Non Banking Financial Companies

NBFCs.. An introduction
NBFCs are important financial intermediaries and an integral part of the Indian financial system. They have the advantage of lower transaction costs, quick decision making , customer orientation and prompt provision of services. Egs. NBFCs attract a large no. of small investors since the rate of return on deposits with them is relatively high.

NBFCs.. An introduction
NBFCs are quite flexible in meeting the credit needs of specific sectors like equipment leasing, hire purchase, housing finance and consumer finance. Here the reason being the gaps between the demand and supply of funds have been high and where established financial entities are not easily accessible to borrowers. Increase in no. of NBFCs because as there exists ease of entry, limited fixed assets and absence of any need to hold inventories. Egs. Fullerton India, Muthoot finance , GE group, Citi Financialsetc. While their functions & services are different , the common feature is acceptance of deposits from the public, borrowing from banks and if registered as public limited cos. Accessing the capital market.

NBFCs - DEFINITION
As per RBI(Ammendment act)1997, a Non banking finance company means : (i) a financial institution which is a company. (ii)a non banking institution which is a company and which has as its principal business the receiving of deposits under any scheme or in any other manner or lending in any manner. (iii) Such other non banking institution as the bank may specify with the previous approval of the Central Government.

NBFCs.. Definition
The definition excludes: financial institutions besides institutions which carry on agricultural operations as principal business. Also excludes insurance or stock exchanges or stock broking companies.

Categories of NBFCs
An equipment leasing company(EL) A hire purchase company (HP) A housing finance company(HFC) An investment company (IC) A loan company (LC) A mutual benefit financial company(MBFC) (i.e. nidhi cos.) A miscellaneous non banking company .i.e. chit fund companies etc.

RBI Act framework , III-B

It regulates different type of NBFCs under the provisions of Chapter IIIB & IIIC. Deposits : defined in a broad sense to include any receipt of money by way of deposit or loan in any other form. However excludes: - Amt. received from banks, - amt. received from Development finance corporations/state finance corps. Or any other financial institutions. -amt. received under the ordinary course of business by way of security deposit,dealership deposit, advance against order for goods/properties/services.

Deposits defined..
The term Deposit further excludes: - amt. received from an individual /firm/association related to money lending. Amt received by way of subscription in respect of a chit. Loans from mutual funds.

Financial Institutions
They mean any non banking institutions/financial companies engaged in any of the foll. Activities: Financing by way of loans, advances any activity , except its own. Acquisition of shares/stocks/bonds/debentures/securities. Hire purchase Any class of insurance, stock broking etc. Chit funds & Collection of money by of subscription/sale of units or other instruments/any other manner and their disbursement.

Financial Institutions
Thus any NBFC is a Financial Institution that is a company whose principal business is the receiving of deposits or lending. (except insurance, stock broking, agriculture financing).

Registration & Net Owned Funds (NOFs)

NBFCs in order to commence or carry on existing business must obtain a certificate of Registration from RBI. Its minimum NOF must be Rs.25 lakh or such other amount not exceeding Rs.200 lakh, as specified by RBI.

NOFs
NOFs mean Paid up capital and free reserves minus : a) accumulated losses, deferred revenue expenditure, other intangible assets, b) investments in shares of subsidiaries/cos. of same group and book value of debentures/bonds/loans/advances/deposits with subsidiaries in the same group , in excess of 10 % of a above.

Maintenance of Assets
NBFCs required to invest at least 5% of O/S deposits in approved Indian securities. (as on last working day of 2nd preceding quarter). Approved Securities - State/Central Govt. securities where there is guarantee of Interest + Principal repayment. Where the investment amt. Is less than above, then penal interest at bank rate + 3% is to be paid to RBI. If shortfall continues then, the co. has to pay 5% above bank rate, to RBI.

Reserve Fund
Every NBFC must create a reserve fund. At least 20% of net profit before declaration of dividends must be transferred to Reserve fund. Exemption allowed if RBI recommends but under conditions of: - NBFC has enough paid up capital +reserves as compared to their deposit liabilities.
- and Reserve fund + share premium is not less than paid up capital.

Power of Regulation/Prohibition
RBI can by order regulate/prohibit NBIs from the issue of Prospectus/advertisement for soliciting deposits from general public . It may also specify conditions for issue of the same. Also can lay rules for Income recognition, Accounting standards, Provision for bad and doubtful debts, Capital Adequacy based on risk weights for assets and deployment of funds.

Power to collect information from NBIs

RBI can issue directions to NBIs for information on deposits - rate, period, purpose and other terms and conditions on which deposits are received. Non compliance may lead to the prohibition of acceptance of deposits by the NBI.

