Classification or Strcuture of NBFIs

One of the leading features of the NBFI sector is its diversity. They are very heterogeneous in
terms of the services and products they deliver, the sectors they operate, nature of funding,
size of the company etc. Hence classification of NBFIs itself is complex. Often, they are
classified into different groups depending on services they deliver, regulatory requirement,
ownership pattern etc.

Number of NBFCs in India

As of March 2018, there were 11,402 nonbanking financial companies (NBFCs) registered
with the Reserve Bank. Among these, 156 were deposit accepting (NBFCs-D) and 249 were
systemically important non-deposit accepting NBFCs (NBFCs-ND-SI).

Important categories of NBFCs the NBFC-D and NBFCs-ND-SI are subjected to prudential
regulations such as capital adequacy requirements and provisioning norms along with
reporting requirements.

The given Chart gives a fair idea about the NBFI universe. First branch indicates the NBFC
segment which is regulated by the RBI. Then there are NBFIs regulated by SEBI, IRDA and
NHB. These institutions are generally big and are regulated by SEBI and IRDA. Usually, the
institutions regulated by RBI, MCA and state governments are NBFCs.

The following classification divides the NBFIs into different groups – All India Financial
Institutions, RBI, MCA, and state government regulated NBFCs, Primary Dealers and Capital
Market Intermediaries also shows the diversity of the sector.
1. All India Financial Institutions (or Financial Institutions)
 Term lending institutions – IFCI, IIBI, Exim Bank, and TFCI

 Specialized Financial Institutions – IDFC, IIFCL, IVCF

 Investment institutions – UTI, LIC and GIC

 Refinance institutions – NABARD, SIDBI and NHB

1. RBI and others regulated NBFCs– (the NBFCs are mostly private sector institutions,
regulated by the RBI, MCA and state governments).
III. Primary Dealers (Pds) – are financial institutions dealing with government securities
both in the primary and secondary markets. PDs are mostly wings of Scheduled commercial
banks and insurance companies. At present there are 19 PDs in India and ten of them are
owned by scheduled commercial banks.

1. Capital market intermediaries– Mutual Funds, stock broking companies, merchant

banks, underwriters etc.
The diverse nature of Non-Bank Finance Institution (NBFI) universe has been depicted in the
Chart along with their respective regulators.

As depicted above, RBI classifies the NBFCs regulated by it into ten categories namely,
Asset Finance Companies (AFCs), Loan Companies (LCs), Investment Companies (ICs)
Infrastructure Finance Companies (IFCs), Core Investment Companies (CICs), infrastructure
Debt Funds (IDF-NBFCs), NBFC-Microfinance Institution (NBF-MFIs), Factoring Companies
(FCs), Mortgage Guarantee Companies (MGCs) and Residuary Non-Banking Companies
(RNBCs).

Classification of NBFCs – Activity based Classification

Snapshot

 The NBFCs are diverse and can be classified from different angle.

 They are classified in terms of size, business type, regulation, deposit taking or not etc.

 In terms of importance – the classification is systemically important and others.

 New type of institutions come with time.

 The types of NBFCs are: NBFC – Investment and Credit Company (NBFC-ICC) (this
category comprises of Asset Finance Company (AFC), Investment Company (IC), and Loan
Company (LC)), Infrastructure Finance Company (IFC), Systemically Important Core
Investment Company (CIC-ND-SI), NBFC IDF or Infrastructure Debt Funds, Non-Banking
Financial Company – Micro Finance Institution (NBFC-MFI), Non-Banking Financial
Company – Factors (NBFC-Factors), NBFC Account Aggregators, NBFC – P2P.
Activity based classification of NBFCs

The NBFCs regulated by the three –RBI, MCA (Ministry of Corporate Affairs) and state
governments. They form the most important segment of the whole NBFI spectrum. The
NBFCs are classified on the basis of the type of funds they avail, asset size, the type of
activities they pursue, and of their systemic importance.

An important consideration while classifying the NBFCs is that whether they are accepting
public deposit or not. For the RBI, the depositor’s safety is very important.

On the basis of liabilities or deposit seeking status, NBFCs are broadly classified into two
categories, viz., (i) NBFC-Deposit taking (NBFC-D) and (ii) NBFCs-Non-Deposit taking
(NBFC-ND). The NBFCs-D are subjected to strong regulatory measures.

Activity based Classification of Non-Banking Financial Companies

An important feature of the RBI regulated NBFCs is their diversified activity. Institutions are
classified in accordance with the nature of functions. New institutions are categorized with
time. The companies creating productive assets were divided into three major categories,
i.e., asset finance companies (AFCs), loan companies (LCs) and investment companies
(ICs).

A new category of CIC-ND-SI (Core Investment Companies- Systemically Important) was

created in August 2010 for those companies with an asset size of Rs100 crore and above.
Microfinance companies of substantial importance are classified as NBFC – MFI. In 2016,
the NBFC -AA category was created. P2P companies are also expected to join the NBFC
category soon.

1. NBFC – Investment and Credit Company (NBFC-ICC) (includes AFC, IC and

LC)

Asset Finance Company (AFC): An AFC is a company which is a financial institution

whose principal business (more than 60%) is the financing of physical assets supporting
productive/economic activity, such as automobiles, tractors, lathe machines, generator sets,
earth moving and material handling equipments, moving on own power and general purpose
industrial machines.

Investment Company (IC): IC means any company that is a financial institution and is
carrying on as its principal business the acquisition of securities.

Loan Company (LC): LC means any company that is a financial institution with its principal
business is providing finance/loans and advances.

2. Infrastructure Finance Company (IFC): IFC is a non-banking finance company a)

which deploys at least 75 per cent of its total assets in infrastructure loans, b) has a minimum
 Net Owned Funds of Rs. 300 crore, c) has a minimum credit rating of ‘A ‘or equivalent d) and
a CRAR of 15%.

