complaint, or if the complainant is not satisfied with the reply given by the NBFC, the complainant can file the complaint with the NBFC Ombudsman

Importance of NBFCs in India

NBFC s have shown an increasing growth in the last ten years. NBFCs is playing its part by meeting the diverse financial needs of the economy. It has channelized the savings and investments of the customers and had helped in the capital formation.

Market Share  

Share of NBFCs in outstanding credit has increased to 17% in March 2018 from 9% in March 2009. In the last few years, the sector has been instrumental in meeting the credit requirements of the economy at a time when bank credit growth has been weak with a number of public sector banks under PCA (Prompt Corrective Action).

Financial inclusion

NBFC has assisted to a large extent in providing financial inclusion by serving the segment that has not been served by banking sector.

NBFCs have a large share of around 53% for micro-finance and as high as 50% in auto-finance’s total credit requirements. The sector meets 40% of infrastructure and housing finance credit requirements.

Providing long term finance

NBFCs play a key role in providing the corporations with funds through equity participation. Unlike other traditional banks, NBFCs offer long-term credit to trade and commerce industry. These companies help to fund large projects and mega infrastructure projects which boost economic development to a great extent.

MSME sector

MSME sector has large growth potential for generating economic growth and employment in India, but It is also a fact that a large segment in the micro and small industries sector does not have access to formal credit.

NBFCs provides for the financing requirements of this sector by designing suitable innovative products.

Affordable housing

Another area where NBFCs are participating in the inclusive growth agenda is affordable housing. Large NBFCs are setting up units to extend small-ticket loans to home buyers targeting low-income customers across the country.

Challenges faced by NBFCs in India

IL&FS crisis

About IL&FS

IL&FS is a 3 decades old NBFC founded in 1987 that provides services similar to traditional commercial banks in the field of infrastructural lending as a core investment company. It operates through more than 250 subsidiaries all over India.

Its major shareholders include state-backed Life Insurance Corp of India holding, 25.3 per cent stake, Housing Development Finance Corporation with 9.02 per cent, Central Bank of India with 7.67 per cent and State Bank of India with 6.42 percent.

It has been registered with RBI as a ‘Systemically Important Non-Deposit Accepting Core Investment Company’.

What was the crisis?

This crisis came into light when on September 6 IL&FS disclosed that the commercial papers (CP), which were due on August 28, could not be paid on due date and were settled in full on August 31.

IL&FS Financial Services had about $500 million in repayments which were due in the second half of last financial year while it had only about $27 million available.

Before that IL&FS shocked markets when it postponed a $350 million bonds issuance in March due to demand for a higher yield from investors.

As per the report by Reuters, by the middle of September, IL&FS and IL&FS Financial Services had a combined Rs 270 billion of debt rated as junk by CARE Ratings.

The series of defaults led to a ratings downgrade. A downgrade in the credit rating led to lowering of price of bond’s which affected debt funds.

Causes of crisis

Assets-Liability mismatch

This mismatch occurs when liability increases disproportionate to the assets of a company.  In case of IL&FS, it happened because company was financing long term loans by raising short term debt instruments like Commercial Papers.

While company need to repay its short term loan within a year, it is not going to get back its loaned amount before 10-12 years, thus it creates assets-liability mismatch.

Land acquisitions

A major reason behind troubles of IL&FS is complications in land acquisition. The 2013 land acquisition law made many of its projects unviable. Cost escalation also led to many incomplete projects. Lack of timely action exacerbated the problems.

 

PPP model

  • Public private partnership (PPP) model was introduced by government of India to improve the infrastructure of the country, but it did not prove to be profit maker for private companies.
  • Under this model, IL&FS started financing and developing infrastructure projects, but on the part of government there have been delays in approvals and passing necessary regulations.
  • The value stuck in between IL&FS and government is estimated to be around $ 90 billion. Huge amount is stuck in arbitration between IL&FS and government.

 

Shift in the Strategy: 

IL&FS was basically started as a finance company, but over a couple of years they not only financed infrastructure projects, but they also started ownership of the same, thus needing more and more finance to complete these long-term projects, which came from borrowing from banking sectors as well as money markets.

Rising interest rates

Increase in the interest rates repetitively by RBI has led to increase in the cost of borrowings by the company.

Lack of access to short-term loans: 

Unlike Banks, NBFCs (like IL&FS) do not have access to RBI repo window.

Effects of IL&FS crisis

  1. The market indices, Sensex and Nifty, fell drastically due to IL&FS crisis.
  2. Defaults in payments by subsidiaries of IL&FS triggered fear of liquidity crisis in the financial markets.
  3. Fears of a liquidity crunch following the IL&FS crisis has hit the mutual fund industry hard. Liquid debt funds have been the worst hit. Estimates suggest that Rs 70,000 crore has been redeemed from liquid funds.
  4. Series of defaults by IL&FS and its group companies and downgraded credit ratings led to massive sell-off in shares of NBFCs and Indian shadow banking was at the crossroads creating ripple effects through the economy.
  5. As the panic and fear factor glooming around the market, the Indian financial market faced the worst liquidity crunch in a decade. Non-availability of cash in the market made the borrowings even costlier and hard of the NBFCs and other companies to raise funds.
  6. liquidity crunch will also impact the funding cost of Non-Banking Financial Companies (NBFCs) and housing finance companies which rely on short-term CPs and NCDs as their source of funds and impact their margins.

RBI’s released draft guidelines for Liquidity Risk Management Framework

In the backdrop of the liquidity issues being faced by non-banking finance companies, the Reserve Bank of India (RBI) on Friday issued a draft circular on ‘Liquidity Risk Management Framework’. The draft proposes:

  • to introduce Liquidity Coverage Ratio (LCR) for all deposit taking NBFCs; and non-deposit taking NBFCs with an asset size of ₹5,000 crore and above.
  • The LCR requirement shall be binding on NBFCs from April 1, 2020, with the minimum High-Quality Liquid Assets (HQLA) to be held being 60 percent of the LCR, progressively increasing in equal steps reaching up to the required level of 100 percent by April 1, 2024.
  • High-Quality Liquid Assets (HQLA) means liquid assets that can be readily sold or immediately converted into cash at little or no loss of value or used as collateral to obtain funds in a range of stress scenarios.
  • They should have sufficient collateral to meet expected and unexpected borrowing needs and potential increases in margin requirements over different time frames.
  • The NBFCs have to formulate a contingency funding plan for responding to severe disruptions, which might affect their ability to fund some or all of their activities in a timely manner and at a reasonable cost.
  • Net cumulative negative mismatches (fund outflows exceeding inflows) in the maturity buckets of 1-7 days, 8-14 days, and 15-30 days should not exceed 10 per cent, 10 per cent and 20 per cent of the cumulative cash outflows respectively.
  • The NBFCs are required to adopt liquidity risk monitoring tools/metrics in order to capture strains in liquidity position.
  • An Asset-Liability Management Committee (ALCO) that would consist of NBFC’s top management and should be responsible for ensuring adherence to risk tolerance and limits set by Board and for implementing NBFC’s liquidity risk management strategy.

SOURCE

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By admin August 9, 2019 15:34