Power to call for information from FIs and Issue Directions :

To regulate the credit RBI, can ask for information on paid up capital , reserves, liabilities, investments, persons/period for which finance was provided , terms and conditions of finance, ROI etc.

Duty of NBIs and Auditors

Furnish all information to RBI as per directions given. RBI may issue directions to NBFCs for furnishing P&L A/c. Balance Sheet, disclosures of liabilities in books of account etc. Auditors must mention this compliance in the Statutory Report. If all of the above not done, NBFCs may be prohibited from accepting deposits.

Inspection
RBI has the power to order for inspection of NBIs by its officers, for verifying the correctness of informations furnished or informations which NBIs have failed to furnish. The management of the NBIs must produce all books of accounts to the inspecting authority.

Penalties
Wrong material statement in the prospectus : 3yrs imprisonment + fine Registration Failure + NOF maintenance : imprisonment of 1-3yrs+ fine of 1 - 5 lakhs. Failure of auditors to comply with any order : fine not exceeding Rs.5000

NBFCs Acceptance of Public Deposit Directions : IIIC

NBFCs include : ELC, HPFC, IC, LC, MBC, MBFC MBC : Mutual Benefit Companies . They are not notified under sec 620 A but comply with 637 A of the Companies Act (to Nidhi Companies )by the Govt., and has at least Rs.10 lakhs NOF. MBFC : Mutual Benefit Finance Companies . A financial institution notified under 620A of the Companies Act. Only such companies notified under section 620A of the companies act will be classified as Nidhi Companies.

NBFCs Acceptance of Public Deposit Directions :

MNBC : Meaning financial institution carrying all or any of the following types of business: Collection of money in lump sum/installments by way of subscriptions, sale of units/certificates/, membership fees, service charges with respect to savings, for Utilization of the collected money for : giving to subscribers by draw/gifts, refunding to subscribers the money collected with/without bonus, managing the arrangement of collection from subscribers and paying to them the entitled sum on basis of draw of lots, undertake any other business similar to those referred above.

RNBCs
Residual Non Banking Companies. All non banking companies other than NBFCs and MNBCs fall into the category of RNBC. They are also into receiving deposits under any scheme in lumpsum/instalments by way of subscriptions/sale of units/certificates or in any other manner.

Acceptance of Deposits: regulations

The regulations covers all deposits except the following receipts; Received from Central/State authority received from IDBI/LIC/GIC/SIDBI etc. received by way of subscriptions to shares/debentures/bonds etc received from directors/shareholders brought in by promoters received from a relative of a director of NBFC received from issuance of commercial papers.

Acceptance of Deposits :
Restrictions to MBC/MBFCs : Can accept deposits only from their shareholders, provided not in the nature of current account deposits. Cannot issue advt. For inviting deposits from shareholders. Not allowed to pay commission/brokerage to any person for collecting deposits.

Restrictions on NBFCs: deposits

Minimum credit rating:
NBFCs must obtain minimum credit rating for their fixed deposits for accepting deposits, at least once a year. Copy of rating to RBI. RBI to be informed about all upgrading/downgrading. This rule does not apply to an equipment leasing or hire purchase company.

Restrictions on NBFCs: deposits

Period of Deposits : NBFCs cannot accept demand deposits. They can accept/renew deposits for a min. period of 12 months to a max. of 60 mths.

Ceiling on quantum of deposit:

ELC/HPFC :
with min. NOF of Rs.25 lakhs, compliance of Prudential norms & CAR of 15% as per last audited B/S, then permitted to accept deposits upto 1.5 times of NOF or max of Rs.10 crore whichever is lower. The ceiling is 4 times NOF , if they have minimum investment grade credit rating

LCs/Ics :
under same condition of NOF, CAR &Prudential Norms, can accept deposits not exceeding 1.5 times of their NOF, if the have minimum credit rating. If cos have AAA rating , but CAR is less than 15% then they are prohibited from accepting deposits in excess of outstanding as on DEC18, 1998 or 1.5 times NOF , which ever is more.

Down grading of Credit Rating.

If credit rating goes below the minimum specified investment grade, then : ELC/HPFC must immediately stop accepting deposits and report to RBI within 15 days. Reduce the excess public deposits within three years from date of downgrading.

Ceiling on ROI
Can be paid or compounded on rests. The rests should not be shorter than monthly rests. The ceiling is currently 12.5 %

Deposit Acceptance Directions..

Payment of Brokerage :
Brokerage /commission/incentive on deposits with all NBFC is 2% of deposit. Reimbursements of vouchers ,bills etc, upto 0.5% of deposits is permitted. Renewal of Deposits : NBFCs can permit deposit renewal before maturity to avail benefit of higher interest rate provided the renewal is for a period higher than the remaining maturity period. And interest on the expired period of deposit is reduced by 1% , from the rate the NBFC would have paid , if it had been for the period it has run. Any excess interest paid should be recovered back.