3. CICs and Systemically Important Core Investment Company (CIC-ND-SI)

4. NBFC-IDF or Infrastructure Debt Funds

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

6. Non-Banking Financial Company – Factors (NBFC-Factors):NBFC-Factor is a

non-deposit taking NBFC engaged in the principal business of factoring. The financial assets
in the factoring business should constitute at least 75 percent of its total assets and its
income derived from factoring business should not be less than 75 percent of its gross
income.

7. The NBFC Account Aggregators: is a financial entity that function as an account

aggregator (for NBFC customers), who will provide information on various accounts held by a
customer in a consolidated, organised and retrievable manner.

8. NBFC – Peer to Peer lending (P2P): The RBI has given NBFC status to the P2P
segment. Detailed regulation is on design stage.

In February 2019, the RBI has merged three categories of NBFCs viz. Asset Finance
Companies (AFC), Loan Companies (LCs) and Investment Companies (ICs) into a new
category called NBFC – Investment and Credit Company (NBFC-ICC). Around 99% of the
NBFCs now comes under NBFC-ICC.

Specialized NBFCs
Snapshot

 Specialized NBFCs are those impactful institutions emerged in recent years by providing
specific products/services.

The RBI taking into account the diversity of institutions engaged in the NBFC sector. It has
come out with detailed regulatory framework for each type of institutions. Many of these
financial institutions are performing unique functions different from others. For this certain
special categories of NBFCs are identified by the RBI as following:

NBFC – Core Investment Companies – (CIC –ND-SI)

NBFC – Micro Finance Institutions (NBFC –MFIs)

NBFC –Infrastructure Finance Companies (NBFC –IFCs)

 NBFC – Infrastructure Debt Funds (NBFC –IDFs)

NBFC – Factors

Deposit taking and Non-Deposit taking NBFCs

The deposit taking NBFCs have to follow higher regulations. For the deposit taking NBFCs, there
are requirement of capital adequacy, liquid assets maintenance, exposure norms (including
restrictions on exposure to investments in land, building and unquoted shares), Asset Liability
Management discipline and reporting requirements. In 2012, the RBI has introduced 15% SLR
norm for the deposit taking NBFCs.

NBFCs-ND are subject to minimal regulation as they were non-deposit taking institutions. They are
considered as posing little threat to financial stability. Still, because of the growing importance of
this segment, the big NBFCs among the non-deposit seeking group are also strictly regulated. These
big NBFCs are classified as NBFCs- ND Systemically Important (NBFC-ND-SI). They are
regulated with norms almost equal to that of banks. For these big NBFCs, capital adequacy,
exposure norms, Asset Liability Management discipline and reporting requirement are almost equal
to that of banks.

Regulation relating to acceptance of deposits by NBFCs

As per the RBI regulations, there are certain NBFCs that can accept public deposit. For these
institutions, certain norms are to be followed including – interest rate cap on deposits, rating
requirements, minimum net owned fund requirements, CRAR requirements etc. These criteria are
mentioned in the box.

Deposit with NBFCs

The deposit taking NBFCs are limited in number. Similarly strong restriction on deposit
mobilization is a major feature of regulation. Following are some of the important regulations
relating to acceptance of deposits by NBFCs:
1. The NBFCs are allowed to accept/renew public deposits for a minimum period of 12 months and
maximum period of 60 months. They cannot accept deposits repayable on demand.
2. NBFCs cannot offer interest rates higher than the ceiling rate prescribed by RBI from time to time.
The present ceiling is 12.5 per cent per annum. The interest may be paid or compounded at rests not
shorter than monthly rests.
3. NBFCs cannot offer gifts/incentives or any other additional benefit to the depositors.
4. NBFCs (except certain AFCs) should have minimum investment grade credit rating.
5. The deposits with NBFCs are not insured.
6. The repayment of deposits by NBFCs is not guaranteed by RBI.

 Certain mandatory disclosures are to be made about the company in the Application Form issued by
the company soliciting deposits.

 Deposit accepting NBFCs have to meet 15% SLR

 NBFC may get itself rated by any of the five rating agencies namely, CRISIL, CARE, ICRA and
FITCH, Ratings India Pvt. Ltd and Brickwork Ratings India Pvt. Ltd. If an NBFC defaults in
repayment of deposit, the depositor can approach Company Law Board or Consumer Forum or file
a civil suit in a court of law to recover the deposits. There is no Ombudsman for hearing complaints
against NBFCs as well.

An unrated NBFC, except certain Asset Finance companies (AFC), cannot accept public deposits.
An exception is made in case of unrated AFC companies with CRAR of 15% which can accept
public deposit without having a credit rating upto a certain ceiling depending upon its Net Owned
Funds.

From 2004 onwards, the NBFCs cannot accept deposits from NRIs except deposits by debit to NRO
account of NRI provided such amount does not represent inward remittance or transfer from
NRE/FCNR (B) account. However, the existing NRI deposits can be renewed.

Ceiling on public deposit acceptance by NBFCs

There is a ceiling on acceptance of Public Deposits by NBFCs authorized to accept deposits. The
limit for deposit acceptance is stipulated in terms of Net owned funds, given that the instiution
maintains CRAR and rating requirements. An NBFC maintaining required minimum NOF/Capital
to Risk Assets Ratio (CRAR) and complying with the prudential norms can accept public deposits
as follows:

Systemically important NBFCs

Snapshot

 Systemically important NBFCs are those with an asset size of Rs 500 crore or more.
The size of institution is an important criterion in the regulation of NBFCs. Now. They are
categorized into three groups for the purpose of administering prudential regulations namely,
NBFCs-D (Deposit taking), non-deposit taking NBFCs (NBFCs-ND) and those non-deposit taking
NBFCs which are big or systemically important (NBFC- ND-SI). The systemic importance of the
NBFC is measured in terms of its asset size. Hence a category of systemically important NBFCs are
also categorized and is known as NBFCs-ND-SI (Non-Deposit taking, Systemically Important).

