A Non-Banking Financial Company (NBFC) is a company registered under the Companies Act, 2013 or 1956carrying on thebusinesslisted underSection 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,
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 the immovable property.
A non-banking company that has principal business of receiving deposits under any scheme or arrangement in one lump sum or in installments by way of contributions or in any other manner, is also a non-banking financial company (Residuary Non-banking Company).
Non-Banking Financial 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?
An activity becomes a principle business when a company’s assets from that activity constitute more than 50 percent of its total assets and
Income from those assets constitutes more than 50 percent 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 a very small way and has principal business in agricultural operations, industrial activity or sale or construction of immovable property, it will not be regulated by RBI.
Types of Non-Banking Financial Company (NBFC)
Non-Banking Financial Company 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 ₹ 500cr or more as per last audited balance sheet are considered as systemically important NBFCs.
The tag of systemically important NBFCsdepicts 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 a list of all types of Non-Banking Financial Company, please refer the list given in the next segment
Asset Finance Company (AFC)
Principal 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 support productive/economic activity, such as automobiles, tractors, lathe machines.
See AlsoForex vs. Stocks – FC BLTAGYfastest way to make money online?4 Of The Best Forex Trading Strategies That Work: You Need For [2021] | Norfolk FX TraderInvestors in Airbnb arbitrage business allege they were defrauded in scheme promising 'higher returns than the stock market' - Top World News TodayInvestment 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-BankingFinanceCompany- IFC is a one:
which deploys at least 75 percent of its total assets in infrastructure loans,
has a minimum Net Owned Funds of ₹ 300 crores,
has a minimum credit rating of ‘A ‘or equivalent
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 crores 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 constitute 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 Non-Banking Financial Company 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;
The total indebtedness of the borrower does not exceed ₹ 1,00,000
the aggregate amount of loans, given for income generation, is not less than 50 percent of the total loans given by the MFIs
The loan is repayable on weekly, fortnightly or monthly installments at the choice of the borrower
NBFC- Non-Operative Financial Holding Company (NOFHC)
It is a 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.
Harmonization of NBFC sector
RBI in a recent announcement mergedthethree categories of NBFCs viz. Asset Finance Companies (AFC), Loan Companies (LCs) and Investment Companies (ICs) have been merged into anew category called NBFC – Investment and Credit Company (NBFC-ICC).
As per the definition of RBI, NBFC-ICCmeans 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 inany of its Master Directions.
The objective of this harmonization is to allow greater operational flexibility to NBFCs. Post the aforesaid harmonization, 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 from Banks?
Banks
NBFCs
Can accept demand deposits
Cannot accept demand deposits
Banks are part ofpayment and settlement system
NBFCs are not part of the 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
the 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 what type of NBFC will be regulated by which regulator. Following is the chart that provides 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 an 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 ofNBFCs in India
Non-Banking Financial Company have shown 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 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
Non-Banking Financial Company has assisted to a large extent in providing financial inclusion by serving the segment that has not been served by the 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
Non-Banking Financial Company play a key role in providing 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 potentialfor generating economic growth and employment in India, butIt is also a fact thata 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 acore 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 percent stake, Housing Development Finance Corporation with 9.02 percent, Central Bank of India with 7.67 percent 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 the 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 the 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 rating downgrade. A downgrade in the credit rating led to a lowering of the price of bond’s which affected debt funds.
Causes of crisis
Assets-Liability mismatch
This mismatch occurs when liability increases disproportionately to the assets of a company. In the case of IL&FS, it happened because the company was financing long term loans by raising short term debt instruments like Commercial Papers.
While the company needs 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 an assets-liability mismatch.
Land acquisitions
A major reason behind the 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 the government of India to improve the infrastructure of the country, but it did not prove to be a 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. A huge amount is stuck in arbitration between IL&FS and government.
The 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 increasing 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
The market indices, Sensex and Nifty, fell drastically due to IL&FS crisis.
Defaults in payments by subsidiaries of IL&FS triggered fear of liquidity crisis in the financial markets.
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.
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.
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.
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:
Also read: Sucking Up Surplus: SEBI Needs Financial Autonomy To Remain EffectiveRight To Information (Amendment) Bill, 2019Source
to introduce Liquidity Coverage Ratio (LCR) for all deposit-taking Non-Banking Financial Company, 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 is 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 percent, 10 percent and 20 percent 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.