Payment of interest on overdue deposits

NBFCs permitted to pay interest on overdue deposits if: total/part amt. Of overdue deposit is renewed from date of maturity. The interest should be prevailing rate on the date of maturity, which would be payable on a renewed deposit. If NBFC fails to pay the deposit on maturity date, following a claim by the depositor, it would be liable to pay an overdue interest at the rate as applicable to the deposit.

Advertisement & Stat. in lieu of Advt.

Advt. Rules, 1977 mandatory for all NBFC/MNBC They must specify following: Actual Rate of Return- through interest, premium,bonus & other advantages. Details mode of repayment of deposit, maturity period,Int. payable, ROI & terms on premature withdrawal, other special conditions for acceptance/renewal of deposits. When the NBFC intends is accepting deposits without an advertisement, then Statement in Lieu of Advertisement , with all the above details is to be furnished to RBI

Prepayment of Deposits
Directions do not permit withdrawal of deposits before 3 months. NBFC has to pay interest on premature withdrawal : - no interest on withdrawal between 3 mths and 6 mths.

Not more than 10% on withdrawal between 6 12 mths.

1% less than contracted rate, on withdrawals after 12 mths, but before maturity.

For MNBCs the interest payment is nil, for premature withdrawals after six months , 1% less than contracted rate . RNBC , 2 less than contracted rate , on premature withdrawal after 1 yr .
LOANS : up to 75% of deposit for NBFCS, 70% for MNBCS @ 2% above coupon rate.

Special Provisions ;
Information in Board Report : details of due and unclaimed deposits, in the Report of Board of Directors under section 217, along with steps taken if amt. exceeds Rs.5 lakh. Safe Custody of Approved Securities : to be entrusted to a scheduled commercial bank, Stock Holding Corp, Depository Participant, in the place of registered office . Securities cannot be used except for re- payment of depositors.

Special Provisions :
Employees Security Deposit with scheduled commercial bank in joint name with the NBFC, and withdrawn only with written permission of employee. Submission of Accounts to RBI audited B/S, audited P&L, along with Directors Report after being passed at AGM. Auditors Certificate : to be submitted along with Accounts. Returns submitted to RBI - furnishing information in First Schedule with reference to financial position. Also the names , addresses, phone nos of directors, names & designations of officers authorized to sign for the company, names & addresses of auditors of the co.

RBI NBFC Prudential Norms

Relating to : Income Recognition Accounting Standards Asset Classification Provisioning for loans and Advances Capital Adequacy Concentration of credit/investments. Applicable to all NBFCs, RNBCs, except MNBCs with a NOF of Rs.25 lakhs & above.

Prudential norms Income Recognition

Income including interest, discount or any other charge on NPAs should be recognized when realized. Any income realized before asset became an NPA to be reversed. Basics of identifying NPA : assets with overdue int. more than 6mths, term loans & demand loans, with installments/interest overdue for 6 mths, 6 mths overdue bills,other current assets overdue for 6 mths, Any dues on Account of Sale of Services which remained overdue for 6 mths, Lease rentals overdue for 12 mths, Loans advances and other credit facilities that are overdue.

Prudential Norms - Accounting Standards

Accounting for Investments : Board of Directors of the NBFC to frame the investment policy, including classification of Investments as long term and short term. Inter class transfers of investments allowed only at the beginning of the half years(apr-oct), at lower of Market Price Or Book Value. Depreciation on investments to be provided for, and appreciation ignored. Quoted Current Investments : for valuation purposes to be classified into equity, preference shares, debentures/bonds, govt. securities/T bills, units of mutual funds. Etc. Then valuation on basis of market value or cost which ever is lower.

Prudential Norms - Accounting Standards.

Unquoted Equity Shares :
Such shares which are current investments to be valued at cost or Break up value , whichever is lower.((break up value - equity cap+reserves -tangible assets& reval.reserves)/no. of eq.shares in the investee co.). Break up value can be substituted by fair value which is mean of BV and earnings value. Unquoted Preference Shares:lower of cost or face value. Unquoted Govt. Securities/Units of Mutual Funds: Book value of assets + interest accrued.Units of Mutual fund at NAV of each

particular scheme.

Prudential Norms - Accounting Standards.

Commercial Paper : valued at carrying cost.(I.e. book value, Long term investment : ICAIs accounting standards Unquoted Debentures : to be treated as long term loans

Prudential Norms - Asset Classification

All forms of loans/advances classified into four broad groups: Standard Assets :no default in repayment of principal/interest is perceived. Does not show problems, carries normal risk. Sub standard Assets : classified as NPA for period not exceeding 18 mths. Principal/Interest payment have been renegotiated. Provisioning Requirements : a general provision of 10% of total outstanding is to be made.