The threshold for defining systemic significance for NBFCs-ND (NBFCs-ND-SI) is Rs 500 crores.

With this revision in the threshold for systemic significance, NBFCs-ND shall be categorized into
two broad categories viz.,
1. NBFCs-ND (those with assets of less than Rs. 500 crore) and
2. NBFCs-ND-SI (those with assets of Rs. 500 crore and above).
For Systemically Important Core Investment Companies (NBFC -CIC- SI), the asset size is Rs 100
crore.
 What is a core investment company
Snapshot

 Core Investment Company is an NBFC with the principal business of acquisition and carrying of
shares and other securities of companies.
Core Investment Company (CIC) is a non-banking financial company carrying on the business of
acquisition of shares and securities and which (a) holds not less than 90 per cent of its net assets in
the form of investment in equity shares, preference shares, bonds, debentures, debt or loans in group
companies and (b) its investments in the equity shares in group companies constitutes not less than
60 per cent of its net assets as on the date of the last audited balance sheet.

Salient features of the regulatory framework for CICs are:

1. i) Core Investment Companies (CIC) with an asset size of less than Rs100 crore will be exempted
from the requirements of registration with RBI. For this purpose, all CICs belonging to a Group will
be aggregated.
2. ii) CICs with asset size above Rs. 100 crore but not accessing public funds are also exempted from
the requirement of registration with RBI.
iii) Due to systemic implications on account of access to public funds (such as funds raised through
Commercial Paper, debentures, inter-corporate deposits and borrowings from banks/FIs), CICs
having asset size of 100 crores or above are categorized as Systemically Important Core Investment
Companies (CICs-ND-SI) and are required to obtain Certificate of Registration from the Reserve
Bank. Other CICs need not get registration.

NBFC – MFIs

Microfinance institutions (MFIs) with their volume of business, customer base, diversity of
products and financial inclusion potential have emerged remarkable institutions.  Among the MFIs,
reasonably big MFIs measured in terms of asset size are given NBFC – MFI status by the RBI.

What is NBFC – MFI?

An NBFC-MFI is a non-deposit taking NBFC, with Minimum Net Owned Funds of Rs.5 crore (for
NBFC-MFIs registered in the North-Eastern Region of the country, it will be Rs. 2 crore) and
having not less than 85% of its net assets as “qualifying assets”.

Qualifying assets and lending limits

Qualifying assets are loans provided by the NBFCs that shall meet certain specifications. Loan
disbursed without collateral by an NBFC-MFI to a borrower with a rural household annual income
not exceeding Rs. 1, 00,000 or urban and semi-urban household income not exceeding Rs.
1,60,000 and total indebtedness of the borrower does not exceed Rs.1,00,000 will be a qualifying
asset. Loan, if any availed towards meeting education and medical expenses shall be excluded while
arriving at the total indebtedness of a borrower.
 There are certain disbursement and repayment norms as well related with the loans by NBFC –
MFIs.

A part of the aggregate amount of loans may be extended for other purposes such as housing
repairs, education, medical and other emergencies. However aggregate amount of loans given for
income generation should constitute at least 50 per cent of the total loans of the NBFC-MFI.

An NBFC which does not qualify as an NBFC-MFI shall not extend loans to micro finance sector,
which in aggregate exceed 10% of its total assets.

Interest rate structure of NBFCs

There are certain restrictions on the interest rate that can be charged by the NBFC MFIs. Interest
rates charged by an NBFC-MFI from its borrowers will be the lower of the following:
1. Cost of funds, plus margin: Cost of funds means interest cost given for funds obtained by the
NBFC. Margin means a markup or profit of a maximum of 10 per cent for large NBFCs-MFI and
12 per cent for others. Large NBFCs-MFI are those with asset sizes above Rs 100 crore
2. The average base rate of the five largest commercial banks by assets multiplied by 2.75. (Suppose
that the average base rate is 10%, the lending rate for MBFI-MFs can be 27.5%). The average of the
base rates of the five largest commercial banks shall be advised by the Reserve Bank. The Bank will
announce the applicable average base rate on March 31, 2014 and every quarter end thereafter.
The interest rate guideline shows that MFIs can charge interest rate on individual loans slightly
above 26%, depending upon the cost (base rate of banks) at which they get funds from commercial
banks. the maximum variance permitted for individual loans between the minimum and maximum
interest rate cannot exceed 4 per cent.

Processing charges by NBFC-MFIs shall not be more than 1 % of gross loan amount. Processing
charges need not be included in the margin cap. Further, NBFC-MFIs shall recover only the actual
cost of insurance for group, or livestock, life, health for borrower and spouse.

NBFC-MFI can charge a differential rate of interest to its customers but the variance for individual
loans between the minimum and maximum interest rate cannot exceed 4 per cent.

Altogether there are only three components for interest cost for individuals taking loans from an
NBFC MFI. They are – the interest charge, the processing charge and the insurance premium
(which includes the administrative charges in respect thereof). An NBFC-MFI cannot levy any more
charges apart from the three mentioned above. The NBFC-MFI does not levy penalty on delayed
payment.

Membership in SHG/JLG by borrowers

A borrower can be a member of only one SHG/JLG or borrow as an individual. He can borrow from
NBFC-MFIs as a member of a SHG or a member of a JLG or borrow in his individual capacity.
Further, a SHG or JLG or individual cannot borrow from more than 2 MFIs.

Credit Information by NBFC- MFIs

 Every NBFC-MFI has to be a member of at least one Credit Information Company (CIC)
established under the CIC Regulation Act 2005, provide timely and accurate data to the CICs and
use the data available with them to ensure compliance with the conditions regarding membership of
SHG / JLG, level of indebtedness and sources of borrowing.

Recovery procedures

Taking into consideration, the alleged coercive methods of recovery adopted by MFIs, RBI has
mandated that NBFC-MFIs shall ensure that a Code of Conduct and systems are in place for
recruitment, training and supervision of field staff, incorporating the Guidelines on Fair Practices
Code issued for NBFCs vide circular CC No.266 dated March 26, 2012 as amended from time to
time. Also, Recovery should normally be made only at a central designated place. Field staff shall
be allowed to make recovery at the place of residence or work of the borrower only if borrower fails
to appear at central designated place on 2 or more successive occasions.

Capital adequacy ratios for NBFC – MFIs

All NBFC-MFIs shall maintain a capital adequacy ratio consisting of Tier I and Tier II Capital
which shall not be less than 15 percent of its aggregate risk weighted assets. The total of Tier II
Capital at any point of time shall not exceed 100 percent of Tier I Capital.

Infrastructure Debt Funds NBFCs

Snapshot

 IDF-NBFC is set up by NBFCs as a company to give funds to the infrastructure sector.

 The IDF-NBFC is a cousin of IDF-MF (Mutual Funds) which are created as trusts.
IDFs are investment vehicles for channelizing investment into the infrastructure sector.
Infrastructure Debt Funds are investment vehicles created to channelize debt funds into the
infrastructure sector. As per regulations, IDF can be in two forms- as a trust or as a company. If the
IDF is created as a company it should register as an IDF-NBFC and will be regulated by RBI.

The IDF-NBFCs can be sponsored by banks and Infrastructure Finance companies and are
registered as trusts.

IDF-NBFCs would take over loans extended to infrastructure projects which are created through the
Public Private Partnership (PPP) route and have successfully completed one year of commercial
production. Such take-over of loans from banks would be covered by a Tripartite Agreement
between the IDF, Concessionaire and the Project Authority for ensuring a compulsory buyout with
termination payment in the event of default in repayment by the Concessionaire.

Eligibility conditions for IDFC-NBFCs

 The NBFC should have a minimum Net Owned Funds (NOF) of Rs.300 crore;

 Capital to Risk Weighted Assets (CRAR) of 15%;

 Net NPAs should be less than 3% of net advances;

 Should have been in existence for at least 5 years;

 it should be earning profits for the last three years;

 its performance should be satisfactory and free from supervisory concerns;

 It shall have at the minimum, a credit rating grade of ‘A’ of CRISIL or equivalent rating agencies.

Residuary NBFCs
Residuary Non-Banking Company is a class of NBFCs whose ‘principal business’ is to receive
deposits, under any scheme or arrangement or in any other manner. Functioning of these companies
is different from that of NBFCs in terms of method of mobilization of deposits and requirement of
deployment of depositors’ funds. These companies, however, have now been directed by the
Reserve Bank not to accept any deposits and to wind up their businesses as RNBCs.

NBFC Account Aggregator

The NBFC Account Aggregators is a financial entity that function as an account aggregator (for
NBFC customers), who will provide information on various accounts held by a customer in a
consolidated, organised and retrievable manner.

What is the significance of NBFC -AA

 Usually, people may have different financial products from the financial institutions – savings bank
deposits, fixed deposits, pension, insurance policies, Mutual Funds et. Customers may have only
vague idea about their holdings of these products and services.

Here, the purpose of the NBFC – AA is to provide information to the customer about the various
products he has in a common format. It will provide information on various accounts held by a
customer in a consolidated, organised and retrievable manner.

Services of the AA should be backed by appropriate agreements/authorisations between the

aggregator, customer and financial service provider. The AA has to follow the terms and conditions
of the licence (such as customer protection, grievance redressal, data security, audit control,
corporate governance and risk management framework).

The idea of NBFC originated from the Financial Stability and Development Council (FSDC).

What is Peer to Peer Lending NBFC

The RBI has come out with a well-designed regulatory regime of Peer to Peer lending operators.
These entities will be now treated as a Non-Banking Finance Company. Detailed regulations
including registration procedures, fund requirements etc. were brought out by the RBI.

What is Peer to Peer Lending?

 According to the RBI guidelines, ‘Peer to Peer Lending Platform means an intermediary providing
the services of loan facilitation via online medium or otherwise, to the participants.’ Participants are
persons who has entered into an arrangement with an NBFCP2P to lend on it or to avail of loan
facilitation services provided by it.

What is NBFC-P2P?

Non-banking financial company – Peer to Peer Lending Platform (NBFC-P2P) means a non-
banking institution which carries on the business of a Peer to Peer Lending Platform.

Eligibility and Registration for P2P

 Only entities registered as a company can get P2P registration from the RBI.

 Every NBFC-P2P shall obtain a certificate of registration to start P2P lending activities before
starting operations.

 Every company seeking registration with the RBI as an NBFC-P2P shall have a net owned fund of
not less than rupees twenty million (Rs 2 crores) or such higher amount as the RBI may specify.
After receiving applications, RBI may check and grant NBFC status for providing P2P lending.

Activities of P2P

The RBI has defined P2P as an online platform that matches lenders with borrowers in order to
provide unsecured loans. The P2P:

 should act as an intermediary providing an online marketplace or platform to the participants

involved in Peer to Peer lending;

 should not mobilise deposits or give loan on its own.

 should not provide or arrange any credit enhancement or credit guarantee;

 should not facilitate or permit any secured lending linked to its platform; i.e. only clean loans will
be permitted;

 should not hold, on its own balance sheet, funds received from lenders for lending, or funds
received from borrowers for servicing loans and the specified funds.

 Should not permit international flow of funds;

 Should store and process all data relating to its activities and participants on hardware located
within India.
Prudential norms for P2P

 NBFC-P2P shall maintain a Leverage Ratio not exceeding 2.