Prudential Norms - Asset Classification.

Doubtful Assets : an asset which remains sub standard for a period exceeding 18 mths. Provisioning : 100% if the advance is not covered by realizable security. In addition provision to the extent of 20 - 50% of the secured portion. Loss Assets : assets where loss has been identified/or potential threat of non recoverability is seen. Provisioning : entire asset to be written off. If assets to be shown in books , then 100% outstanding to be provided for .

Capital Adequacy Requirements

All NBFCs required to maintain a minimum capital ratio of Tier-I and TierII capital , equivalent to 12% of the aggregate risk weighted assets and risk adjusted value of off-balance sheet items. Tier II not to exceed at any point of time 100% of Tier I Capital. Tier I Capital : owned funds less investments in share of other NBFCs and shares /debentures/bonds/outstanding loans & advances, deposits with subsidiaries & cos. In same group , in excess of an aggregate of 10%.

Capital Adequacy Requirements

Tier II consists of : Preference Shares : excluding those convertible into equity. Revaluation Reserves: at a discount of 55% , for inclusion in Tier II capital. General Provision & Loss Reserves:1.25% of risk weighted assets. Hybrid Debt : all capital instruments that have characteristics of equity and debt. Subordinate Debt. : I.e. fully paid and unsecured debt, free of restrictive clauses, and not redeemable at the initiative of holder & without the consent of the NBFCs supervisory authority.

Risk Weighted Assets

Assets include :
On Balance sheet Items: (multiplied with their respective risk weights) Cash and Bank Balances (0) Investments :(bonds of PSBs/PFIs - 100%, shares units of Mutual Funds 20%) Current Assets : (stock on hire, ICDs, loans & advances ,loans to staff, Bills Discounted - 100%) Fixed Assets : leased out assets, Premises, Furniture & Fixtures 100% Other Assets - Income Tax at Source - 0, Adv.tax -0, Int. due on Govt. Securities - 0, Others - 100

Risk Weighted Assets.

OFF BALANCE SHEET ITEMS : Financial & other guarantees : 100 Shares/Deb.underwriting obligations - 50 Partly paid Deb., Bills discounted, lease contgracts entered into but not executed, 100 Other contingent liablities - 50

Other Prudential norms ...

Prohibition on loans and advances : any default by NBFC on any public deposit, then it is prohibited from giving loans/credit/making investments/ - as long as default exists. LAS : NBFCs prohibited from giving loans against their own shares. Restrictions on Investment in Land/Build and Unquoted Shares : EL/HPFC - should not invest more than 10% of NOF. For LC/IC respective proportion is 10 and 20%. If land/building /unquoted shares is acquired in settlement of debt, then should be disposed in 3yrs.These ceiling do not apply to investment in eq. Cap of insurance co.

Other Prudential norms

Concentration of Credit/Investments:
NBFCs cannot lend to a single borrower/single group of borrowers in excess of 15 & 25 % of their owned funds. Loans & investments together for a single party - 25%, 40% for a group of parties. For determining above lendings and investments, off balance sheet items to be considered as credit , and invest in debentures to be treated also as credit and not investments.

NBFCs Auditors Report Directions

For all NBFCs the auditors have to report whether it : has applied for registration with RBI, incorporated before Jan 9, 1997, has received communication for granting/refusal of registration, has obtained certificate of registration of incorporation on/after Jan 9, 1997

NBFCs Auditors Report Directions...

For NBFCs Accepting Public Deposits :
auditors to include a statement on : public deposits/other borrowings are with prescribed limits. Credit rating of Fixed Deposits assigned by Agency is in force, and total Outstanding deposits at any point of time has exceeded the limit specified by the rating agency.
Whether NBFC has defaulted in repayments of deposit principal/interest. The NBFC has complied with all prudential norms, Capital adequacy requirements, liquidity requirements.

NBFCs Auditors Report Directions...

Whether NBFC has furnished to RBI half yearly return on the specified prudential norms, the return on deposits as specified in Public deposit Acceptance norms. In case of opening/closing of new branches, appointment of agents to collect deposits the RBI directions complied with.

NBFCs Auditors Report Directions...

For NBFCs not accepting Public Deposits: auditors must report whether : Board of Directors have passed resolution for non acceptance of deposits. THE NBFC has accepted any deposits The NBFC has complied with Prudential Norms .

NBFCs Auditors Report Directions...

Obligation of the Auditor to the RBI Must report to the RBI whether:
Any of their statements in the audit report are qualified/unfavorable. In auditors opinion the NBFC has not complied with Deposit Acceptance Norms/Prudential Norms The NBFC has not complied with provisions of Chapter III - B of RBI Act.