 Lending limit: The aggregate exposure of a lender to all borrowers at any point of time, across all
P2Ps, shall be subject to a cap of Rs 10,00,000/-.
 Borrowing limit: The aggregate loans taken by a borrower at any point of time, across all P2Ps,
shall be subject to a cap of Rs 10,00,000/.

 The exposure of a single lender to the same borrower, across all P2Ps, shall not exceed Rs 50,000/-.

 The maturity of the loans shall not exceed 36 months.

The loan recovery practices of other NBFCs will be applicable to P2Ps. There should be proper
redressal mechanisms for complaints. Fund should be transferred directly from the lender’s bank
account to that of the borrower. This is needed to check money laundering.

Regulation of NBFI Sector

During the 1990s, the NBFIs witnessed proliferation in terms of their number. This expansion has at
the same time necessitated regulation from the RBI. In 1997, the government has amended the RBI
Act to allow it to regulate the NBFI sector.  Since then, the RBI is introducing various regulatory
measures in accordance with the needs of the circumstances.

RBI has been given the powers under the RBI Act 1934 to register, lay down policy, issue
directions, inspect, regulate, supervise and exercise surveillance over NBFCs. The Reserve Bank
can penalize NBFCs for violating the provisions of the RBI Act or the directions or orders issued by
RBI under RBI Act.

There are some NBFCs who are not registered with the RBI or are not regulated with the RBI.

For example, the Housing Finance Companies are regulated by the National Housing Bank,
Insurance Companies by IRDA, Stock broking, Merchant Banking Companies, Venture Capital
Companies and companies that run Collective Investment Schemes and Mutual Funds are regulated
by SEBI, Nidhi Companies are regulated by the Ministry of Corporate Affairs and Chit Fund
Companies are under the regulatory ambit of the respective State Governments.

As financial institutions, the NBFCs are exposed to different types of risks.  Here, regulation of the
sector has become very important to preserve the sector healthy.

           The control of the sector was more relevant in the wake of rapid product development and
diversification, sweeping changes in technology along with trends indicating consolidation in the
financial sector.

Amendment of the RBI Act in 1997

           RBI started regulating the NBFCs since 1997, with the amendment of the RBI Act 1934. The
Amendment Act was comprehensive as it extensively controlled the NBFI sector. These Regulatory
and Supervisory Framework provides includes compulsory registration of NBFCs, prudential
regulation of various categories of NBFCs, issue of directions on acceptance of deposits by NBFCs
and surveillance of the sector through off-site and on-site supervision. Net owned fund
requirements, liquidity and CRAR requirements, supervision framework, disclosure standards etc.,
have made the sector at par with banking sector in terms of regulation.
           Prudential regulations are applicable to NBFCs. Regulatory norms on income recognition,
asset classification and provisioning requirements applicable to NBFCs, exposure norms,
constitution of audit committee, disclosures in the balance sheet, requirement of capital adequacy,
restrictions on investments in land and building and unquoted shares, loan to value (LTV) ratio for
NBFCs predominantly engaged in business of lending against gold jewellery, besides others are
extensive for NBFCs. Deposit accepting NBFCs have also to comply with the statutory liquidity
requirements.

           Later, the RBI has differentiated deposit accepting NBFCs from the non-deposit accepting
NBFCs and put strong regulation on the former group to protect the interest of the depositors.
Another classification in terms of business size is systemically important NBFCs. This is a group
with higher business with over Rs 500 crores assets. For these systemically important NBFCs, the
regulatory requirements are higher.

The Dangers and the Regulatory Challenges

Growing size and interconnectedness of the NBFCs in India also raise concerns on financial
stability. Reserve Bank’s made valuable efforts to fined tune regulation of the sector.  Minimizing
the risk thirst of NBFCs, ensuring depositor’s interest, address regulatory arbitrage and help the
sector grow in a healthy and efficient manner were the main objectives of regulation. The RBI
identified systemically important non-deposit taking NBFCs as those with asset size of Rs 500 crore
and above and bringing them under stricter prudential norms (CRAR and exposure norms).

           Another notable feature of the RBI’s regulation is that it has come out with detailed
classification of institutions like NBFC-MFIs, Core Investment Companies, Infrastructure Debt
Funds etc. For each category, minute regulatory specifications are made for overall development of
the institutions.

           The focus of regulatory measures with respect of NBFCs was on expanding the coverage of
the reporting arrangements, fair practice codes for credit card operations, merger/ amalgamation of
NBFCs with banks, securitisation of standard assets, increase in the directed investments by RNBCs
and prior public notice about change in control management. Accordingly, entry level norms for and
existing NBFCs have been laid down.

While extending regulation, the RBI is vigilant not to curtail the all-important positives of NBFCs.
The risks are to be addressed to keep the financial innovation capability of the sector. Their ability
to provided financial products to the unbanked areas and downtrodden people is to be kept alive.
Similarly, their dynamism in business is also to be preserved.

The principles of regulation are broadly aimed at (i) protection of interests of depositors, (ii)
mitigating the systemic risks emanating from inter-connectedness with the rest of the financial
system, and (iii) Consumer Protection.

The amended RBI Act also empowers it to take punitive action against the erring institutions. These
includes cancellation of Certificate of Registration, issue of prohibitory orders from accepting
 deposits, filing criminal cases or winding up petitions under provisions of Companies Act in
extreme cases.

Regulatory measures

 Compulsory registration of NBFCs engaged in financial intermediation

 Prescription of a minimum Net Owned Fund

 Maintenance of certain percentage of liquid assets

 Creation of reserve fund and transfer thereto every year a certain percentage of profits to the reserve
fund

 Mandatory credit rating for deposits, capital adequacy, income recognition, asset classification etc.

 Compulsory credit rating for bad and doubtful assets

 Exposure norms and other measures to keep a check on their financial solvency and financial
reporting

 Strict regulation for deposit seeking NBFCs

 The RBI also has supervisory mechanism for NBFCs based on three criteria: viz., (a) the
acceptance or otherwise of public deposits; (b) the size of NBFCs, and (c) the type of activity
performed.
           Regarding prudential regulations, all NBFCs-ND with assets of Rs. 500 crore and above,
irrespective of whether they have accessed public funds or not, shall comply with prudential
regulations as applicable to NBFCs-ND-SI.

Convergence of regulatory standards between NBFCs and banks

           In the initial period, regulatory norms were lighter compared to banks. But over the last one
decade, most of the prudential regulatory measures were applied to NBFCs also. Important type of
NBFCs like Deposit taking NBFCs, Systemically Important NBFCs, Systemically Important Core
Investment Companies, Microfinance NBFCs etc are strictly regulated by the RBI. Direction of
regulation is that there is convergence in regulatory standards between banks and NBFCs now.

           Regulatory convergence implies that some of the regulatory measures are common for banks
and NBFCs. Like commercial banks NBFCs have to meet capital adequacy requirements
(CAR/CRAR). The NBFCs are mandated to maintain 15 per cent of their public deposit liabilities in
Government and other approved securities as Statutory Liquidity Ratio (SLR). NBFCs, like banks
have a minimum net owned fund requirement. As per 2015 budget, the government has extended
SARFAESI coverage to the NBFC sector. Many of the prudential regulatory standards like NPA
norms, asset qualification norms are applicable to NBFCs as well. Regarding these prudential
regulation measures, the NBFCs have lighter norms compared to banks. But the Mor Committee
has suggested applying the degree of regulatory measures on the NBFC sector.

           The NBFCs are not subject to certain regulatory prescriptions applicable to banks. They need
not make CRR with the RBI; they don’t have priority sector lending as well.
            The NBFCs do not have deposit insurance coverage and refinance facilities from the Reserve
Bank. NBFCs do not have cheque issuing facilities and are not part of the payment and settlement
system.

Nachiket Mor Committee on NBFCs

Snapshot

 The Mor Committee argued for convergence of regulatory norms for banks and NBFCs in general.
The ‘Committee on Comprehensive Financial Services for Small Businesses and Low-Income
Households’, was appointed by the RBI in September 2013. Main objective of the Committee was
to prepare a detailed report on India’s vision for financial inclusion and financial deepening and to
review existing strategies and develop new ones to achieve the objective of financial inclusion and
financial deepening.

The NBFC sector is doing a commendable job on the financial inclusion front. On NBFCs, the
Committee advocated convergence of certain regulatory aspects between banks and non-banking
financial companies (NBFCs). Many of the recommendations of the More Committee are in line
with that of the Usha Thorat committee (Working Group on Issues and Concerns in the NBFC
Sector – Corporate Governance and Disclosures for NBFCs).

Convergence Recommendations of the Committee

The Mor Committee pictured a scenario where NBFCs operate not merely as ‘shadow banks’ but as
an integral part of the large banking system. It gave example of the French banking legislation
where irrespective of how credit institutions fund themselves, they are considered banks, and, as
such, subject to all banking regulation. The Committee stressed rationale for the convergence
regulatory norms in terms of capital adequacy, rules on credit risks, risk-weighting of assets,
provisioning, non-performing asset (NPA) norms and the applicability of fair practices code.

The Committee suggested convergence of the regulatory norms with regard to classification of non-
performing assets and the eligibility under SARFAESI Act, 2002. Later the government has made
the SARFAESI Act applicable to NBFIs also. Similarly, priority sector lending norms and the lender
of last resort facility should not be made applicable to NBFCs.

In view of the parity between banks and NBFCs, the Committee suggested that NBFCs be notified
as ‘secured creditors’ under the SARFAESI Act as to allow them access to the DRT Forum for
recovery of their debts.

Ponzi Schemes, illegal fund mobilisations- counter measures in India

Measures to protect the interest of the public against illegal financial activities

 Illicit money activities are several- money laundering, Ponzi schemes and illegal deposit
mobilization are the major ones.
 Several legal, administrative and information steps are taken by the regulators and governments to
curb illegal money activities.

 The RBI awareness initiatives are major efforts that works through the public domain.

 State Level Coordination Committee Meetings (SLCCM) and FSDC (Financial Stability and
Development Council) are bodies that frame rules to counter illicit deposit mobilization etc.

 Protection of Interest of Depositors in Financial Establishments Act by state governments is a major

weapon.

 Prize Chit and Money Circulation (Banning) Act 1978.

 Financial Intelligence Unit and Economic Offence Wing are dedicated mechanism that counter
illicit money.

 The Prevention of Money Laundering Act is the chief instrument to fight money laundering.

 SEBI’s monitoring of Collective Investment Schemes is a countercheck in the capital market.

Illegal financial transactions create many social and economic evil in the society. To eradicate such
financial evils, regulators including RBI, SEBI and governments -both Central and States have
made several arrangements.

RBI measures against illegal deposit mobilization

The RBI is making efforts on different fronts including information and warning to the public,
mandating registration of all types of institutions that engage in monetary transactions and monitors
the activities of suspected entities. It gives information to the state governments regarding illegal
financial activities and deposit mobilization. Similarly, the central bank is strongly regulating and
supervising the NBFC sector to safeguard the interest of the public.

RBI initiates prompt action, including imposing penalties and taking legal action against companies
which are found to be violating RBI’s instructions/norms on basis of Market Intelligence reports,
complaints, exception reports from statutory auditors of the companies, information received
through State Level Coordination Committee Meetings (SLCCM) meetings etc. The Reserve Bank
immediately shares such information with all the financial sector regulators and enforcement
agencies in the SLCCMs.

The RBI issue of cautionary notices in print media and distribution of informative and educative
brochures/pamphlets and close interaction with the public during awareness/outreach programs.
Townhall events, participation in State Government sponsored trade fairs and exhibitions. At times,
it even requests newspapers with large circulation (English and vernacular) to avoid accepting
advertisements from unincorporated entities seeking deposits.

Protection of Interest of Depositors in Financial Establishments

State governments have enacted Protection of Interest of Depositors in Financial Establishments Act
to help in nailing unincorporated entities and companies from illegally accepting deposits. The state
governments and their machineries have specific provisions for the recovery by attachment and sale
of assets of the defaulting companies, entities or their officials in case of customer cheating by
using the provisions of the Act.

The Act makes offences, such as, unauthorized acceptance of deposits by any entity, firm or
company a cognizable offence, that is entities that are indulging in unauthorized deposit acceptance
or unlawful financial activities can be immediately imprisoned and prosecuted.

Sixteen States and 1 Union Territory have this legislation in place as on date. These States are
Andhra Pradesh, Assam, Bihar, Goa, Gujarat, Himachal Pradesh, Karnataka, Madhya Pradesh,
Maharashtra, Mizoram, New Delhi, Tamil Nadu, Tripura, Uttaranchal, Sikkim, Meghalaya, J&K
and Chandigarh Administration.

What are money circulation/Ponzi/multi-level marketing schemes?

Money circulation, multi-level marketing/Chain Marketing or Ponzi schemes are schemes

promising easy or quick money upon enrollment of members. Income under Multi-level marketing
or pyramid structured schemes do not come from the sale of products they offer as much as from
enrolling more and more members from whom hefty subscription fees are taken. It compels
members to enroll more members, as a portion of the subscription amounts so collected are
distributed among the members at the top of the pyramid. Any break in the chain leads to the
collapse of the pyramid, and the members lower in the pyramid are the ones that are affected the
most.

Ponzi schemes are those schemes that collect money from the public on promises of high returns.
As there is no asset creation, money collected from one depositor is paid as returns to the other.
Since there is no other activity generating returns, the scheme becomes unviable and impossible for
the people running the scheme to meet the promised return or even return the principal amounts
collected. The scheme inevitably fails and the perpetrators disappear with the money.

Indulging in all these schemes is a cognizable offence under the Prize Chit and Money Circulation
(Banning) Act 1978.

The Act prohibits any person or individual to promote or conduct any prize chit or money
circulation scheme or enrol as member to its schemes or anyone to participate in it by either
receiving or remitting any money in pursuance of such chit or scheme. Contravention of the
provisions of this Act, is monitored and dealt with by the State Governments.

Any information/grievance relating to such schemes should be given to the police / Economic
Offence Wing (EOW) of the concerned State Government or the Ministry of Corporate Affairs.

The RBI Act 1934 specifically prohibits unincorporated bodies like individuals, firms and
unincorporated association of individuals from accepting deposits from the public if they are
carrying on financial activity or are accepting deposits as their principal business.

The Act gives powers to the Reserve Bank and the State Government to obtain a search warrant
from the Court to investigate the acceptance of deposits by such UIBs.
To deal with issues relating to unauthorised deposit acceptance and financial frauds, the State Level
Coordination Committee (SLCC) mechanism has been strengthened under the initiative of the
Financial Stability and Development Council (FSDC).

Financial Intelligence Unit

Financial Intelligence Unit – India (FIU-IND) was set by the Government of India in 2004 as the
central national agency responsible for receiving, processing, analyzing and disseminating
information relating to suspect financial transactions. FIU-IND is also responsible for coordinating
and strengthening efforts of national and international intelligence, investigation and enforcement
agencies in pursuing the global efforts against money laundering and related crimes. FIU-IND is an
independent body reporting directly to the Economic Intelligence Council (EIC) headed by the
Finance Minister.

What are Collective Investment Schemes?

Another area where the regulators are working to protect the interest of depositors are Collective
Investment Schemes (CIS). They are schemes where money is exchanged for units, be it time share
in resorts, profit from sale of wood or profits from the developed commercial plots and buildings
and so on.

SEBI is the regulator of CIS. Information on such schemes and grievances against the promoters
may be immediately forwarded to SEBI as well as to the EOW/Police Department of the State
Government.

 IL&FS problem explained

The crisis at IL&FS explained

The problems of the infrastructure sector have not just created banking sector NPAs; but also
spreading into the NBFC sector. This is what one can observe from the recent default made by
NBFC biggie – theInfrastructure Leasing & Finance Services (IL&FS).

What is IL&FS? 

IL&FS was founded in 1987 with equity from Central Bank of India, Unit Trust of India etc. to fund
infrastructure projects.

It was registered as a NBFC in the format of a core investment company with the RBI. There are 51
core investment companies in India as on September 12, 2018. A Core Investment Company is
registered as NBFC with the principal business of acquisition and carrying of shares and other
securities of companies. This means that a core investment company acts like a conglomerate or
association of several other firms.

As a core investment company, the IL&FS Ltd, serves as the holding company of the IL&FS
Group, with most business operations conducted through subsidiaries, indirect subsidiaries,
associated companies and joint ventures. The IL&FS entities are doing their business in
infrastructure, technology, finance and social and environmental services.As per the balance sheet
of IL&FS is a conglomerate of 169 entities including 24 direct subsidiaries, 135 indirect
subsidiaries, six joint ventures and four associated companies.

Who owns IL&FS?

The ownership of IL&FS is shared by institutional investors– LIC, SBI, foreign institutional
investors including ORIX Corporation of Japan and Abu Dhabi Investment Authority (ADIA). As
on March 31, 2018, LIC and ORIX Corporation are the largest shareholders in IL&FS with their
stake-holding at 25.34 per cent and 23.54 per cent, respectively. Other significant shareholders are:
Abu Dhabi Investment Authority (ADIA) (12.56 per cent), HDFC (9.02 per cent), CBI (7.67 per
cent) and SBI (6.42 per cent).

Among these, the government owned intuitional investors – LIC and SBI have a significant holding
both (together they have 32% shareholding). Both the LIC and SBI are under the control of the
Department of Financial Services (DFS). Several IL$FS entities have IAS officers – serving and or
retired as board members. Hence, any initiative to bring back IL$FS has to get the indirect
ratification of the government.

Five of the seven new board members appointed by the government after its takeover of the IL&FS,
are also Civil Servants (IAS and IAAS).

What is the problem with IL&FS?

The problem of the company started when the IL&FS Financial Services- a group company,
defaulted on its payment obligations of bank loans, term and short-term deposits besides failing to
meet the commercial paper redemption obligations in September 2018. After the default, the rating
agency ICRA downgraded the ratings of short-term and long-term borrowing programmes of
IL&FS. The defaults also shocked hundreds of investors, banks and mutual funds who provided
funds to IL&FS. Failure of the company to pay back its obligations also spread panic among
investors who provided finances to other non-banking financial companies. Being one of the biggest
NBFC, the IL&FS default raised doubts of the liquidity and financial conditions of the entire NBFC
sector.

What is the root cause of the problem?

The main issue with IL&FS was its way of funding projects and getting its own fund. As an NBFC,
it mobilises funds from other institutions and investors through different routes.

Here, the company has a short term borrowing of around Rs 25000 crore out of the total borrowing
of Rs 91000 crore. This short-term borrowing is used to finance long term infrastructure projects
where money is invested for a long term. Almost 80% of the company’s assets are long dated in the
form of infrastructure assets and receivable claims etc. What has happened to the company is that
there is a ‘pyramiding of debt’.
On the other hand, the company has to renew its short-term borrowings frequently. For example, the
Commercial Paper (CP) which is a popular mode of getting money from the market, has a
maximum maturity period of 365-days whereas the minimum period is seven days. Relying on such
short-term fund to roll over infrastructure financing is a risky business. One of the first default of
IL&FS happened in the case of CPs.

This type of the financial situation can be manageable for the company if it can continuously
refinance its debts; in one way or the other. But IL&FS was not able to do so.

A large number of its projects are stuck on various stages of completion. Some others are in
litigation. Even some projects are government related and are in trouble.

When needed to pay back its short-term debts, the company is not able to liquidate its assets quickly
as they are in infrastructure sector.

Basically, the IL&FS problem was a liquidity problem typical to any financial institution engaged in
financing of long-term projects using short-term funds.

The stalled projects and failed projects were leaving a negative effect on the finances of IL&FS. If
such problems in the infrastructure sector has left big NPAs in the banking sector, it has pulled the
NBFC to a default.

IL&FS default and its impact on the NBFC sector

Significance of the IL&FS issue is that for the first time a major NBFC is affected by the ongoing
financial sector problem that so far touched only the banking sector. The twin balance sheet
problem that is rooted in the corporate failure and caught the banks is spreading into the NBFC
sector. Given the regulation and type of financing, the NBFC sector is quite vulnerable. They are
nick-named as shadow banks because of lower level of regulations on them. But in India, the NBFC
sector is quite well and harshly regulated. Actually, there is convergence of regulation between the
two after the recommendations of More Committee.

What is the message of the IL&FS issue to the government and the RBI?

Given the large number of positives of the NBFCs – they are adaptable, accessible for industry,
provides valuable and quick credit to the needy, delivers diverse products, leaders of financial
innovations etc. if the sector is affected badly, the economy may be affected worse. Hence, the
government and the RBI should make sufficient follow-up to by providing timely liquidity and
restoring investor confidence in NBFCs.

Most importantly, one more financial institution became vulnerable and here also, the entity was
more or less controlled by the government, including several board members being IAS officials in
the past. Hence, like in the case of PSBs, some sort of governance problems is there with
government-controlled entities. It should be corrected with right time intervention.

Ways to revive IL&FS

 The IL&FS is not facing an insolvency problem, rather a liquidity problem. Its assets are higher
than its liabilities. Hence, what it need is immediate money plus a revision of its funding strategy by
reducing reliance on short term debt.

The responsibility is now with the major institutional shareholders – LIC, HDFC, Japan’s Orix Corp
and Abu Dhabi Investment Authority. They have to inject money into the entity like participating in
the proposed Rs 4,500-crore rights share sale. At the same time, IL&FS should quicken the sale of
identified 25 projects, mainly in the road and power sectors. The company has already received firm
offers for 14 projects, said people in the know. When the asset sale is carried out, the company can
bring down debt by about Rs 30,000 crore. But the completion may take about 18 months.

Reconstitution of the IL&FS board

The government after the recommendation of the NCLT, reconstituted the IL&FS board with new
six members. New board of director will be led by popular banker Uday Kotak. The NCLT in its
verdict transferred the control of the board to the government appointed board.
RBI, government steps to support the NBFC sector

The NBFC sector has been facing severe liquidity crisis in the context of the problems at IL&FS.
NBFCs are usually depending upon investors and institutions like commercial banks for funds.
Their money is allocated among projects and businesses and the prevailing NPA issues have
affected them as well. Given the NBFCs are providing quick and right time finance to different
sectors of the economy, their financial instability will adversely affect the economy as well. Hence,
the RBI and other institutions reached to provide liquid support to them.
1. RBI conducted Open Market Operations of Rs 36000 crores till end December 2018.
2. SBI decided to double its purchase of securitized loans from NBFCs to Rs 30000 crores.
3. NHB increased refinancing limit to NBFCs from Rs 24000 to Rs 30000 crores.
4. RBI increasessingle borrower exposure limit for NBFCs, which do not finance infrastructure, from
10 per cent to 15 per cent of capital funds, up to December 31, 2018.
5. RBI has liberalized liquidity norms for banks when the banks are giving loans to NBFCs on the
bases of government securities held by the latter. Here, the RBI relaxed conditions for FALLCR
(facility to avail liquidity for liquidity coverage ratio) related to SLR (statutory liquidity ratio)
requirements.